Are Preferred Shares Interesting Today?

Just a quick note before we get started on the future of this newsletter.

I’m in the process of winding down the premium part of the newsletter in favour of something more inclusive for everyone — meaning it will be 100% free with zero ads. Here’s the quick version of what’s going to happen:

I’m going to work on the conversion this week, meaning the first edition of the new newsletter will drop next Sunday, Oct 11th.

Things will be mostly the same as you’re used to, with a couple changes. The first is a lot of the more big picture stuff won’t be discussed here anymore. You can find those topics on the podcast with Bob. He’s excellent at that kind of stuff. Discussing it with him will be a positive for everyone. I’m going to focus on individual stocks and sector analysis.

And secondly, the title of the newsletter will be different. I’m rebranding as Conservative Dividend Investing — which gives me more freedom to write about non-Canadian topics. You may have already seen the switch on Twitter.

(By the way, the choice of conservative in the name is not a political statement. It has to do with the types of companies I like. I want conservative balance sheets and lower payout ratios. Just to clear up any potential confusion.)

I’m not going to abandon the Canadian market altogether. I still have about 80% of my assets invested in Canada, although that number will likely fall over time. There are about 75 interesting dividend growers in Canada. That number expands to about 400 in the United States, plus various foreign stocks that trade on U.S. exchanges. I’ll look at the entire list and cover names from both sides of the border. I hope to simultaneously educate U.S. investors on Canadian stocks and Canadian investors on U.S. stocks.

I’m looking to have a more worldwide portfolio, and the newsletter branding will better reflect that.

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Onto today’s topic, preferred shares.

A little casual swearing, huh? I like it.

A preferred share is like Donny and Marie Osmand. Donny and Marie were a little bit country and a little bit rock and roll. A preferred share is a little bit equity and a little bit of a bond.

(That’s also a reference from 1970. God, I’m old.)

A corporation’s hierarchy of claims goes a little something like this:

Preferred shares are junior when compared to debt, but they have one advantage — their dividends get priority over common share dividends. In tough times common share dividends will be cut or eliminated before preferred share dividends get whacked. However, in really tough times both sets of dividends will go away while the company focuses on paying off creditors.

Preferred shares also qualify for the Dividend Tax Credit in Canada, making them a much more attractive after-tax option than bonds, which are taxed like the rest of your income. One can avoid this by putting bonds inside a RRSP or TFSA.

There are three kinds of preferred shares in the Canadian market, including:

Preferred shares in the U.S. typically fall under one of these categories as well.

Some preferred shares are cumulative, meaning they have to catch up on any unpaid dividends before being able to reinstate the common share dividend. Others are not; there’s no financial penalty for suspending dividend payments.

Preferred shares will trade higher or lower based on the financial health of the company, but generally they act like long bonds. A long duration bond trades down when interest rates are rising, and will then rally if interest rates are falling. A bond has a par price of $100, while a preferred share also has a par price. In Canada that price is almost always $25 per share, while in the U.S. it’ll often be one of $25, $50, or $100 per share.

Because a perpetual preferred is very much like a long bond — in theory a preferred share can be outstanding forever — it will sell off in an environment like today. That creates an opportunity for a certain kind of investor.

I wrote about preferred shares years ago. Ignore the stock picks — they’re hopelessly outdated — but feel free to read more about them at the link below. It covers some other stuff that I didn’t get to. I don’t want to get too into the weeds here.

Let’s start with the disadvantages. There are two, which really come down to one thing.

The big issue with preferred shares is the same issue with bonds — there’s no growth. And since preferred shares trade like long bonds, they’ll move more. So you have the possibility of no long-term growth and significant capital losses if you get in at the wrong time.

But there are a couple of advantages, too:

Your author was buying preferred shares the last time the sector tanked in Canada, back in 2023. I locked in yields between 6.5% and 8%, held for about a year, and flipped them for 25-40% total returns — all while collecting tax-advantaged dividends. I sold because I thought there were better opportunities for a superior total return at that point.

But there’s nothing saying you have to sell once a preferred share recovers. You could hold on for years or even decades, contently collecting your generous payout four times a year. It’s an interesting option for the retirees out there, especially those in their 70s or 80s who would rather get income today than upside tomorrow.

I understand the ETF option, especially for those of you who aren’t well versed in the preferred share universe. It takes a certain amount of understanding to grasp the concepts, and then the preferred share market itself is illiquid, opaque, and just plain confusing.

There’s a million people with an opinion on Royal Bank, Enbridge, or Power Corporation. There’s virtually nobody who can tell you the differences between each of their preferred share issues. You have to go straight to the source and read the prospectus, which 99% of investors won’t do. Most of the other 1% want nothing to do with preferred shares. So it’s a very small market.

This lack of liquidity is an opportunity for those of us who are willing to wade into the space and do a little bit of work. Good preferred shares get unfairly punished as larger investors need to get out. These are the issues that have the best upside potential later.

Meanwhile, a preferred share ETF simply holds the entire universe of preferred shares. So it will fall when interest rates move higher, and do the opposite when rates normalize again. But it only has a very small percentage of its assets invested in the best opportunities. A preferred share ETF will hold a lot of larger preferred shares, and a small amount of smaller preferreds. That’s not the ideal setup here, so I avoid these products.

I’ll stop with the yakky-yak and profile a few interesting preferred shares in Canada, and then a couple from the U.S.

Let’s start with the George Weston preferred shares, which trade under the ticker symbols WN.PR.A-E.

I’ll focus mostly on WN.PR.E, but I’ll note that the economics of the other issues are pretty much the same. They offer pretty comparable yields today. This preferred share has sold off aggressively lately, falling from $22.50 to $20.34 in just a few weeks. That’s close to a 10% drop, which is big in the preferred share world.

This one is a perpetual preferred share, meaning its $0.2969 quarterly dividend stays the same forever. That works out to a 5.8% yield, which is an excellent payout compared to George Weston’s credit risk. The parent of both Loblaw and Choice Properties has a strong balance sheet and can easily fund both its common and preferred share dividends from the payouts it receives from its two main underlying holdings.

Up next is the Sagen MI Canada preferred share, which trades under the ticker symbol MIC.PR.A. This is the old Genworth Mortgage Insurance Canada, which was acquired by Brookfield Business Partners in 2020. Your author owned the stock at that point, and I was a little disappointed the company was taken private for what I thought was a too-low price.

But I did buy these preferred shares back in 2023, locking in a generous yield and selling about a year later for a nice gain. That helps me be a little less bitter about the whole thing.

After the stock has sold off significantly, Sagen MI Canada’s preferred shares are currently available for a 6.1% yield. These are a perpetual preferred that pay a quarterly dividend of $0.3375 per share, and it’s unlikely they will be called anytime soon because the Insurance Companies Act of Canada says these preferred shares have to stay to satisfy liquidity requirements.

I’ll note these ones traded for closer to a 7% yield in 2023, so there still might be room for them to fall.

Finally, I’ll mention a rate-reset preferred share. This one comes from National Bank and it trades under the ticker symbol NA.PR.C.

This preferred share currently offers a $0.4391875 per share quarterly dividend, which had to be broken down to the fifth decimal place for some reason. That works out to a current 6.66% yield, but that yield won’t last long. These ones reset on November 15th, 2027, when one of two things will happen:

This is when things get a little complicated, so let me explain. As it stands today, the five-year Government of Canada bond yield is 3.69%. Add 3.43%, and we get a yield of 7.12%.

The yield on a rate reset preferred share is always based on the $25 par price. 7.12% of $25 works out to a $1.78 per share annual dividend. This preferred share trades for $26.50 as I write this, meaning the forward yield is a still robust 6.72% — assuming the Bank of Canada five-year bond rate stays the same. If it falls in the next year, then the preferred share will reset at a lower yield.

If you believe rates increase from here, then a rate-reset preferred share like this one is the ticket. It won’t sell off as much because it has that rate reset protection. If you think rates have peaked here and will go down, then you want a perpetual preferred. You’ll get the upside.

A good site with more info on Canadian preferred shares is this one. There are a few broken links and some outdated info, but that’s a minor complaint.

U.S. preferred shares are attractive right how because rates are higher in the U.S., which translates into bigger yields. But that’s offset by currency risk for Canadian investors.

Canadian investors don’t get the dividend tax credit when they buy U.S. preferreds, but there’s no withholding tax if you stick them in your RRSP or RRIF. They also won’t be taxed very badly if you’re a retiree who mostly has dividend income.

One interesting company with multiple preferred shares is Morgan Stanley, which somehow survived the 2008-09 financial crisis as a stand-alone company. These days it is majority owned by the Mitsubishi UFJ Financial Group, with a 23% stake. After pivoting to a business model that focused more on asset management than trading, its balance sheet looks to be better than Goldman Sachs’.

We’ll look at the Morgan Stanley Series I, which trades under the ticker symbol MS.PR.I.

This preferred share has been around since 2015. In 2024, the issuer had a choice. It could either call (buy back) the stock, or convert to a floating rate security. It chose the latter, and currently offers a payment of the CME Term Secured Overnight Financing Rate plus 3.708%.

That works out to 4.08% + 3.708%, or 7.788% on the par value, or a $0.48675 quarterly dividend — assuming the payout was calculated today. That works out to a fantastically generous 8.5% annual yield, since shares are trading comfortably below par value.

The problem is this is a floating yield. It’ll fall if rates fall. A perpetual preferred lets you lock in the yield, which has certain advantages. This one is an attractive choice if you think short-term rates stay elevated.

Let’s profile a U.S. perpetual preferred next. I chose The Hartford Insurance Group Series G preferred share, a perpetual preferred that offers a $0.375 per share quarterly dividend. This one has sold off significantly. As I write this it trades for $21.90 per share, which is its lowest level since its 2018 IPO. That includes the March 2020 period, too.

That works out to a 6.9% yield, which is better than the National Bank preferred share we profiled earlier. Plus there’s no rate reset risk. You could sit back, relax, and collect the generous dividend forever.

The Hartford Group isn’t a household name, but it’s an excellent insurer. Its preferred shares have a BBB credit rating, which is about as good as you’re going to get in that world. Since preferreds rank below debt in the corporate hierarchy, they will almost always get assigned a slightly lower credit rating.

The Hartford Group has been a consistent repurchaser of its shares, decreasing the amount outstanding from 354M in 2021 to 270M today. It did so while maintaining balance sheet strength, increasing its dividend by 10%+ annually, and growing the bottom line. Plus, these guys are disciplined underwriters; the company has an 18%+ return on equity.

If you’re looking for a good resource for U.S. preferred shares, check this one out. It’s the best I’ve been able to find so far.

Preferred shares can be an interesting income source, especially when purchased amid periods of uncertainty. You can lock in impressive yields, which can boost a retiree’s income. And when rates inevitably head lower again, you get the capital gain as well.

Even if you don’t sell and you buy these preferred shares to hold, the outcome is still pretty good. Just a small percentage of your portfolio in these products can increase income, while the rest of the portfolio does the heavy lifting for capital gains.

I used to be a periodic participant in the space. In 2023 I was actively buying quality names that yielded 7-8%. I held them for 12-18 months, collected nice dividends while I waited, and when I punted them to put the cash in what I thought were better opportunities, I locked in nice gains.

These days I’m less active. I’m still relatively young, even though the various aches and pains might make it seem otherwise. I want my dividend income to go up over time as I buy and hold various dividend growth stocks. Preferred shares offer a nice one-time boost, but then I need to reinvest those dividends to get the growth. That’s not bad for a retiree, but it’s just not right for me.

Besides, Weathsimple is an excellent brokerage for Canadians — except for one thing. You can’t trade preferred shares on the platform.

So, for those reasons, I’m not participating. But I still keep an eye on the sector.

Your author has no position in any preferred shares mentioned. Nothing written above is investment advice. It is for research and educational purposes only. Consult a qualified financial advisor before making any investment decisions.