Sell in May, Then Buy Preferreds

Hedge your portfolio with fixed income via preferred stock

   
Sell in May, Then Buy Preferreds

The dreaded aphorism that we should bail on stocks in May and not return until November doesn’t sit well with this long-term diversified portfolio aficionado. Still, there are some folks out there who think it’s a good idea. Or maybe they’re just scared.

And yet, that little voice inside tells them they should have some kind of exposure. After all, perhaps they need some fixed income.

That’s why I think, if you’re going to sell some of your portfolio, redeploy that capital into preferred stocks.

First, let’s review what these securities are all about. Preferred stocks are often referred to as “stock-bond hybrids,” as they share characteristics of both types of vehicles. Let’s use one of my holdings as an example.

Hotel REIT Ashford Hospitality Trust (NYSE:AHT) issued 8 million shares of 8.45% Series D Cumulative Preferred Stock at $25 a share, callable 7/8/2012. (Translated, this means that the company issued 8 million shares at $25, raising $20 million in the process.) It carries the Series D moniker to distinguish it from other issuings.

A look at a couple of important terms in there:

The $25 price is basically the IPO price if it were a straight-up equity, but it’s really closer to the par value of a bond. It’s actually known as the “fixed liquidation value.” So if Ashford were ever to get liquidated, holders of the preferred stock would receive $25 per share. One advantage of preferred stock is that holders sit ahead of common stockholders in a bankruptcy, second only to bondholders.

“Callable 7/8/2012″ means Ashford could, since last year, call back in all the shares of this stock at $25 per share. Obviously, the only reason they would do this is if the stock were trading above $25 and/or Ashford believed they could save themselves more than $20 million in dividend payments going forward. This also will depend on the company’s liquidity position. In the case of Series D, the dividend is 8.45% of $25, or $2.11 a share per year. Since Ashford is paying some $16 million annually in dividends, there might be some merit to the idea that they’ll call these shares in sooner rather than later. However, the Series A has been callable for years and yet remains trading. The theory here is that Ashford might be comfortable paying dividends on this stock beyond even the call date, because they’d have to expend a lump sum to call back the stock. Instead, since it’s like paying high-yield debt on the money, they might instead elect to continue doing this so they don’t have to go to the debt or equity markets to raise more funds if need be.

“Cumulative” means that if Ashford misses a dividend payment, it still is on the hook for it and all other missed payments if the dividend is ever reinstated. Interestingly, many hotel stocks suspended their preferred dividends during the financial crisis, but Ashford did not.

Preferred stocks trade more like bonds, however. They don’t move very much in price. The trading range will depend on two things: the company’s financial stability, and competition from other fixed-income investments. With bonds yielding next to nothing, preferreds should be the way to go for some time to come.

Here are some of the preferreds worth looking at. (Note: Different brokers assign different symbols for preferreds.)

  • Ashford 9% Series E
  • HSBC 6.36% Series B
  • Public Storage 6.875% Series O
  • JPMorgan Chase 7% Series J
  • Duke Energy 6.4% Series K

Lawrence Meyers owns shares of AHT Pref. D.


Article printed from InvestorPlace Media, http://investorplace.com/2013/05/sell-in-may-then-buy-preferreds/.

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