Is Cabot Dividend Investor Right for You?
How to Secure a Safe Retirement Income Stream
The Basics of Preferred Stocks
We’re two weeks away from publishing the first issue of my brand-new Cabot advisory, Cabot Dividend Investor, and I’m very excited. In the past few weeks, I’ve heard from a lot of current Cabot subscribers and Cabot Wealth Advisory readers who are also excited, or who are curious about the new service. Some of you have called just to say that you’ve been looking for a retirement-focused advisory, and you’re happy we’re finally offering one. I’ve also gotten lots of questions from readers who aren’t sure if Cabot Dividend Investor is right for them, but think it might be.
Some of you have written to ask if you’ll be able to mesh the advice with the growth investing you’re already doing, by reinvesting the dividends now and then taking the income down the road. The answer is definitely yes. I’ve also heard from several readers who want to know if they’ll be able to follow the Cabot Dividend Investor advice in their IRAs; the answer to that is also yes.
The idea behind the new advisory and IRIS, the stock-picking system that powers it (it stands for Individualized Retirement Income System, click here to learn more about it) is to give a range of income-focused ideas and advice that can benefit investors at all stages of retirement planning. So if you think Cabot Dividend Investor might be for you, it probably is. I’d at least suggest you try it out (and we’re offering a six-month money back guarantee in case you decide you can’t use the advice).
Today, to give you a better feel for the range of investments we consider for the Cabot Dividend Investor portfolio, I’d like to share an excerpt from the Complete Retirement Income Guide that’s part of every subscription. The Guide includes profiles of many different kinds of income investments, from bonds to MLPs (master limited partnerships). One of the investments it covers is preferred stocks, which appeal to investors whose top priorities are current income and capital preservation (or safety).
Preferreds might not be for you right now, but they might become something you’re interested in down the line. They’re a little different from most other investment types though, so you should know what you’re buying before you start looking around. Here’s my quick overview of the basics of preferred stocks:
Preferred stocks are a special class of shares that are traded like stocks but actually represent debt, like a bond or loan. They do not represent or confer ownership, and the distributions rarely go up. So you’d only buy a preferred for steady income, not capital gains.
That said, preferred stock can generate very steady income. The yields are usually between 4% and 8%. And preferred shareholders are usually better protected—both in and out of bankruptcy—than common stock holders.
Preferred stock is usually issued at a par value of $25.00, although shares are sometimes issued for different amounts, including $50 and $100. When the shares are issued, the company announces the shares’ coupon rate and consequent annual dividend (which is the par value times the coupon rate). Although the coupon rate determines the annual dividend at the outset (because preferred shares are debt, prevailing interest rates and credit conditions will determine what rate the company can issue preferreds at) the annual dividend is actually the number that won’t change over time. The “coupon rate” or yield may.
For example, a company that wants to issue preferreds yielding about 8% would declare an annual dividend of $2 (because $2 ÷ $25 = 0.08). Once the preferreds are trading, the annual dividend won’t change, so the yield may vary slightly. Most preferreds issued at $25 will trade in a range between $23 and $27, depending on market conditions and investor sentiment about the company and the preferreds. If the preferreds are trading at $26, then the current yield on the shares will be 7.69% ($2 ÷ $26 = 0.0769).
While preferred stock dividends still have to be “declared” by a company’s board quarter-to-quarter or year-to-year (unlike bond distributions, which are mandated), they usually won’t change. In addition, preferred stock dividends are very safe because they are paid before dividends on the common stock. And preferreds are above the common stock in the capital structure, so in bankruptcy, preferred shareholders’ claims over the company’s assets are superior to ordinary stockholders’ (although in practice, both usually get nothing).
Preferred stock dividends are also usually cumulative, meaning that if the company doesn’t pay some (or all) of its promised distributions, investors will receive them at a later date. The unpaid portion is considered “dividends in arrears” and must be paid before any other dividends. Check to make sure your preferred is “cumulative” to see if it has this feature. If it’s “non-cumulative,” skipped dividends don’t have to be made up.
Most preferreds are also callable. Callable preferreds will have a call price (usually also $25) and a call date. On or after the call date, the company has the right to buy back the preferreds from investors for the call price. The company has no obligation to call its preferreds, and many preferreds are not called for years after their call dates. A company is most likely to call its preferreds if interest rates have dropped and the company can now issue less-expensive debt.
If your preferreds are called, you’ll receive the call price of the shares plus any unpaid dividends. Having your preferred stock called can be a good thing if you bought it below the call price, and a bad thing if you paid too much for it.
If you’re considering buying a preferred above its call value, you should first figure out your potential yield to call. For example, let’s say you’re considering paying $26 per share for a preferred that pays $2 a year in dividends but is callable at $25 in two years. If the preferred is called, you’ll lose $1 per share. But you’ll earn $4 in dividends in the meantime. Thus, your yield to call (average annual return until the call date) would be 5.82%, quite a bit lower than the current yield of 7.69% ($2 ÷ $26 ) but still decent. You can figure out your yield to call using a calculator like the one at www.moneychimp.com/calculator/bond_yield_calculator.htm.
Some preferreds also have maturity dates, which is a date, between 30 and 100 years after the issue date, when the preferreds must be called.
And some preferred stock is convertible, meaning it can be converted into ordinary stock on or after a given date. This option gives preferred stockholders more potential upside.
One downside to preferred stock is that preferred holders usually don’t have voting rights as common stockholders do.
Lastly, while preferred stock is theoretically as easy to buy and sell as common stock, some preferred stocks are very lightly traded and may be difficult to buy or, more importantly, sell, at a desirable price. In general, it’s a good idea to avoid preferred stocks trading less than 4,000 shares daily, on average. In addition, preferred ticker symbols are not standardized—they usually take the form of the issuing company’s stock symbol followed by a letter indicating the preferred series, but some also include dashes, dots or a ‘P’ for preferred—so always double check to make sure you’re buying the specific issue you want.
Quantumonline.com is a good source of information on specific preferred stocks, including their annual dividends, call and maturity dates, whether they’re cumulative or convertible, and whether their dividends qualify for the 15% dividend tax rate.
That’s it for today’s excerpt, but if you’re intrigued, just click here to learn more about the range of income investments we’ll be covering in Cabot Dividend Investor, from preferred stocks to dividend growth stocks to REITs and MLPs. Every subscription to Cabot Dividend Investor comes with a trio of educational reports covering these investment types and more, and detailing how you can combine them to create the perfect portfolio for you retirement, whether it’s in progress or a few years down the road.
Chloe Lutts Jensen
Chief Analyst, Cabot Dividend Investor