Defensive driving preferred

From CartoonStock

Like in driving, it pays to be defensive in the capital markets when times are uncertain, investing ideas have dried up or one is unsure where the markets are heading. Now that the stock market is hitting record high and stocks are expensive by any measure, prudence dictates that some semblance of capital gains protection is required.

But is there a prudent way to accomplish it without really turning back at the market? Preferred stocks may provide some comfort.

What is usually traded at the stock market are common stocks, which represent your ownership to the issuing corporation. The value of the common stocks should rise and fall with the fortune of the underlying company. If that company has excess cash from its retained earnings, it may opt to give it back to the shareholders from time to time as cash dividends, if at all.

A preferred stock is somewhat different. It also represents ownership, but as the name suggests,  it has some preferred features over that of common. You are guaranteed to be ahead of common holders when surplus cash is handed out. What's more, at the time of issue, dividend yield  or the amount you are expected to be paid out as a percentage of the initial cost and the schedule of payments are spelled out. Those who own large blocks of these shares--passive investors or holders of conservative mutual funds-- are just too happy to wait for those regular dividends which come quarterly, semi-annually or annually.

You are also ahead of the common shareholders, but below the debt holders when it comes to claims to the remaining assets of an issuing corporation which is in the process of liquidation (bankruptcy).

That's why it appeals to large conservative investors, fixed-income mutual funds, retirement funds and plain passive investors. Large blocks of these stocks usually end up at major shareholders themselves, banks which in effect are funding the company by subscribing to these shares, or affiliated companies.

The flip side is that preferred stocks are usually non-voting and non-participating, which means that you don't have much say in the affairs and management of the corporation. That's fine with us, small investors, since we don't expect to.

At any time too, the issuer may close the tap by redeeming the issued shares. I used to own Ayala Corp. preferred stocks (PSE: ACPR, retired) but the corporation took it out from the market.

There is also a special kind called a convertible preferred stock. This means that the holder can convert it to common shares when certain conditions are met. The common conditions include the price at which it can be converted to common, usually at a premium (higher) than the share price at the time of issue; and time lapse of a few years since issue date.

Thus, the holders look forward to a potential upside to their investment when the strike price has been breached and some. In the meantime, they are collecting the regular dividends. You can also convert to common, which is more tradeable, when the issuer can no longer pay any cash dividends.

An example of the latter is Swift Foods Incorporated preferred (PSE: SFIP). I inherited some SFIP shares when the Concepcions, the majority owners of RFM and SFI at the time, decided to unlock the value of their illiquid and non-performing SFIP stocks by giving these out to RFM common shareholders as property dividends some time ago at a ratio of 1 SFIP for every 46 RFM shares.

Both types can be traded at the exchange since both are listed, but the common shares are more liquid. I decided to sell mine directly to avoid the extra paper work, but majority of the holders have been converting them to common. The net effect would be that SFIP would disappear altogether in time while the number SFI outstanding common shares would increase; thus diluting the ownership of existing holders.

Fortunately for us, small investors who are less than derring-do at the stock market, a number of these preferred stocks are listed and tradeable. These are listed below:

Yields		Updated:	12-Apr-13
		Last		Listing
	Coupon	Price	Actual	Price
PFP	8.0000%	1045.00	7.6555%	1000.00
SMCP1	8.0000%	74.00	8.1081%	75.00
PPREF	9.5210%	112.00	8.5009%	100.00
FPHP	8.7231%	101.40	8.6027%	100.00
FGENG	7.7808%	112.50	6.9163%	100.00
FGENF	8.0000%	103.50	7.7295%	100.00
SMC2A	5.6250%	75.00	5.6250%	75.00
SMC2B	5.7188%	78.00	5.4988%	75.00
SMC2C	6.0000%	77.80	5.7841%	75.00

The first few letters identify the issuer: Thus, PFP is Purefoods Preferred while PPREF is Petron Preferred. The last few characters identify the series. The coupon is the promised payout per annum.

Even if you bought PFP and PPREF at a higher price than issued, the yields would still be higher than those for SMC preferred.  The SMC2 series were in fact issued to replace the costlier SMCP1 and other indebtedness while FPHP is currently being redeemed. These types of stocks are less liquid than common, however.

However, they don't appreciate much in price due to their predictable nature.

Now you have another choice for defensive play.