On the Hunt for VIP Dividends

It’s a weird time to be a dividend investor.

Dividend stocks are a great defense when there’s fear in the air. Inflation fears are real with energy-driven price increases front and center. These trickle through the rest of the economy as higher input costs for most goods and services.

Consumers are already worried. The most recent University of Michigan Consumer Sentiment Index is at the lowest level recorded in the history of the index.

The stock market, meanwhile, is off living in its own little world supported by greed. The CNN Fear & Greed Index has held its greed reading for two weeks now. It is at its highest level since last July. And for some reason, the S&P 500 continues to hit new highs.

It would be the perfect time to load up on dividend stocks to build a defensive portfolio if market valuations weren’t sky high. When stock prices go up, our yields go down. I’m finding companies that I’d like to own, but not at current prices.

So, I headed over to another corner of dividend investing that is often ignored.

Set Payments and Less Volatility

I’m talking about preferred stocks. Preferreds perform almost like a hybrid of a stock and debt (bond). Like common stock, they are listed on the major exchanges and are easily traded using your brokerage account. Like a bond, preferred shares do not have voting rights, have a set dividend payment, and have a par/face value.

The set dividend payment and face value generally make preferreds less volatile. The amount you’re getting paid is not tied to the whims of the board of directors. And if your shares are called or redeemed you know exactly how much you’ll receive. Most high-quality preferreds typically trade in a narrow band—a few dollars above or below their face value, which is usually $25.

If a company completely fails and is liquidated, preferred shareholders are positioned in the claim line between debt holders and common stockholders. In a situation less dire than liquidation, a company will cut its common share dividend before it goes after the preferred dividends.

Now, preferred dividends can be suspended, but most offerings are considered cumulative. That means the missed payments are due to preferred shareholders before any money can be paid out to common shareholders. You’ll still want to make sure that a company has the money to continue to pay out your preferred dividends before adding one to your portfolio.

Where To Look

You can surely look for preferred stocks trading close to their face value and collect your VIP dividends.

I tend to use preferreds as a way to speculate with less risk. I want to find preferreds that are trading below their par value, meaning other investors are currently underestimating their value and potential.

One example is when a company or industry is going through a strategic transformation. There are also instances where a company pays a dividend on its preferreds but not on its common shares.

Fidelity has a great free screener that anyone can use. I don’t have an account there or any feelings positive or negative about Fidelity—but I do like this screener tool. Just search for it in your favorite internet search engine.

You can screen by all sorts of criteria, but I always start with the same one. I want to find an above average yield for a below average price. When I set yield and price as my two filters, Fidelity will give me the median of the whole preferred universe as the benchmark. I then use them as the bounds for searching.

This search returned quite a few financial and real estate companies. Both sectors have only seen single digit returns over the past year, while the S&P 500 is up 29%.

It might also shock you to know that there were some energy companies on this list as well. Yes, at a time when the market is incredibly bullish on energy stocks. That’s because the par value limits the potential upside on capital gains. Investors see that potential upside on the common shares and are ignoring these preferred offerings. Our goal is solid income for years to come, so these discounted shares are more desirable than overpriced common shares with no or low dividends.

In a time when the markets don’t make complete sense, we’re going to have to reach for every tool in our toolbox and that includes preferred shares. Have you been adding any preferred to your portfolio recently?

For more income, now and in the future,

Kelly Green