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Rupert Hargreaves
Rupert Hargreaves
Articles (614)  | Author's Website |

Following Benjamin Graham Into Preference Shares

Graham loved preference shares. Should you?

October 10, 2018 | About:

If any readers are avid consumers of the writings of Benjamin Graham and other value investors active during the first half of the last century, something you will have noticed is that a large volume of the investment analysis and advice is focused on preferred stock.

Most of the time, when Graham is referring to stock, he is referring to preferred rather than common stock. In his work, he usually singles out "the common" (common stock), implying that this part of the capitalization structure did not feature prominently in his analysis work.

Today, however, references to preferred stock in the financial press are limited. The asset class has gone from being a widely referenced and analyzed segment of the market to an obscure part of the financial world.

Looking for value

With this being the case, I thought it might be interesting to take a look at this part of the market to try and provide some insight for investors who might be interested in this fascinating asset class.

Trying to find data on preference shares is not easy. Unlike common stock where there are literally thousands of websites providing constant analysis every single day, with preference shares you need to spend more time and effort analyzing each security and its place in the capital structure.

There are passive investments for investors who are unwilling to do the extra legwork. For example, the iShares U.S. Preferred Stock ETF is a $15 billion ETF with an expense ratio of 0.46% and an average daily volume of just over three million shares, which proves exposure to over 300 preference shares.

One of the largest holdings in this ETF is the Barclays PLC, Non-Cumulative Callable Dollar Preference Shares. These preference shares are an interesting way to bet on the success of UK-based Barclays Bank (NYSE:BCS).

Over the past 10 years, the common stock of this company has only disappointed investors, but the preference shares have produced a steady return. Currently trading 3.1% above the liquidation value of $25, the shares yield 7.9% and pay a dividend on a quarterly basis. As the stock is non-cumulative, dividends are only payable to the extent that payment can be made out of profits available for distribution, and do not accrue if it skips a distribution. With a net profit of £3.5 billion expected for 2018, it looks as if there's plenty of capital available to maintain the distribution for the foreseeable future.

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Staying with banks, another interesting security is Citigroup Inc. (NYSE:C)'s 6.875% Fixed Rate/Floating Rate Noncumulative Preferred Stock. Currently trading at 9% premium to liquidation value, this preference shares currently yields 6.3%. However, what is interesting about this particular security is that from Nov. 15, 2023, the dividend moves to a floating annual rate "equal to three-month LIBOR plus 4.130%." In a rising rate environment this could be an attractive investment. Having said that, one thing to note is that the stock also becomes callable on Nov. 12, 2023, which would allow Citi to repurchase the shares before they revert to the floating distribution.

A more exotic security is Kinder Morgan (NYSE:KMI)'s 9.75% Series A Mandatory Convertible Preferred Stock. This stock has a liquidation preference price of $50 and a current dividend yield of 13.4% paid quarterly. The conversion price on the shares is between $36.2840 and $30.8800.

The current price of Kinder Morgan's common is just under $19, which explains the 30% discount to the liquidation preference value.

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Nevertheless, this could be an attractive investment if you're looking for a way to play a recovery in Kinder Morgan's stock price while at the same time receiving a 14% annualized dividend yield.

This is just a snapshot of the wide variety of preference shares on the market today. As the market is so under followed by other investors, this could be a great place to find hidden value, just as it was when Benjamin Graham started his career in the 1920s.

Disclosure: The author owns no share mentioned.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


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