Capital gains and generous dividends are available in these preferred stocks.
I’m more of a value investor than a growth investor. Value investors seek out stocks that are trading at a price that is not reflective of the stock’s future potential. This same value strategy can apply to other securities as well.
One such area is preferred stocks.
To review: A stock gives an investor ownership in a company. A bond is a loan in which the investor gets an interest payment in exchange for the loan. Debt always has the highest position if the company files for bankruptcy.
Preferred stocks allow a company to raise money without diluting the ownership of other shareholders, while also allowing current bondholders to maintain their position in the capital stock. Preferred shareholders edge out common stockholders in a bankruptcy.
With bonds, if a company misses an interest payment, bondholders can seize the company. Preferred stockholders have no such power but they have an advantage over the common shareholders in that the common stock dividend must be suspended first before the preferred stock dividend gets altered.
Because preferred stocks trade more like bonds, if they are trading below par value, that means they are trading below the price at which the company can liquidate the issue by redeeming all the shares, usually at $25.
Why might a comparatively safer investment be trading at a discount? For value investors, it is likely due to some market inefficiency. There’s something that has spooked investors about the issue that may not be true. In other cases, it may be for a very good reason, so you have to evaluate the situation on case-by-case basis.
With that in mind, here are two preferred stocks that seem to be trading well below their redemption value and worth buying.
The first is Bank of America Preferred H (NYSE: BML.PRH). This issuance has a current annualized yield of 4.2% yet trades at a 26.2% discount to par (around $18.69). Why is it trading at such a discount? There are several reasons.
First, the yield on this issue is not quite as high as others of its ilk. It pays less than 2%, whereas most preferred stock will yield around 6%. There’s also been some unwarranted negative sentiment towards B of A having to do with the bank’s structural integrity. I think that’s nonsense. I say take the 4.2% yield and the chance at a 30%+ capital gain.
There’s an interesting play in the biotech realm with Cyclacel Pharmaceuticals 6% Convertible Exchangeable Preferred Stock (NASDAQ: CYCCP). Cyclacel is a biopharmaceutical company developing oral therapies that target the various phases of cell cycle control for the treatment of cancer and other serious diseases. Its most advanced drug is in Phase 3 trials.
The deal here is that the company has $26 million in cash and no debt. The preferred stock pays 9.3% and trades at a huge 35% discount to par. This expresses pessimism that the company will develop products that actually generate revenue. In this case, you are basically buying the preferred to enjoy the dividend, and assume it gets paid unless the company runs out of money.
CYCCP is more of a gamble, but if it pays off, you are buying at $6.47 on par value of $10.
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