Switching preferred shares: Black Diamond runs for the Experienced Investors only
November 26, 2015 by InvestingForMe
So, in keeping with our comparison of investing with skiing and the need to check out the signposts before you leap, this time round we’re going to talk about the Black Diamond runs of selling one deeply discounted/over sold preferred share to buy another.
What does that mean exactly? Well, it means be warned. Investing in deeply discounted preferred shares in the current fluctuating market is not for the beginner. You’re going to be in for a steeper, bumpier ride with maybe a few hidden obstacles along the way. But if you’re an experienced investor and realize the risks involved, and you’re willing to commit to the extra time and effort it takes, you might just make one of the best investing runs of your life.
Making the switch: a 4-step process
A more experienced investor is always on the lookout for a good bargain, right? But before you leap to invest in/ or switch into a deeply discounted rate-reset preferred share, you should follow these 4 simple steps to help you decide if the switch will be worth the risk:
- Analyze your current preferred shares.
- Search for and analyze potential buy candidates.
- Calculate the estimated increase/decrease in income/profit.
- Make the decision.
Example: Let’s say you own 500 Bank of Nova Scotia rate-reset preferred shares
Step 1: Analyze your current shares
In March 2010, when the Bank of Nova Scotia issued a Rate-Reset preferred share (BNS.PR.Y) to investors, you bought 500 shares. The shares were initially sold for $25.00 each and they paid an initial fixed dividend rate of $0.9625 or 3.85%.
In March 2015 the share’s dividend rate was reset to a rate equal to the sum of the Government of Canada 5-year Bond yield (GCAN5YR) plus 1.0%, or $0.455 (1.82%) per share and the share’s market price dropped to $18.95, today.
The result? Over the past 5 years, you would have received a total of $4.8125 in dividends and lost $6.05 per share in market value for an overall, simple, rate of return of -0.1% per year. (Not a great outcome!)
Going forward, what can you expect if you decide to live with your losses, refuse to sell the shares, and hold them until the next dividend rate-reset in 2020? Well, over the next 5 years, all you’re going to earn are the reduced dividend payments, which will total a-not-so-impressive $2.275 per share.
So, you can certainly continue to hold onto the shares and hope interest rates start to rise and that they increase enough to boost the dividend rate in 2020. But that would mean that the 5-year interest rate would need to increase by at least 2.85% (i.e., more than triple from today’s current levels). “It might happen,” as it’s sometimes said, but as we have witnessed from the last 5 years of interest rate forecasts, no one knows where interest rates will be next week, next month, next year, let alone in 5 years’ time.
So, bottom line? You can continue to hold on to those beaten-up rate-reset preferred shares and hope for the best, or maybe it makes more sense to sell your current shares and invest in a preferred share with more attractive dividends.
Step 2 and 3: Search for and calculate Black Diamond switch ideas
Here are a couple of current real possible investment opportunities in the deeply discounted rate-reset preferred share market place:
- Intact Financial Corporation (IFC.PR.A)(Credit Rating=Pfd-2(low)) Stable Trend) Here is a rate-reset share that currently trades at $14.76 and pays $1.05 or 7.11% until its next dividend reset in December 2017. If the Government of Canada 5-year Bond yield is the same as it is today (0.82%), the new dividend rate after 2017 will be $0.635 or 4.30%. If you invested the $9,475.00 in these shares, you’d own approximately 642 shares and you’d receive approximately $2,571.21 in dividends over the next 5 years, which would be double the $1,137.50 you’ll receive if you continue to hold the 500 shares of BNS.PR.Y.
- Enbridge Incorporated (ENB.PR.B) (Credit Rating=Pfd-3(high) Stable Trend) This rate-reset share last traded at $14.50 and will pay $1.00, or 6.90% per share, per year, until June 2017 when the dividend rate will be rest. At that time, if bond interest rates remain at current levels, we can anticipate the dividend rate will be reset at a lower level and pay $0.805, or 3.22%, per share, from June 2017 until June 2022. So, if you used the $9,475.00, you could buy 653 shares of this preferred today, and you’ll receive approximately $2,819.32 in dividends over the next 5 years, which is more than double the $1,137.50 you’ll receive if you continue to hold the 500 shares of BNS.PR.Y.
- Veresen Inc. (VSN.PR.C)(Credit Rating=Pfd-3 Stable Trend) Here is a rate-reset share that currently trades at $17.47 and pays $1.25 or 7.15% until its next dividend reset in March 31, 2019. If the Government of Canada 5-year Bond yield is the same as it is today (0.82%), the new dividend rate after March 2019 will be $0.9575 or 5.48%. If you invested the $9,475.00 in these shares, you could buy 542 shares and you’d receive approximately $3,149.70 in dividends over the next 5 years, which would be almost 3 times the $1,137.50 you’ll receive if you continue to hold the 500 shares of BNS.PR.Y
Step 4: Make the decision
Once you’ve done the math with your options, go ahead and make a decision. But remember, analyzing and switching deeply discounted rate-reset preferred share investments is not for beginners. It takes a higher level of experience and knowledge to do it successfully. But, when done properly, switching into more profitable deeply discounted rate-reset preferred shares can make more dollars and sense! But you have to know the risks and be properly equipped.
Read the 1st article in this series - Wouldn't it be great if investments came with a rating like a ski run?
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