Christian Farstad - Vancouver ScotiaMcleod

Investors are often confused regarding calculating the rate of return they will be getting on rate reset preferred shares. Don’t be suckered into thinking that the yield is what your return will be. This is a common misunderstanding.

If the rate reset preferred share you are considering buying is trading above the par value of $25 you need to consider the capital loss if the shares are called at the reset date. Remember that many rate resets are called on their reset dates so this a real concern.

To calculate the yield to reset you need to include the current yield plus the eventual capital loss if the shares are called at the reset date. Many Canadian bank preferred shares are trading with a current yield of 5% but the yield to reset is much lower as they trade at premium. The yield to reset for many Canadian banks is in the high 3% area.

This is still a good return for a pretty conservative investment especially when you take into consideration the dividend tax credit.  Plus, the high current yield allows you take even more advantage of the dividend tax credit compared with other preferred shares and your capital loss can be offset with some capital gains.

To bring the point home, I want to reiterate the importance of knowing what you are buying and why you are buying it. Don’t make the current yield mistake. Make sure you understand yield to reset for the different types of preferred shares.

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