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Preferreds

Utility Preferreds: Safe High Dividends

While most banks are paying less than 1% on CDs, many preferred shares issued by utility companies are paying 5% to 6% dividend yields.

Utilities, banks, insurance companies, real estate investment trusts and others sell preferreds to raise cash. Usually, preferred share prices don’t move much. Most are issued at $25 and prices typically range between $24 and $27. However, when an industry is out of favor, just as happened with banks around the end of last year, preferreds might trade below that range, creating capital appreciation opportunities.

In this column, I’ll focus on finding preferreds issued by utilities paying dividends equating to 6% to 7% yields. I picked utilities because regardless of what happens as a result of politicians driving the economy over the "fiscal cliff," most utilities will chug along and meet their debt obligations.

Here are some things you need to know about preferreds.

About Preferreds
Most preferreds are “callable” meaning that the issuer has the right to call (redeem) them at the “call price,” which is usually the original issue price. The shares can be called at any time after the “call date.” You would enjoy $1 per share capital appreciation if you bought shares at $24 that were called at $25. Conversely, you’d lose $1 per share if you paid $26 for the same shares. Thus, if you pay more than the call price, confirm that call date is far enough into the future that the cumulative dividends that you receive more than make up for the potential capital loss. Your yield is the next 12-month’s dividends divided by the price you pay for the shares. "Yield to call" is the average annual yield if preferreds were called on the call date.

Finding Preferreds
Use Quantum Online (www.quantumonline.com) to find and research preferreds. You can use Quantum’s screener to find candidates. Click Income Tables and then select Income Securities Screening Form to access the screener.

Leave everything that you’re not interested in on the form blank. I selected Utilities for Company Type and “Baa2” for minimum Moody’s Credit Rating. Moody’s rates preferreds using a complicated series of letters and numbers. Fortunately, Quantum lists the possible ratings on its screening form. The Baa2 rating is Moody’s second lowest “investment grade” rating. I also specified "call dates equal to or greater than 9/26/2015" to limit the list to preferreds with call dates at least three year out.

Quantum listed four preferreds meeting those requirements. In addition to Moody’s, the screener also lists the Standard & Poor’s credit ratings which often differ from the Moody's ratings. Avoid preferreds with ratings shown in red (non-investment grade) for either rating agency. Click on the preferred ticker symbols to see Quantum’s description. Click on any term with a link to see Quantum’s definition of that term.

Besides for Quantum’s information, you’ll also need the current trading price, the dividend yield based on the current price, and the average trading volume. You can get them on TDAmeritrade (www.tdameritrade.com). You don’t have to be a TDAmeritrade customer. Simply enter the preferred ticker symbol in the Quotes box. If you're going to buy around 100 shares, rule out preferreds with average daily trading volumes less than 2,000 shares. Require at least 5,000 share average daily trading volume if you're planning on buying 500 or more shares.

Here are the preferreds turned up by the screen along with the yields from TD Ameritrade.

•  Alabama Power 6.45% Series Non-cumulative (ticker ALBMP), current yield 5.7%

•  Alabama Power 6.50% Series Non-cumulative (ALAWP), current yield 5.4%

•  Entergy Arkansas 5.75% Series First Mortgage (EAA), current yield 5.2%

•  Georgia Power 6.50% Series 2007A (GAPWP), current yield 5.7%

When I looked, the Georgia Power preferreds were only trading around 500 shares per day, which it too low.

Unlike common stocks, preferred ticker symbols are not standardized. Your broker may use a different symbol. Use your broker’s symbol lookup function and enter the issuing company name to see a list of all preferreds issued by that company.

Research the issuing company to learn if there are any problems that might cause it to suspend its preferred payouts. The more you know about the issuer’s outlook, the better your results.

published 9/26/12

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