By conducting a simple two-step analysis, preferred stock investors can identify preferred stocks that the market may have underpriced, given the risk.
We learned during the Global Credit Crisis that agency ratings were imperfect for a variety of reasons. Shortcomings of both mathematics and character led to grossly incorrect ratings in too many cases.
But historically, short of such crisis conditions, agency ratings of securities have served millions of investors all over the globe very well for many decades. And as imperfect as these ratings are, the fact is that most investors have little choice but to use such ratings as a proxy for investment risk-- even though what the investor wants to know and what the rating is measuring are, at least to a certain extent, two different things.
Investors are usually trying to determine the likelihood of a bankruptcy of the company they are considering investing in while rating agencies are trying to quantify creditworthiness. To most investors, these are two views of the same scenery. Where agency ratings come in the form of a quantitative rating on a scale, investor conclusions about risk are reflected in today's market price (and hence yield).
Step 1: Moody's Versus The Market
When rating agencies and investors see risk the same way, a group of preferred stocks with the same rating would be priced by the market such that they offer the same yield. Same risk, same return. This theory is easily demonstrated by...
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We learned during the Global Credit Crisis that agency ratings were imperfect for a variety of reasons. Shortcomings of both mathematics and character led to grossly incorrect ratings in too many cases.
But historically, short of such crisis conditions, agency ratings of securities have served millions of investors all over the globe very well for many decades. And as imperfect as these ratings are, the fact is that most investors have little choice but to use such ratings as a proxy for investment risk-- even though what the investor wants to know and what the rating is measuring are, at least to a certain extent, two different things.
Investors are usually trying to determine the likelihood of a bankruptcy of the company they are considering investing in while rating agencies are trying to quantify creditworthiness. To most investors, these are two views of the same scenery. Where agency ratings come in the form of a quantitative rating on a scale, investor conclusions about risk are reflected in today's market price (and hence yield).
Step 1: Moody's Versus The Market
When rating agencies and investors see risk the same way, a group of preferred stocks with the same rating would be priced by the market such that they offer the same yield. Same risk, same return. This theory is easily demonstrated by...
Note To Readers: This article was chosen to appear on the popular investing website 'Seeking Alpha'.
By clicking here a new window/tab will open on your screen to this article as it appears at SeekingAlpha.com.
Receive my Seeking Alpha articles by email: When viewing one of my articles at Seeking Alpha, click on the "Follow" button under my picture. You will be notified by email when I post a new article to Seeking Alpha.
Please enjoy reading this article at Seeking Alpha.
Many Happy Returns.
