Last week, I noticed something funny about my J.P. Morgan Series J preferred shares in my portfolio. Typically, I usually set up my portfolio on Google Finance and just use that as a quick check during the day to see how the portfolio is doing.
At A Glance:
Symbol: US: JPM-J Price: $25.92 Yield: 6.75%
For a few days, I noticed it was always losing $0.54 (considered semi big movement for a preferred share) but the share price had remained unchanged. Then I found out the news – JP Morgan was going to redeem $4.8B worth of preferred shares, of which included my J-Series.
In my dividend hunting craze, I included investing in preferred shares – a first for me. Preferred shares are traded like shares but act more like bonds. They can be used by corporations as another means of financing – borrowing from investors, and paying interest in the form of quarterly dividends. Unlike common shares, preferred shares have no voting rights; but typically pay a higher dividend and are higher up on the repayment list (but below bond holders) should the company go bankrupt.
My silly mistake? Looking at just the yield of the and NOT taking into account the redemption period.
Preferred shares have different properties tied to them (they can be converted to common shares, redemption periods, etc.). Redemption periods enable the issuer to buy back, or redeem / call, the shares at par value. They would probably do this if a) they had enough capital available and b) they can re-issue out a new set of preferred shares at a lower rate. In a low rate environment (as is now), why would a company want to pay 7% interest when they could re-issue at 5 or 6? Typically, the redemption period is after 5 years from issuing the share.
Anyways, because of this redemption option, I now realize not to get all starry-eyed from the yield. There’s a calculation called yield-to-call which determines what the real annual yield is if the preferred shares were to be redeemed. There’s a great calculator available here with instructions – but at the end of the day, it’s a check to see what yield you will actually get based on the current price of the stock, the dividend it provides, and when a company will redeem the shares and at what value.
It’s easy to get starry-eyed from the yield. For example, Citigroup N-series preferreds pays $0.492188 / quarter and with its current share price at $28.73, that’s a 6.8% yield! With a redemption date of Oct. 30, 2015, that means you’re looking at 10 quarterly dividend payments BUT Citi is likely to call in those shares and give you $25 – so you’re paying $3.73 ($28.73-$25.00) now for $4.92 (.492188*10) worth of dividends. Punch that into the calculator and your yield to call is 1.8% – you’re not losing money, but you’re certainly not really making the 6.8% you thought you’d be making.
Of course, we could be investing in preferred shares of companies that don’t have the capital to re-buy and re-issue, or where the current price is below the par value, but those companies are more at risk at NOT giving us our dividend or our capital back. Those are calculated risks to take – but for my purposes, I really just wanted something secure, stable, and just provided a steady stream of income.
So, lessons learnt:
- Know what you are investing in and any risks/drawbacks associated to it
- A high yield too good to be true usually comes with some caveats – understand them
- Use yield-to-call / yield-to-worst calculations
Let’s not make those silly mistakes again. 😛