What are some important things to consider when buying and selling preferred shares?
- Record and Ex-dividend Dates. Whether purchasing or selling preferred shares, an investor must be aware of these dates as dividend income is the most important reason for owning preferred shares.
- Preferred share features. In addition to the annual dividend payment and current market price, investors need to know and understand each of the features and how they might influence the share’s future market price and dividend income stream.
- The current market price of the preferred share in relation to the imbedded features and the stated par value. For example, if an investor pays $26.50 for a $25.00 par value preferred share, which pays an annual dividend of $1.50, only to find that the issuing company redeems the shares at $25.00 twelve months after the purchase, this would result in a 0.0% rate of return, before income tax and maybe worse on an after-tax basis. Conversely, buying the same preferred share at $24.00 could result in $1.50 in dividends and $1.00 in capital gains, for a 10.42% annual “cash” return, before income tax.
- The issuer’s credit rating and the current credit rating direction. Is the company’s rating trend negative or positive? Purchasing a preferred share only to have its credit rating decline will hinder the preferred share’s market price and may lead to permanent price impairment.
- A preferred share investor should try to understand the current direction of interest rates. Before purchasing a preferred share, an investor should understand how the share price could be impacted by changing interest rates and attempt to calculate the benefit or negative impact of the preferred features. For example, if interest rates were to rise, then a Floating Rate feature would help to support the share’s market price.
- Liquidity. Some preferred share issues are more easily purchased and sold in the market because there are more buyers and sellers and a larger number of shares issued. For example, if an investor identifies and attempts to purchase 1,000 shares of a preferred that only trades 200 shares per day, the investor will have a difficult time buying the shares and at a consistent price. It may be even more difficult to sell the preferred shares, at a future date, if the shares have no liquidity.