Preferred Stock Investors: Is It Time To Sell?

Today's elevated share prices for high quality[1] preferred stocks have left many preferred stock shareholders, who are looking at huge but unrealized capital gains building up in their brokerage cash accounts, wondering if they should sell and pocket the gains now while they can.

We all know that the market price pendulum swings both ways which is actually one of the many positive aspects of preferred stock investing. During times of low prices, preferred stock investors enjoy higher dividend income as yields increase and coupon rates offered by new issues become more generous. When prices go back up, shareholders have selling opportunities that bring income in the form of capital gains to those who choose to sell. Income generation swings back and forth between increasing dividends or increasing capital gains.

But those who realize their capital gains by selling their shares face a dilemma - since prices are so high, what do you then buy if you are to reinvest[2]?

Should You Sell?

If I were to offer you $100 today or the same $100 two years from now, which would you pick? Since an unknowable future has more risk, most people would take the same money sooner rather than later. That can become important when deciding whether or not to sell a preferred stock.

The decision that preferred stock investors have to make is whether or not it is in your best interest to sell the shares that you purchased when prices were much lower. After all, the quarterly dividend payments stop once you sell your shares.

But you will likely realize between one and three years of income in the form of a capital gain by selling at today's high prices.

Get Paid Twice On the Same Principal

By selling your shares and collecting a capital gain, rather than collecting future quarterly dividends, you are essentially being paid the same money but in advance. So any further returns that you earn by reinvesting your original principal are in addition to the return that you have already pocketed in the form of capital gain cash.

Even if you reinvest in another preferred stock that provides a lower dividend payment than what you were making on the sold shares, you are getting paid twice on the same principal over the reinvestment period.

Take a look at this example.

Let's say you purchased PSA-Q from Public Storage (PSA) a year or so ago when it was first introduced for $25.00 per share. PSA-Q pays a 6.50% annual dividend (coupon) so that's $0.41 per quarter of dividend income for every share that you own.

PSA-Q is selling for an unheard of $28.34 today (July 16, 2012) so by selling, you will realize a $3.34 capital gain per share.

That's over two years' worth of dividend income (8.1 quarters). By selling now, you earn the same income on your $25 principal but do so in advance (you earn the same money sooner rather than later).