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Looking for Income? BCE Preferred Ab Shares

If you are afraid of a market correction and looking for safer alternatives to park some cash, consider preferred shares. Preferred shares trade on the market indexes like stocks but their main attraction is bond like payouts in the form of dividends. Depending on the preferred share chosen, the dividend can be paid out quarterly or monthly, and will feature either a fixed rate or floating rate dividend.

Let’s take a look at BCE preferred Ab shares, currently trading on the TSX for $15.03. This preferred share features a monthly floating rate dividend of $0.08229/share. This equates into a yield of 6.57% on an annualized basis. Given the fact bond yields have been decreasing due to low interest environments these preferred shares can provide a good alternative to yield investments – while providing safety and capital gains.

Before you invest in preferred shares, here are some things you should know:

1) Liquidity on preferred shares are generally much lower than common shares. This means daily average trading volume could be low resulting in higher bid/ask spreads and making it more difficult to trade at a specific price point.

2) Floating rate dividends are tied to market interest rates. When interest rates increase so does the dividend. The opposite is true when interest rates decrease. This results in a lower yield.

3) As dividends are the primary concern with preferred shares it is important to know that a company can lapse on a dividend payment or with hold in extreme cases where the company faces financial difficulty. For the most part I find these situations uncommon unless the company is on the verge of bankruptcy or other means of distress. Huge warning signs will generally be prevalent in the underlying stock price, preferred share price, or dividend yield if this is the case.

4) Preferred shares may have a rate reset which changes the dividend payout based on market interest rates and other factors. This will usually take place once every 5 years or as defined in the preferred share prospectus. During these periods the stock price may become volatile due to changes in the rate reset.

5) The company may choose to redeem the preferred shares. In the case of redeeming shares there is specific price the company must redeem the shares defined in the prospectus. This can be important if a preferred share is trading above par value as it will result in a capital loss when redeeming. If the shares are trading below par value during redemption then this will result in a capital gain.

6) Most preferred shares have rights to dividends prior to common share holders. This means a company will not pay out a dividend to common share holders unless preferred share holders are paid first. In the event of missed dividend payments during company distress, the company will need to reimburse preferred share holders before implementing a common share dividend policy again.

7) In the event of company liquidation, preferred share holders rank higher than common share holders to liquidation preference. How ever preferred share holders are ranked lower than bond holders. This means if a company dissolved, bond holders rank first preference to be reimbursed, followed by preferred share holders, then common share holders. As preferred shares are ranked higher than common share holders, there is usually an element of safety to holding preferred shares.

In the case of BCE I believe the dividend yield and share price offer an attractive entry point. Policy makers in the US recently reduced interest rates by 0.25% while Canada has maintained current interest rates. In the event of a 0.25% reduction to Canadian interest rates (considering the stock price remains the same) this would result in a reduced dividend yield from 6.57% to 6.27%. Although I see an interest rate cut as a potential in the near future, I believe the share price has already reflected these changes. Given the BCE Fixed Preferred A shares trade at $15.55 and represent a dividend yield of 5.80%, I find the Floating Preferred Ab more attractive. If interest rates were to decrease by 0.75%, the fixed and floating preferred shares would be equivalent in yield. Anything below 0.75% reduced interest rates and the fixed preferred shares would be a better option to hold.

Of particular note with BCE Preferred Ab shares is the redemption value of $25.50. Based on today’s trading price, this would represent a capital gain of approximately 69.6%. Although I don’t see the company redeeming these preferred shares anytime soon the potential for capital gains remain attractive. If interest rates instead rise in Canada this will support the preferred share price as the dividend yield will increase.

If you are worried of a market correction and looking for safer alternatives than common shares to park your cash than preferred shares may be the answer. During market correction many investors will drop stocks for safe alternatives like bonds. When bond yields are extremely low and stocks run out of favor, preferred share prices may increase.

Disclosure: I am long BCE Preferred Shares Ab. My initial sell target is $18.

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