Preferred shares as investments

Compared to common equity and debt investing, not a lot is written about preferred shares. They fall between common shares and debt. Debt is more secure and common shares have more capital gains potential. Like debt, fixed dividend preferred shares do deliver a regular income stream. The preferred issues we looked at averaged close to a 5% yield, considerably more than a GIC. Preferred stock has some potential for capital gain while sheltering the downside as it is not as volatile as common stock. Generally preferred shares have more security than common stock when it comes to payment of dividends and return of original capital.

Preferred stock can often trump debt when it comes to how much you retain of the income. If you hold preferred shares outside of a tax free savings account (TFSA) or your RRSP, you will get a better tax treatment on the dividends. For a base income of  $50,000 per year at your job, additional preferred dividends of $2,000  will pay $283 less in federal tax than the like amount of interest income. If your holdings are within a TFSA or RRSP, the tax benefit disappears.

For some preferred issues, there is another plus that is not often mentioned. If you elect a dividend reinvestment plan (DRIP) certain issuers like Royal Bank and CIBC will reinvest your dividends in common shares of the bank. This way you become a holder of both types of issues for each institution without incurring any additional brokerage fees. For example, 500 shares of Royal Bank’s AD $25 par preferred will generate $562.50 in dividends a year which will buy about 11 of the bank’s common shares paying a dividend of $2.16 each. After five years, you will have received about $2,815 in preferred dividends and an additional $297 in common dividends and hold approximately 55 common shares of Royal Bank.

There are around 180 fixed dividend preferred shares listed on the TSX. In the table below we examined shares of this type issued by the five big banks. The results are impressive. To Oct. 11, 2011, the average year to date total return (capital gains plus dividend yield) for these 34 issues was 10.66%. The same average for the common stock of these banks was a decline of 0.53% and the TSX composite lost 9.9%. If you don’t want to buy individual issues, there are some ETFs that might be interesting. Claymore S&P/TSX CDN Preferred Share ETF (CPD) had a total return of 2.08% and a dividend yield of about 4.8%. Horizons Preferred Share ETF (HPR) comes in with total returns and dividend yields of (3.40%) and 4.25% respectively. iShares S&P/TSX North American Preferred Share Index has a total return of 0.24% and a yield of 4.41%.