Monday, June 15, 2009

Preferred Stock Investing Reader Question (sign in to post your question)

What is the Target Sell Price and how do I use it? Paula G.

From the February 2009 issue of the CDx3 Newsletter (free, what's this?)

Traditional preferred stock investors invest in preferred stocks for the great dividend income. Even though the daily market price of preferred stocks fluctuates with rates (rates and the market prices of preferred stocks move in opposite directions, see Preferred Stock Investing, page 52), many traditional preferred stock investors use a buy-and-hold approach.

But what if the market price rose to a point where it became worth your while to sell? How could you tell?

Preferred stock investors can use the "Target Sell Price" (presented in chapter 13 of Preferred Stock Investing) as a guide during a "seller’s market" for preferred stocks (characterized by high market prices, above $25 per share, and low dividend rates).

This chart shows you the results that you would have gotten by investing in the highest quality preferred stocks ("CDx3 Preferred Stocks"). If you would have used the Target Sell Price as a selling guide for every CDx3 Preferred Stock issued between January 2001 and December 2006 (pre-credit crisis*), this chart shows you the average market prices that you would have sold your shares for (in yellow) and the average effective annual return that you would have earned by doing so (in white).

The Target Sell Price calculation results in a value that preferred stock investors can use to help answer the question “…am I better off selling now for a capital gain or holding onto my shares and collecting more dividend income.”

Let's look at an example. Preferred Stock Investing teaches you how to purchase preferred stocks for a market price below $25.00 per share. If you purchase a preferred stock that pays an annual dividend of, say, 8% you are going to receive $2.00 per year in dividend income, or $0.50 per quarter. If the market price of your 8% preferred stock rose from the $25 per share that you originally paid for it to, say, $26 per share, would you sell it?

If you did, you would make a $1.00 per share capital gain. Remember, your 8% preferred stock pays you $0.50 per quarter, so selling for a $1.00 capital gain is equivalent to two quarters worth of dividend income – and you’ll receive it all at once, the moment you sell. You won’t have to wait for two quarters in order to get your money.

What if the market price went to $26.50? You would make a $1.50 profit for every share. That’s three quarter’s worth of dividend income right now; no waiting another nine months to receive the same amount. Would you sell for $26.50?

As you can see by the above chart, preferred stock investors can pile a nice capital gain on top of great dividend income, resulting in very respectable returns, by using the Target Sell Price as a guide.

The individual CDx3 Preferred Stocks issued since January 2001 used for this chart are itemized, along with the sell date, sell price and effective annual return that you would have earned in chapter 15 of Preferred Stock Investing.

* Note that we have been in a "buyer's market" since June 2007 when the current credit crisis set in. CDx3 Preferred Stocks paid an average annual dividend yield of 7.7% during 2007 and 11.2% during 2008 before counting any future capital gain. Selling 2007 and 2008 preferred stocks will come later once dividend rates come back down and, correspondingly, market prices come back up.

Many Happy Returns.