Choosing the right fixed rate preferred share for investment

In the article “Choosing the right fixed rate preferred share for investment,” the focus is on Bank of America’s preferred dividends and the impact of the net non-interest expense category on the bank’s Q4 2023 results. Despite the turmoil, Bank of America’s preferred dividends remain well covered. The Series QQ preferred shares are highlighted for their 5.4% dividend yield, but investors are advised to carefully consider other higher-yielding preferred shares before making a decision. The author of the article, who holds a long position in the Series L preferred shares (BAC.PR.L), expresses a bullish outlook on Bank of America’s common shares. With these insights, investors are provided with valuable guidance on choosing the most suitable fixed rate preferred share for their investment.

Factors to Consider

When it comes to investing in preferred shares, there are several important factors that investors should take into consideration. These factors can greatly impact the overall performance and potential returns of preferred shares. In this article, we will explore the key factors to consider when evaluating preferred shares and making informed investment decisions.

Dividend Yield

What is Dividend Yield?

Dividend yield is a crucial factor to consider when evaluating preferred shares. It represents the annual dividend payment as a percentage of the share price. Dividend yield is calculated by dividing the annual dividend payment by the market price of the preferred share.

Importance of Dividend Yield

Dividend yield provides investors with an idea of the income potential of a preferred share investment. A higher dividend yield indicates a higher income return on investment. However, it’s important to note that a high dividend yield may also indicate higher risk or other underlying issues within the company issuing the preferred shares.

Comparing Dividend Yields

Investors should compare the dividend yields of different preferred shares to identify potential investment opportunities. While a higher dividend yield may be more attractive, it’s crucial to consider other factors such as the credit rating of the issuer, the stability of the dividend payments, and the overall financial health of the company.

Credit Rating

Importance of Credit Rating

Credit rating is an essential factor to consider when evaluating preferred shares. It provides investors with an assessment of the issuer’s creditworthiness and the likelihood of defaulting on dividend payments. A higher credit rating indicates a lower risk of default.

Understanding Credit Ratings

Credit ratings are determined by independent credit rating agencies such as Moody’s, Standard & Poor’s, and Fitch Ratings. These agencies evaluate various factors including the financial strength, debt levels, and overall stability of the issuer. Preferred shares with higher credit ratings are generally considered safer investments.

Preferred Share Credit Ratings

Investors should look for preferred shares that have been assigned high credit ratings by reputable credit rating agencies. These preferred shares are more likely to provide stable and consistent dividend payments, making them attractive options for income-focused investors. However, it’s important to note that higher credit ratings often come with lower dividend yields.

Liquidity

What is Liquidity?

Liquidity refers to the ease at which an investor can buy or sell a preferred share without causing a significant change in its market price. Highly liquid preferred shares have a large number of buyers and sellers, allowing investors to enter or exit positions quickly and efficiently.

Importance of Liquidity

Liquidity is an important factor to consider when investing in preferred shares, as it affects an investor’s ability to buy or sell shares at favorable prices. High liquidity provides flexibility and reduces the risk of being unable to sell a position when desired.

Assessing Preferred Share Liquidity

Investors should consider the trading volume and average daily trading value of preferred shares to assess their liquidity. Preferred shares with high trading volumes and substantial daily trading values are generally more liquid and easier to trade. Additionally, preferred shares listed on major stock exchanges tend to be more liquid compared to those traded over-the-counter.

Call Provision

What is a Call Provision?

A call provision is a feature that allows the issuer of preferred shares to redeem them before their maturity date. This gives the issuer the option to buy back the preferred shares at a predetermined price, usually at a premium to the current market price.

Impact on Investor’s Return

The presence of a call provision can impact an investor’s return on preferred shares. If the shares are called, investors may lose the opportunity to continue receiving dividends for the remaining term of the investment. Additionally, if the shares are called when the market price is below the call price, investors may lose potential capital appreciation.

Evaluating Call Provisions

Investors should carefully assess the call provisions of preferred shares before making an investment decision. They should consider the likelihood of the shares being called, the potential impact on their returns, and any associated risks. Preferred shares with higher call protection may be more attractive to investors seeking stable and long-term income.

Conversion Feature

What is a Conversion Feature?

A conversion feature allows preferred shares to be converted into a predetermined number of common shares of the same issuer. This feature provides investors with the option to convert their preferred shares into common shares, potentially benefiting from any future appreciation in the common share price.

Benefits of Conversion Feature

The conversion feature can offer potential upside for investors, especially if the issuer’s common share price increases significantly. By converting their preferred shares into common shares, investors can participate in the potential capital gains and enjoy additional liquidity.

Considerations for Conversion Feature

Investors should carefully evaluate the terms and conditions of the conversion feature before investing in preferred shares. They should consider the conversion ratio, conversion price, and any restrictions or conditions associated with the conversion. Additionally, investors should assess the future prospects and potential upside of the issuer’s common shares.

Risk Assessment

Along with considering the various factors discussed above, it is crucial for investors to assess the risks associated with investing in preferred shares. Understanding and managing these risks can help investors make informed decisions and protect their investments.

Market Risk

Understanding market risk is essential when investing in preferred shares. Market risk refers to the potential fluctuations in the overall stock market that can impact the prices of preferred shares. Economic factors, geopolitical events, and market sentiment can all contribute to market risk.

Potential Impact on Preferred Shares

Market risk can have a significant impact on the performance of preferred shares. A decline in the overall stock market can lead to a decrease in the prices of preferred shares, potentially resulting in capital losses for investors. Conversely, a favorable market environment can drive up the prices of preferred shares, generating capital gains.

Mitigating Market Risk

To mitigate market risk, investors should diversify their portfolios by investing in preferred shares from different issuers and industries. Additionally, conducting thorough research and staying updated on market trends and economic indicators can help investors anticipate and navigate potential market fluctuations.

Interest Rate Risk

Interest rate risk is another crucial factor that investors should consider when evaluating preferred shares. Interest rate risk refers to the potential impact of changes in interest rates on the prices of preferred shares.

Importance of Interest Rate Risk

Changes in interest rates can directly affect the prices of preferred shares. When interest rates rise, the prices of existing preferred shares generally decrease, as investors can find more attractive fixed-income investments elsewhere. Conversely, when interest rates decline, the prices of existing preferred shares tend to increase.

Impact on Preferred Share Prices

Preferred shares have fixed dividend payments, and as interest rates change, the market value of these fixed income securities can fluctuate. The relationship between interest rates and preferred share prices is inverse – as interest rates rise, preferred share prices tend to decline, and vice versa.

Strategies to Manage Interest Rate Risk

Investors can utilize various strategies to manage interest rate risk when investing in preferred shares. These include diversifying their portfolios with a mix of fixed-rate and floating-rate preferred shares, investing in preferred shares with shorter maturities, and staying informed about changes in interest rates and their potential impact on the preferred share market.

Conclusion

In conclusion, when evaluating preferred shares for investment, it is essential to consider a range of factors that can impact the performance and potential returns of these securities. Dividend yield, credit rating, liquidity, call provisions, and conversion features are all critical factors to assess. Furthermore, it is crucial to conduct a risk assessment and consider market risk, interest rate risk, and reinvestment risk. By carefully evaluating these factors and making informed decisions, investors can strategically select preferred shares that align with their investment goals and risk tolerance.