BUFFETTS BOOKS ACADEMY: INTERMEDIATE COURSE

LESSON 23: VALUE PREFERRED STOCK – CALCULATE THE YIELD TO CALL (YTC)

YIELD TO CALL (YTC) CALCULATOR

LESSON OBJECTIVES

1. Learn where you can conduct research on preferred stock.
2. Learn where you can find the essential elements of preferred stock.
3. Learn how you can determine the yield to call on a preferred stock.

LESSON SUMMARY

In this lesson we learn that www.QuantumOnline.com is the best resource to use when investigating preferred shares. The site is completely free, well organized information and the most comprehensive site on preferred shares. What is really strong about this site is the sorting function that is ranking the preferred stocks based on your preferences.

Among the desired qualities to look for is the presence of a call date that suits your investment horizon. The reason for that is that as soon as the call data has passed, the issuer has the option to buy your preferred share back at par value. Assuming you have chosen a preferred share with good qualities like a high yield, this would immediately be terminated when called back. Something you do not like to see is a coupon that has been delayed. This information can also be found in here.

The essential information for a preferred share to look for beside if it is called is if it is cumulative. While dividend can still be deferred it has to pay out the dividend at some point in time unless it goes bankrupt. Common stock holders cannot be paid before the preferred shareholders, which is a nice leverage to have for the preferred shareholders.

The risk of the issuing company not being able to meet their debt obligation is also very important to look for. When there is a high risk of that, it will turn into a delayed dividend payment to the preferred shareholders, and in the end for a loss of investment. What www.QuantumOnline.com is doing is giving you the credit rating from Moody’s and S&P. If you are not completely familiar with Moody’s and S&P you can find more information in lesson 14.

Another way to assess the health of the company is by looking at the debt to equity ratio and the current ratio, which was presented in lesson 18.

Again in this lesson we learned how important it is to learn as much about the preferred stock in question as possible. All preferred stocks have a prospectus, and any investor should read that carefully.

For evaluating a preferred stock Buffettsbooks.com has created a free calculator you can use. The output from the calculator is “yield to call”. That is a measure telling to which return you can expect to receive in annual yield until the preferred share has matured.

One thing that is important to remember when using this calculator, or any other valuating calculator, is that it is no guarantees for the calculated result. Your preferred share might be called or payments might be delayed.

In short, the investor should look for:

• Cumulative preferred stocks is favored contrarily to non-cumulative stocks.
• Does the preferred stock have a call date? – and is it appropriate for your investment horizon?
• Evaluate the company’s risk of not meeting the debt obligations.
• Prospectus in detail.
• Calculate the yield to call.

The most comprehensive literature if you want to learn more about preferred shares can be found in Security Analysis written by no other than Benjamin Graham, Warren Buffett’s mentor and professor. In this older, but still valid book, large sections are dedicated to preferred shares. While Benjamin Graham is in general skeptical about this form of security, he has excellent pointers in terms of which criteria he suggest preferred shares should be selected from.

Related Article: Preferred Stock Valuation

NEW VOCABULARY

Prospectus
A detailed document meeting the requirement of the SEC, disclosing all terms that a preferred share is offering potential investor.

Yield to Call
Often simply referred to as YTC, and is an estimate of the return the investor will receive from the respective preferred share from today and until it matures. It is a very used measure to compare preferred shares.

LESSON TRANSCRIPT

First of all, know that you will need to refer to the video to fully understand what’s written here.

On the left side of the video is the website quantumonline.com. On the right side is the buffettsbooks.com website.

Quantum Online is probably the best website to conduct research on preferred stocks. Everything under this is free. I recommend you sign up for an account, because you’ll have full access to all their different search results in different preferred shares and the access to the sight. Once you sign up for an account like mine, go to the income table. Click and select All Preferred Stock. It gives you pages of lists of all these preferred stocks that you can invest in. this is definitely the most comprehensive spot to find something that deals with preferred stocks. An online search looking at a preferred stock only comes up with nothing but unorganized information scattered. Quantum Online really have organized information.

We’ll start from left to right. At the very top you have the symbol, the security itself, the date that the security was introduced which is the IPOD, the coupon rate, the annual amount you’d be paid off for a dividend, the coupon rate, the dividend rate, the call price, the preferred stock that could be called at, the day for the call, the maturity date, the Moody’s ratings, and the S&P ratings. This is very useful when looking at preferred shares, because they often have a little bit of debt and sometimes doesn’t display the best financial deisions for the company that you’d be investing in. It tells you whether it’s a 15% tax rate or not. When you buy that, it has the full perspective where you can go ahead and pull off all the detailed information about a specific preferred stock. Last is the distribution dates – the very first one we’re looking at here.

It says suspended. That means the coupon or the dividend that this preferred stcok was paying is longer paying that. It gives you all the really important information all in one line for our preferred stock. You’re going to be hard pressed to find this type of information consolidated in one place. This is one reason I’m a huge proponent of Quantum Online.

One of the nice things about this website is at the top, if you want to filter all these preferred stocks based off the description, you can click security subscription. It puts the most appetizing ones at the top and the least durable at the bottom based off on that description. A high yield and accumulative preferred share at the top like this one is what we see here. Avoid something that has suspended dividend payment.

The call date is important. When looking for a preferred stock, you want to have a longer call day opposed to a shorter one, because if the call date is tomorrow and it’s a very high yielding preferred stock, the company will buy those. They don’t have to pay that high dividend. The longer the call date is, the longer you have to hold that preferred stock the better.

Now, click on call date to pull up all of these security based off the longest yielding call dates. The call dates keep in the next pages keep decreasing. On this first, Simon Property Group has 8 3/8% yields on the dividend. This is cumulative preferred stock, which is good. The call date is 2027. It’s 2012 now. You have approximately 15 years before you have the company’s ability to start buying these preferred shares back. That’s good thing if you’re buying this especially because it’s yielding high at 8.38%.

How powerful is this website to sort all these different preferred shares? Everything is all available on that one screen capture. To take a closer look to Simon Property Group, open it in another window. If you’re going to buy this preferred stock, this gives you all the information and all the details that you need to know.

Where can you find the essential information? First, look forward to a cumulative preferred stock. This means the company pays the dividend of 8.38%. If the company is running into some rough times and they don’t want to pay, they can withhold the dividend payment under a cumulative preferred, but when they don’t have enough money, they have to make up all the payments that they missed before they can pay anyone in the common. You’re eventually going to get your money especially if you hold it to the all date or the maturity date. You really want to avoid non-cumulative preferred.

The call date. The call date on the security is 2022 – 10 years from now before you own that preferred stock, and before it could be called back by what could be when they pay you. The rate they’ll pay you would be this call price of $25. If they were going to buy the preferred share back on you on that date, they would pay $25. The maturity date is typically when you’d receive the call price or the Par value of a bond.

You should know how much a debt the company has. Here are Moody’s and S&P’s ratings to give you a quick idea of the capability of the company to fulfill those payments. An A- proves the ability to meet their debt obligations. However, if the company falls on hard times, it would be stopped in split second because it’s a non-cumulative preferred share. If you want to dig deep, look at the Wachovia common shares – its debt to equity ratio, current ratio, etc. – and assess the health of the company.

If quantum online pulls up all the information you see now on the video specifically for the security, you may call their point of contact, Alice Lehman. Ask her any questions you want about this preferred share.

Let’s go ahead and use the Buffett’s Books Yield to Call Calculator to understand this lesson more. The company wants to purchase those preferred shares, because they don’t want to continue paying an 8% interest rate. To do this, decide which method to use. For me, I always look at the yield.

Now, I’ll show you a search tool on this website. Go up to the top and look up SPG-J. The preferred shares listed on the New York stocks exchange have a coupon rate of 8.3%, because it pays a dividend of $4.18 every year. This preferred shared will be bought back from you. They’ll pay $50. The call date on this is 2027, so we have approximately 15 years before this preferred share gets called back. It has no maturity date; beware of things like this! The premium depends on the interest rates. The value of preferred share and the value of a bond decreases as interest rates increase and vice versa. With low interest rate, this is the right time to look for shares or bonds. If you need short term, this is something to look at.

Let’s plug this in our calculator. Our annual dividend payment is $4.18. The call value is $50. Remember, no dollar sign or percent signs; just put in the raw numbers. Put 15 for the length of years of the call to date. Put in 15, but if you really want to do an accurate move, you have to estimate. For now, we’ll just put in 15. Here, we don’t see what these preferred stocks are currently trading for. Figure out by clicking over on to the New York stocks exchange chart. As we pull up, this is the information and you can see how this preferred share has been trading. It’s at $69.50 now.

Let’s go head and plug that in as our market price. When it says the coupon rate is 8.38%, that doesn’t mean you’ll 8.38%. That just means that you could buy it at the original price that they issued it at which was $50. You would get that 8.38% until the preferred share would be called or you just continue receiving that forever sine it has no maturity date.

That’s not the case here. This preferred share is for $69.50 if you buy it today. That return is going to be different than what this calculators doing. It figuring it out for based off the assumption that his companies is going to purchase these shares at that call date. Hit calculate and see that the yield to call is 4.832%. That’s significant difference. The person that would go can say this preferred share is an a cumulative preferred, which is good. However, again, that’s not the case at all, because you’re such a large premium. You’re paying almost $70 to buy this stock when it’s only callable at 50. That’s why your yield to call is much lower to 8.38. You’re seeing 4.832% now. That’s the thing that you really got to focus on when buying preferred shares. You might be better off buying a bond which is more secure than the preferred share, plus it pays a higher return! Buying a corporate bond is less risk. Consider these when you start looking at preferred shares.

It will take time, but if you go back and rematch this video and go to quantum online, you will understand better.