Income Investing Basics from QuantumOnline.com
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Income Investing Basics

This page describes the basic concepts of income investing for a QuantumOnline user new to income investing. The paragraphs below apply to fixed income investments such as preferred stocks and similar securities. For definitions of any our the terms used below, see our Glossary of Income Investment Terms which can be found on our Information menu at the top of any page.

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How much do preferreds pay? - Preferred stocks are what is termed fixed income securities. The term fixed income means that the preferreds pay fixed annual amounts as dividends (in quarterly, monthly or sometimes semi-annual payments) and these fixed payments generally do not vary over the life of the securities. The exact amount that preferreds pay is fixed and is defined in the Prospectus that was provided the original purchasers during the security's original public offering (IPO) when the security was first sold to investors. The annual amount of the preferred dividend is normally expressed as a percentage (the coupon rate) of the liquidation preference (normally equal to the original price to the public). The formula for preferred dividend payments is that the annual dividend payment is equal to the coupon rate times the liquidation preference amount. For example, a preferred with a $25.00 liquidation preference per share and an 8.25% coupon rate will pay $2.0625 per share per year ($25.00 times 8.25 divided by 100 equals $2.0625). If the dividend is paid quarterly, the preferred will pay $2.0625 divided by four or $0.515625 per quarter per share. If you own 100 shares of the preferred, you will receive a quarterly dividend of $0.515625 times 100 shares or $51.5625 per quarter; or $2.0625 times 100 shares or $206.25 per year.

The QOL tables specify the coupon rate (see the Cpn Rate column), the annual amount of the dividend (see the Ann Amt column), and the liquidation preference (see the LiqPref column) for all securities listed on the table.

What is the current yield? - The above dividend percentages as expressed as the coupon rate apply only if the current market price is equal to the liquidation preference. As that is often not the case, an investor needs to calculate current yield of an investment. For example, lets take the above case of a $25 preferred with a coupon rate of 8.25% which means it pays an annual dividend of $2.0625 per year. If that preferred is currently selling for $26.50 per share, its current yield would be $2.0625 divided by $26.50 times 100 which gives a current annual yield of 7.783%. If that preferred is currently selling for $23.50 per share, its current yield would be $2.0625 divided by $23.50 times 100 which gives a current yield of 8.777%. Note that the preferred is still paying its fixed dividend of $2.0625 per year but the current yield changes depending on the current market price of the preferred. The changing current yields simply means that the investor needs to consider the current yield as determined by the current market price to determine what a preferred will yield for their investment.

To find the current yield on any security, click on the stock exchange (NYSE, NYSE Amex, etc.) shown of the table under the Stock Exchange column which will produce the current (delayed 15 to 20 minutes) market price of the security from the appropriate stock exchange. Then, divide the annual amount given on the table by the current market price, then multiply by 100, to get the current yield in percent.

When is a preferred callable? - Generally, preferred stocks are callable after five years from the date of issue. Callable means that the issuer has the right to call or redeem a preferred stock after the five years are up but is not obligated to call the preferred stock. In other words, the issuer will call (redeem) a preferred stock when it is to their benefit to do so. That means that they will call a preferred stock when interest rates have dropped from the date of issue but they will not call a preferred stock when interest rates have stayed the same or risen during the period.

In general, an issuer will call an existing preferred and issue a new one when interest rates have dropped sufficiently so that they can issue a new preferred with an dividend rate at least 1% lower than the existing preferred. The 1% lower rate is necessary to cover their costs of calling the existing preferred and issuing a new preferred. Of course, an issuer might also call a preferred when they have sufficient funds available to cover the amount of the call and no longer wish to continue to pay the dividends for an existing preferred.

In any event, an investor needs to be aware of when a preferred stock is callable and make their decisions accordingly. Generally when buying income securities an investor would like a call date 3 to 5 years in the future. The QOL tables specify the call date (see the Call Date column) for all recently issued securities listed on the table.

What are the Credit Ratings for a preferred? - Another factor to be considered when buying income securities is credit ratings. QuantumOnline provides a recent (but not necessarily a current) credit rating on each listed security on the table. If you wish further information on credit ratings in general or on the QuantumOnline credit ratings in particular, you should read our QuantumOnline Credit Ratings page which can be found on the Information menu at the top of any page. In general, a new income investor should stick to preferreds with investment grade ratings until they have enough experience to feel confident in considering income investments in non-investment grade securities.

The credit ratings provided on the QuantumOnline tables are from Moody's and S&P. Investment grade ratings are shown in green and non-investment grade ratings are shown in red. The date below the ratings is the date of those ratings and we try to update ratings twice a year. If you are depending on ratings for you investment decisions, you should confirm the current credit rating though the credit rating firm's websites, your broker, etc. before making your final investment decision.

Distribution Dates - Distribution dates are of course important to an income investor as these are the dates when the dividends are actually paid to you. QuantumOnline shows the stated distribution dates for each security. The actual distribution date can vary from the stated date by a day or two depending on weekends, holidays, etc. but the actual payment date is virtually always within a day of two of the listed distribution date.

Ex-Dividend Dates - A new investor needs to understand the record date and ex-dividend date which applies to any preferred security payment date. If you don't understand record dates and ex-dividend dates you are pretty sure to make the rather expensive mistake of buying a preferred assuming that you will be paid the current dividend and then finding out that you are not eligible to receive the dividend since you bought the security on or after the ex-dividend date. Therefore all new income investors need to read the What is the ex-dividend date? section of our What Income Investors Should Know page which can be found on the Information menu at the top of any page.

Maturity Dates - Generally the maturity date of preferreds is not of much interest to income investors. First, that is because traditional preferred stocks do not have a maturity date - they are perpetual securities. Trust preferreds do have maturity dates but since those dates are currently 20 to 50 years in the future they will not have much effect on most preferred investors.

The IPO Prospectus - The prospectus, issued at the initial public offering (IPO), is essentially the legal contract between the investor and the issuer of the security. What the prospectus says is the final answer to any question you might have. So, if you want to know the final answer to a question about a preferred, you need to refer to the prospectus. Unfortunately, most prospectuses are around a 100 pages in length and are a challenge to read. The good news is that generally most of the information any investor wants to know is general within the first 5 or 10 pages of the prospectus. At some point in the future, the new income investor should take up the challenge of learning to read a prospectus but for the moment you should just know they are available and will provide the answers you want if you are willing to take the time to find it.

QuantumOnline provides links to the IPO prospectus of essentially any preferred issued in the last ten years or so. The prospectuses are online at the SEC EDGAR website. The SEC EDGAR website came online roughly ten years ago. For securities issued prior to that time, the prospectuses are not online and therefore no link is provided or available.

If you have read and understood the above information, you now have a good, basic understanding of income investments. There is more to know, much of which is included on the pages under our Information menu, but you certainly should have the basic knowledge necessary to intelligently select income investments for your investment portfolio.

What to look for in a Good Income Investment - To summarize the above thoughts on what you should look for in a good income investment:

  • Credit Ratings - Start your income investment portfolio with only investment grade credit ratings (printed in green on the tables).
  • Call Dates - Select securities with call dates that are three to five years in the future.
  • Distribution Dates - Select securities that pay on distribution dates that fit your schedule.
  • Current Yield - Only when potential income investments meet the above criteria should you then select income securities for the highest available current yield. Remember that it is far more important to be able to sleep at night than to get a few more dollars of income and then have to constantly worry about some shaky high yield income investments.

Don Doan
QuantumOnline.com


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