Why Dividends - A Case Study
Why dividends – A Case Study.
Companies issue two types of stock – common stock, which we are all familiar with, and preferred stock.
When TGA Capital Management bus shares of common stock or preferred stock you own a piece of the company. The company records your ownership on their books under the heading “equity.” This is different than buying a company’s bonds, which are a loan that you are making to the company, recorded as “debt.”
Just like with common stock, a company’s preferred stock trades on a stock exchange (usually the New York Stock Exchange) under a unique trading symbol. TGA Capital Management use this preferred stock trading symbol to buy and sell your shares. The market price of a company’s preferred stock fluctuates every day just like their common stock shares. A company can issue several “series” of preferred stock.
Most preferred stocks pay a quarterly dividend that is usually higher than the same company’s common stock dividend and preferred stock dividends are always paid to shareholders before the dividends of common shares, hence the name “preferred.”
Preferred stock shareholders are always paid first. In exchange, however, preferred stock shareholders generally do not get to vote in corporate elections. And because the quarterly dividends are generally fixed and known in advance, the market price of a company’s preferred stock shares is generally less volatile (less speculation) than the market price of the same company’s common stock shares.
The dividend rate being offered by newly issued preferred stocks tends to go up and down over time (generally between 6% and 9%) and is closely related to prevailing interest rates throughout the economy. As interest rates go up and down over time, so will the dividend rates being offered on newly issued preferred stocks.
The dividend income that you earn from preferred stocks is based on the number of shares you own, not the current market price. So preferred stock investor’s dividend income remains the same whether prices are going up or down.
And rates and market prices of preferred stocks are also related, but inversely; that is, when rates are going up the market prices of preferred stocks will tend to go down and vise versa. Knowing this allows TGA Capital Management daily monitoring of preferred stock to time the buying and selling activities.
TGA Capital Management Preferred Stock expertise allows us how to take advantage of these (and other) characteristics of the highest quality preferred stocks to generate multiple downstream capital gain opportunities while earning above-average dividend income in the meantime.
New Preferred Stocks: How TGA Capital Management focus on cost and return enhances your managed account when we Buy Shares For A Discount Below Par
2012 is potentially a positive year for new preferred stock issues. Because many new preferred are expected to be introduced throughout the year, it is important for our preferred stock advisory/clients to understand a little known technique that allows
TGA Capital Management how we attempt to purchase newly issued preferred stock shares for a discount.
TGA Capital Management has been researching the preferred sector for over 20 years and as a savvy preferred fixed income advisory, we focus and are able to buy shares of newly issued and current preferred stocks for a market price below par. Surprisingly few preferred stock investors take advantage of this technique and end up paying more than they need to for their shares.
New Preferreds For 2012
Most preferred stocks are callable at their “Par Value” five years after they are first introduced to the marketplace. When called or retiring (calling) older preferred stock shares companies will generally issue a new preferred stock at today's lower rates and use the proceeds to call their older, more expensive issues (it’s like refinance).
The dividend rates of preferred stocks up between 2007 and 2009, ultimately peaking at 9.6% in July 2009, due to the Global Credit Crisis. With their five year call dates, these crisis-era issues start becoming callable this year.
This combined with the Federal Reserve's monetary policy of historically low-to-no interest rates, is expected to produce a potential of new preferred stocks as companies introduce new issues this year in order to call those from 2007.
Real Estate Investment Trust companies (REITS) could be very active since they benefit more directly than most from low rates[1]. There were over 50 new preferred stocks issued during 2011 paying an average annual dividend of about 7%[2] from an array of companies such as: Public Storage (PSA), DuPont Fabros (DFT), Vornado (VNO), Associated Bancorp (ASBC), Gastar Exploration (GST), Seaspan (SSW) and many others.
The first weeks into 2012 the action has already started with several new issues being offered. As crisis-era preferred stock issues now become callable, TGA Capital Management knows how to purchase shares of newly issued preferred stocks for a discount when evident and is likely to come in especially handy throughout this year and beyond.
TGA Capital Management and Institutional Buyers Favor Newly Issued Preferred Stocks
Because most newly issued preferred stocks cannot be retired by the issuing company for the first five years, TGA Capital Management seek to purchase newly issued shares since doing so positions our advisory/clients a five year dividend payout.
This demand for newly issued preferred stock shares can also create upward pressure on the market price during the early days of trading, just as we experienced in the first few weeks of January on new preferred stock starts trading on the New York Stock Exchange, forcing many novice, inexperienced preferred stock investors to pay more than the security's par value (which is usually $25 per share, which is generally the preferreds that the advisory focuses on and will utilize in this over view.
For example, IBM preferred stock is trading well over it $25.00 PAR, almost at $28.00 while paying a dividend of more than 4.75% and the advisory purchased this preferred below the $25.00 PAR. So, when TGA Capital Management focuses on securing high quality dividend payers, we already know what our clients potential future capital gain could be, aside, remembering that the dividend payout is based on the amount of shares we own, not the dollar amount of the position. Sure we can sell it at a gain, and repurchase a similar preferred below $25.00 and this exercise to reposition or swap, one at gain for one at discount doesn’t disrupt the advisory clients managed account dividend stream, we also captured the gain of the discounted preferred to be a realized gain.
TGA Capital Management seeks superlative high-quality dividend’s, with a focus on the discount method for our advisory clients.
Note: Dividends that meet the qualified dividend rule are taxed at a flat 20.00% tax rate and long-term capital gains is taxed at 17.00% tax rate, which is very attractive since most individual tax rates are higher than 28.00% tax rate.
So, be sure to also compare your after-tax returns, because it’s what you keep not always what your unrealized capital gains or before tax investment return was or is.
A Case Study
For example, let’s assume you need current income today. Assume both accounts start with $500,000.00. We both sit down and review your income analysis and compare the funding to meet your requirement.
Managed Preferred Account $500,000.00 @ 6.75% Annuity Income $500,000.00 @ 4.00%
Note: The advisory purchased No discount pricing available, you paid a
All the preferred securities at a 5.00% commission, plus a 1.00% trailing
10.00% pricing discount for your commission and deferred rear load if you
Managed account surrender at 10.00% reducing to 0.00%
in tenth year.
Managed accounts (par Value) $550,000.00 $500,000.00
Managed Account quarterly Fee, 0.21375 $-1068.00 $ -25,000.00
Managed Account annual fee, 0.855 $-4272.00 $-5,000.00
Cost $4272.00 $25,000.00
Commissions-Trailing fee None $5,000.00
Total first year cost $4272.00 $30,000.00
Management fee is tax-deductible as to percentage of gross income deductible
Investment related commissions are non-deductible none deductible
shares owned 24,444.444 shares @ 22.50 equals PAR VALUE $550,000.00 $470,000.00
Annual dividend 6.75 paid quarterly equals 1.685 paid on shares Before Tax Income Before Tax Income Owned. When owning an annuity. Annuities do not offer dividends. $33,750.00 $20,000.00
Dividends (Qualified Dividend Rule are taxed at a flat 20.00% -$6750.00 -$5,600.00
After tax income not including your state tax $27,000.00 $14,400.00
Potential of capital gains due to Preferred realized gains at PAR $50,000.00 NONE
Also, note; in the advisory opinion, it is unlikely that the investment in mutual funds provides the full dividend stream, and the tax control, since mutual funds, manage the year-end capital gains declared. Whereas, our advisory clients managed account can be exercised or as a realized gain at the advisory/clients decision.
Also note; the advisory can provide or exercise the use of sell or stop limits and or buy at market limits. Open-end mutual funds nor annuities to this date do not provide stop or loss limits. Thus, advisory cannot minimize downside for advisory/client managed account.
Why is buying shares for less than par important? Since the issuing company will pay shareholders $25 per share when retiring the shares, preferred stock investors who purchase their shares for less than $25 add a layer of principal protection and position themselves for a downstream capital gain (in the event of a call) or sale of the preferred trading over the PAR.
TGA Capital Management - how we purchase shares of a newly issued or current preferred stock below $25 per share?
Creating A New Preferred Stock
Like many things, knowing how to buy newly issued preferred stocks at a discounted price below par is a matter of having information that most others do not have or have, but fail to use.
When a company issues a new preferred stock a group of investors ("underwriters") pool their money (often hundreds of millions of dollars) and buy the new shares from the issuing company. The company also files an application with the New York Stock Exchange (typically) for a new trading symbol under which the new shares will be trading once the NYSE approves the application.
For a new preferred stock with a par value of $25 per share, the underwriters typically pay about $24.25 per share, receiving a $0.75 per share discount from the issuing company. This discount is published in the prospectus of the new preferred stock issue.
The underwriters, owning the new issues at a lower price can be out millions in cash, thus want to sell the shares.
In some situations, the parties involved offer them to the Over-The-Counter (OTC) stock exchange. The new shares will be sold by the underwriters "dealer/brokers" (wholesalers) using a temporary symbol on the OTC at $24.50 or so per share for several days or even for a few weeks before the shares appear on the NYSE or other exchanges.
Due to this distribution scenario, the dealer/brokers are anxious to sell the shares as the underwriters were and will usually sell them to a buyer, any buyer, below PAR, or for about $24.75 per share or so, but below par in almost all cases. Not only, it appears customary that preferreds trade at market below PAR and takes a constant monitoring of these sectors and I do not recommend trying this, especially if you’re a novice investor, and or do not understand the credit markets, let alone picking mutual funds.
Buying Shares Below Par
It is at this point in the process that you, armed with your web browser and an online trading account, can enter the action and purchase shares of a newly issued preferred stock for a discounted price below par. Remember, once the shares begin trading on the NYSE under their new permanent trading symbol, the market price tends to be a bit above $25 per share.
TGA Capital Management continually monitors preferreds globally, while our main focus is domestic. The advisory discipline is to seek high-quality rated preferred and fixed-income with superlative dividend stream and in not owning more than 3.00% of anyone issue, to attain risk avoidance and allocation.
Most individual investors are entirely unaware of the shares trading below PAR until several weeks after trading appears on the indexes and exchanges. After the new shares appear through our screening process and the increase in visibility and, hence, demand pushed the price up above par (with a few exceptions).
2007 - 2009: A Crisis That Keeps On Giving
With our current low-to-no interest rate environment, the fact that most high dividend rate crisis-era preferred stocks have a five year call date has created a unique opportunity for preferred stock. These crisis-era preferreds, issued between 2007 and 2009, will approach their call dates between 2012 (now) and 2014.
According to the Federal Reserve, low interest rates that were put in place prior and during the Global Credit Crisis are going to be with us for at least another few years (2014).
While interest rates on bank CDs have plunged to about 1.2%, the dividend yields offered by the highest quality preferred stocks have settled at about 5.25 to 7%.
TGA-GIA Capital Managed Accounts in preferred shares are generally those who wish to hold fixed-income investments in a taxable portfolio. Preferential tax treatment of dividend income, as opposed to interest income, may in many cases result in a greater after-tax return than might be achieved with bonds. With a qualified dividend tax of 20% compared to a top ordinary marginal tax rate of 35%,[15] $1 of dividend income taxed at these rates provides the same after-tax income as approximately $1.30 in interest. The size of the preferred stock market in the United States has been estimated as USD$100-billion, as of early 2008, compared to USD$9.5 trillion for equities and USD$4.0 trillion for bonds.[16] The issuance of preferred stock began in the late 1800’s.
Investing in Preferred Stocks - What are the advantages of investing in preferred stocks?
· Preferred stocks offer yields that are higher than bond market yields, money market yields and common stock yields.
· When preferred stocks trade at very high yields and at large spreads against senior debt there is a potential to execute risk arbitrage strategies that benefit from price appreciation if yields return to more normal levels.
· Preferred stock returns have low correlations with common stock returns, making themgood diversifiers. They also have relatively low correlations with bonds, with expected volatility and returns between those of common stocks and bonds. This makes them a good complement to a bond portfolio.
· Preferred stocks may be useful in capital arbitrage strategies due to their position in creditor standings between that of equity and other forms of debt, and due to the presence in many preferred stocks of an option to convert to common shares.
The right Investment Advisor does what’s right for you. Understand exactly what you’re paying for. Enjoy a one-on-one relationship. Know that your money is with a secure Financial Institution. TGA-GIA Capital Management also offers fixed certificate of deposits that are FIDC and annuities, for individual, businesses concerned with complete safety and guarantees for the preservation of taxable and non-taxable accounts, (IRA’s, 401k, Pension Plans, Roth Accounts), on a non-commission, 100% liquidity and account access.
In the interim, I can be emailed and or contact at the firm. My email is; MGreen@Greenadvisory.com and I can be reached at; 1-508-224-9646 to discuss your requirements and or provide more detailed information about our Separate Account Management (SAM). The annual Form ADVPTII is available.
With Warmest Regards,
Michael D. Green, Advisor
TGA-GIA Capital Management