Income Portfolio Analysis
A Top-Line Analysis of Income-Generating Investment Strategies
When investors navigate the complexities of evaluating income-producing portfolio strategies, a critical decision emerges: whether to invest in general common stocks with dividends, REIT stocks with dividends, preferred stocks, corporate bonds, and treasury bonds. This document aims to address each of these options, incorporating insights on the structure of the assets, risk, liquidation preference, growth limits, voting rights, and possible tax efficiencies.
We broke out this analysis into sections to walk through each pairing so as not to get overwhelmed by the comparisons.
Preferred Stock vs. Common Stock Dividends: Starting with the most commonly discussed pairing of preferred stock shares vs. general common stock shares that pay dividends. While everyone knows common stock shares that you buy and sell on the exchanges are pure equity purchases that rise and fall with the whims of the market. For this comparison, we are focusing on only those common shares that pay common dividends to keep it comparable for the topic at hand; which is income-producing assets.
Since preferred securities are higher in seniority than common equities, dividends must be paid to preferred shareholders before common shareholders.
I. Priority in Dividend Payments: Preferred stock dividends receive preferential treatment over common stock dividends, entitling preferred stockholders to dividends before their common counterparts. This prioritization ensures a more stable income stream for preferred stockholders, particularly during economic uncertainty, offering a sense of security and reliability.
II. Fixed Dividend Payments: Preferred stock dividends are typically fixed, providing a predictable and steady income for investors. In contrast, common stock dividends fluctuate based on company earnings and board decisions, making them less reliable for income-focused investors. The fixed nature of preferred stock dividends is especially appealing to risk-averse investors seeking stability.
III. Convertibility and Call Features: Preferred stocks occasionally offer additional features like convertibility into common stock or call options, providing flexibility and potential for capital appreciation. These features enhance the appeal of preferred stock dividends. Evoking this strategy has been a long-time favorite of Warren Buffett. His trades have been well-documented, such as when he bailed out Bank of America back in August of 2011 with a $5 billion investment of preferred shares. The shares paid a 6% annual dividend and were convertible to common shares at $7.14 each. The Oracle of Omaha exercised his right to convert those preferred shares to 700 million common shares in June 2017, making an instant profit of $11.7 billion on top of the annual dividends collected since 2011.
IV. Tax Efficiency: In some jurisdictions, preferred stock dividends may be taxed at a more favorable rate than interest income from corporate bonds, adding to the after-tax returns for preferred stockholders. This tax advantage further strengthens the case for preferred stock dividends in income-oriented investment strategies.
V. Sector Concentration: Common stock shares that pay out dividends happen in all sectors of the market across any dividend-paying stock and long-standing “Kings” and “Aristocrat” dividend payers such as KO, IBM, BMY, CMCSA, MMM, etc.