For my preferred shares, I like them to be “Cumulative Redeemable Perpetual and Fixed.” If you don’t know what this means, don’t worry. I did not either until I read the book “The Billionaires Secret.” In Preferred Shares 101, we talked about the benefits of investing in preferreds- now, it is time to get into the basics.
The most critical part of investing in preferred is understanding the terminology. Once you understand the terms, you can go on the hunt to find the best preferred. So let’s dig into the terms and start on our journey.
Cumulative. Cumulative shares are shares that pay all dividends, even if the business skips payments earlier. If a company falls on hard times and has to cut the dividend, it delivers all missed payments when it re-instates the dividend. Buying only cumulative shares is a great way to mitigate risks.
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Non-Cumulative. Non-cumulative shares do not pay missed dividends. For example, if a company cut the dividend in 2020, it would not have to pay back the missed distributions upon dividend reinstatement.
Call Date. The call date is the earliest that a company can call (or buy back) the shares. I like to buy shares that have not passed their call date. You must understand this part; the shares will still exist past their call date if they are perpetual. Some preferred shares have been around for over 100 years. If shares are past their call date, the company could call them at any moment.
Perpetual. Perpetual shares exist forever or until the company calls the shares. Perpetual shares will continue to trade once their call date expires.
Nonperpetual. Nonperpetual shares will retire themselves at a specific date. It can be past the call date, but there is a date. For instance, nonperpetual shares could retire three years after their call date. At which point, you will receive the face-value of the shares, usually $25.
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Redeemable. Redeemable preferreds can be “called” by the company- this means that the company can buy back the shares after the call date. Being redeemable keeps the shares around the issue price because investors will lose money if they pay too much over the redemption price. For example, if the redemption price is $25, would you spend $27 for the shares?
Fixed Dividend payment. I invest in only fixed dividend payments. Companies set fixed payments from the preferred shares’ origination. For instance, a $25 preferred pays $2 annually or 8%. No matter how much you paid for the shares, you would still get $0.50 paid every quarter.
Knowing this math allows you to increase your yield by purchasing the stocks at a discount. For example, buying the same shares for $18 would give you a yield of 11% ($2/$18).
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Floating Rate. Floating rate preferred shares start as fixed. Their payout becomes locked to LIBOR (London Interbank Transfer Rate) or current interest rates on a specific date. There is probably a way to exploit these to your benefit, but I do not buy these. I like to keep things super simple. Banking institutions love to issue preferred with floating rates.
Let’s review how we started this article. I said I wanted my preferred shares to be “Cumulative Redeemable Perpetual and Fixed.” Does the above picture depict shares that meet my criteria? If you said yes, then we would be correct. The actual stock here is not quality; however, the basics fit my investing technique.
I hope I kept this simple enough. I never get more complex than this. I like to keep it simple. Preferred are not expensive, so getting started is fun and accessible. In Preferred Shares 103, we will begin the hunt for our preferred shares.
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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