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I was reading Agree Realty's latest annual report when I spotted their preferred shares (ADC.PRA) on the cover page.
Source: ADC Annual Report
It reminded me that many investors, especially newer ones, might not be familiar with preferred shares or where they fit in the corporate structure. Even for those of us who've been investing for a while, it's a good refresher on why I generally avoid these things.
Let me show you something that will help everything make sense.
Corporate Capital Structure
This pyramid shows us exactly who gets paid first in a company. Think of it as a "who gets the money" pecking order. In a liquidation event (when a company goes broke), any leftover assets start at the top and flow to the bottom. This is why the common stockholders usually get nada when a company goes kaput!
•At the very top, we've got Senior Secured Bonds. They get first dibs on everything and specific company assets back their debt.
•Next down are senior unsecured bonds, second in line but not backed by specific assets. But they're still near the front of the line.
•That middle section with Convertible & Subordinated Debt? Think of them as holding combo meal tickets - they might get to swap their position for something else later.
•Then we get to Preferred Stock. They're standing in line ahead of common stockholders but behind ALL the bondholders. They get steady dividend payments... until they don't.
•Finally, at the bottom, we have Common Stock—that's what most of us own. We're last in line for assets but first in line for company growth!
Here's what makes preferred shares quirky - while bonds are straight-up debt (like a loan to the company), preferred shares are technically stock (ownership) but act more like debt. You get the fixed payments like a bond but without a guarantee of returning your principal. Meanwhile, you miss out on the growth potential that makes stock ownership worthwhile in the first place.
Companies issue these preferred shares for a clever reason - they get to raise money without taking on more debt (which could hurt their credit rating) and diluting their common stockholders' voting power. Plus, some institutional investors like insurance companies and banks must hold a certain amount of preferred shares for regulatory reasons.
Investopedia.com
Let's look at what's happened with ADC.PRA. They issued these shares at $25 each with a 4.25% monthly dividend yield. Sounds safe enough, right? Check this out:
Source: Dividendchannel.com
If you put $10,000 into both the common stock (ADC) and the preferred shares (ADC.PRA) at their beginning in September 2021:
•The common stock grew to $12,376.65
•The preferred shares shrank to $9,270.34
You read that right - even with those "stable" monthly dividend payments reinvested, preferred shareholders LOST money while common shareholders made over $2,300!
There's more. These preferred shares barely trade - only about 7.6K shares daily compared to 519K for the common stock. That could create an issue getting out quickly and at your desired price.
These preferred shares got crushed when interest rates started climbing (and at a record pace). It makes sense - when new preferred shares are issued at 6-7%, nobody wants your old 4.25% shares unless the price drops significantly to make them worth buying. Remember what we say: "When the share price drops, the dividend yield pops!"
Unlike bonds, which at least promise to give you your money back at maturity, preferred shares can exist forever. Sure, Agree has the OPTION to repurchase them at $25 after the call date in 2026, but they don't HAVE to. Why would they if they'd have to issue new preferred shares at higher rates?
Source: Yahoo! Finance
You might look at today's price of $19.60 and think, "Hey, if they call these at $25, that's a nice profit!" But that's a big IF. You could be stuck holding these forever if rates stay high. Meanwhile, your principal is sinking in quicksand while the dividend stays fixed.
For retirees looking for stable income, I get the appeal. A fixed dividend sounds nice. But when your $25 investment drops to $19.60, that stable dividend no longer feels so comforting. And with inflation eating away at your fixed payments? Yuk!
For newer investors, you might think preferred shares are a safer way to start investing. But look at what happened here - you're taking on:
•Interest rate risk (as we've painfully seen)
•Limited upside (no participation in company growth)
•Liquidity risk (try selling quickly with only 7.6K daily volume)
•Inflation risk (fixed payments while everything gets more expensive)
Want safety? Go with bonds - at least you know when you'll get your money back. Want growth? Stick with common stocks - look at how ADC's common shares performed! Want reliable income? Consider Treasury bonds or dividend growth stocks that can increase their payments over time.
Sometimes, the most valuable investing lessons come from understanding what not to buy. Preferred shares might seem like a nice middle ground between bonds and stocks, but they often combine some of the worst features of both—especially in a rising-rate environment.
For most retail investors like us, there are too many risks and not enough rewards. I'll stick with more straightforward investments, where I can clearly understand what I own and why I own it.
Am I way off base, or am I missing something? Do you invest in preferred shares? I'd love it if you hit REPLY and let me know!
Keep compounding!
~Russ
😁THANK YOU to everyone who responded to the last newsletter!!
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