Dividends, preferred shares and a big Canadian bank
The best way to build income is through stocks, says this U.S. advisory whose two latest buys for income include one of Canada’s big banks.
What is the essence of investing?
You give somebody some money, and when they make money, they start giving it back to you.
Income investing means you start getting the money back sooner and more regularly.
But there are several ways to get that income back. And one U.S. advisory joins the growing chorus of experts who think that fixed-income securities are not the best way to do so these days.
The Complete Investor opts for dividend paying stocks and preferred shares, and has just added one of each to its Income Portfolio.
The dividend stock happens to be one of Canada’s big banks, so we’ll go there first. Then we’ll look at the preferred stock the advisory prefers.
Not least, we’ll find out why this advisory joins so many other experts in being wary of bonds and other fixed-income investments.
Confidence in the future
The Bank of Montreal (TSX/NYSE-BMO) was founded in 1817, Ms. Genia Turanova tells her U.S. readers. It is Canada’s third-largest bank, with more than 10 million customers in Canada and the American Midwest.
She stresses the fact that the bank has worked hard to reinvigorate its retail banking franchise in Canada. Indeed, she adds, each of the bank’s groups — BMO Bank of Montreal in Canada, Harris in the U.S., its wealth management private client group and BMO capital markets — share the vision of being “the bank that defines great customer experience.”
The author is not sparing in her praise. “Our confidence in the future of this financial institution grew even greater after the recently reported very strong quarterly results, which support our assessment of the value of the bank’s franchise.”
Higher trading revenues were the main reason the bank beat expectations, but all of the bank’s departments contributed, she reports.
The bank’s capital position and liquidity are both strong, particularly after its December equity offering. And BMO snapped up the Canadian life insurance operations of poor, battered AIG.
Earnings could easily grow in the low teens, the author concludes, and the 4.4 dividend yield certainly makes this an attractive income stock. It is trading today at $63.
If this glowing report is anything to go by, more U.S. investors may be putting their money in the Bank of Montreal soon.
Call-away risk
Chances are, if you’re out looking for preferred shares, you’ll choose a Canadian stock. But let’s see what the case for Comcast Corporation 7% Notes (NYSE-CCW) tells us about preferreds.
Comcast is America’s largest cable company, with over 24 million subscribers and high-speed Internet and telephone services to boot. It has “record-breaking levels of free cash flow,” Ms. Turanova tells us.
It has also taken NBC off General Electric’s hands. Overall, says the analyst, this is a well-run, financially strong company, which gives its preferred shares a solid BBC+ rating.
The dividend payment is fixed for the life of the security. In the case of Comcast, the quarterly payment of $0.4375 produces a handsome yield of 7 per cent. The shares have a face value of $25 and can be called back at that value after September 1, 2011. Right now they trade at $25.50.
If the shares were called back at a price just above face value, “it would be a virtual wash,” says Ms. Turanova, “and meanwhile you’d be getting a nearly 7 per cent dividend. So the call-away risk for Comcast is one we’d readily take.”
Half-bond, half-stock
Preferred shares usually trade at a premium to the common stock (Comcast’s common shares are at $18.83) — offering higher income and less price volatility. They are half-bond, half-stock.
In today’s capital markets, they may combine some of the best of both worlds, Ms. Turanova says. With interest rates stuck at low levels, that 7 per cent yield on a guaranteed dividend certainly looks better than the piddling returns on fixed-income investments.
When interest rates rise, bonds set at a lower payout rate become less desirable and decline in price. Bonds issued at higher rates push it aside and the holder is left holding the bag, as it were. That’s why this advisory’s Income Portfolio has only short maturities on bonds.
Preferred shares are not immune to interest rate changes, the author says. But as stocks they are less sensitive to interest rates and more sensitive to the forces affecting the market.
Similarly, inflation will chew away at any investment, but its ravages are even greater on bonds. Everything costs more and you’re effectively taking in less and less with your fixed interest payments.
In Canada, of course, there is also a clear advantage to receiving dividends, which are taxed at a lesser rate than interest payments.
In the end, Ms. Turanova says, preferred shares can help to fine tune an income portfolio. But the best of all worlds is still found in “the stocks of companies positioned to increase their dividend payments — matching or, better yet, outpacing inflation — rather than the debt issued by those or other companies.”
In short, the good old dividend paying common stock is still king. And a Canadian bank stock is the latest to wear the crown.
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