JPMorgan Chase Series EE: An Inaugural Investment In Preferred Shares

JPMorgan Chase & Co. 6 DEP NCM PFD EE (JPM.PC)

Growth at reasonable price, long-term horizon, value

In the fall of 2018, it was confirmed – my investment clubs portfolio is not yet as bullet-proof as it could be. Its time to stretch beyond our comfort zone.

Some sources distinctly recommend individual investors should not invest in individual preferred stocks. Others endorse it as a valid means of diversifying a portfolio, avoiding risk and hedging against volatility.

Rather than scouring through hundreds of options, my investment club opted to start with a new preferred issue from JP Morgan Chase, a company already on our watch list.

The Series EE issue has a call date of March 1, 2024, is perpetual and pays 6%, nearly double the yield of the common stock.

Ive suspected it since late 2015. When the market sold off andcorrectedin the fall of 2018, it was confirmed. My investment clubs portfolio is not yet as bullet-proof as it could be. The value slipped more than wed prefer in the 2018 reset.

My official title in the club is Portfolio Steward. My responsibilities include managing and balancing our accounts, tracking performance and researching investment opportunities. Ive taken on the responsibility of identifying problems and proposing solutions, because the first without the latter seems indolent.

Initially, our investing strategy was growth at a reasonable price (GARP). In 2016, we adopted a focus on income and began migrating toward a DGI (dividend growth investing) model. In just three years, we have more than doubled our annual income. We improved our yield on cost 70%. So, we have made substantial progress on the shift. But, the downturn late last year highlighted theres room for more defense, forhedgingagainst volatility.

Its time to stretch beyond our comfort zone. I opted to start with preferred shares.

Before I started researching actual investment opportunities, I brushed up on the basic concepts regarding preferred shares. I reviewed several sources:

SAblog post,A Guide To Investing In Preferred Shares, from Colorado Wealth Management Fund,

SAarticle,Is Your Preferred Stock About To Be Called?, from Doug LeDu,

article,The Basics of Investing In Preferred Stock, website,

article,Why Now is the Time to Invest in a Preferred Stock ETF, on mwebsite,

article,Why You Should Avoid Preferred Stocks,,

article,Should You Invest in Preferred Stocks?, from Cash Cow Couples website, and

article,Critical Facts You Need to Know About Preferred Stock,from thedividend.comwebsite.

Interestingly, several of the pieces distinctly recommend individual investors should not invest in individual preferred stocks.

You should never own individual preferred stocks. You should buy a diversified fund that invests in a number of different preferred shares. (from Cash Cow Couple)

The truth is preferred stock, generally speaking, doesnt make much sense for individual investors. (

First, because of the need to diversify the risks, one shouldnt buy individual preferred stocks. (

On the other hand, other sources endorse investing in preferred shares as a valid means of diversifying a portfolio, avoiding risk and hedging against volatility.

Unlike common stock, investors in preferred shares are assured a minimal value (the call price) at a specific future date (the call date). However, this same assured value typically means preferred shares trade in a fairly tight range. Thus, the majority of the return earned on preferred shares is generated from the dividend.

Regarding the dividend, the yield on preferred shares is usually greater than the yield on common stock. Dividend distribution on preferred shares is given precedence over common shares. However, the dividend rate on preferred shares is typically fixed through the call date and does not have the potential to grow like the dividend rate for a common share.

The factors for specific preferred shares, such as the call price, call date, dividend rate, etc., are defined in the issuing companys prospectus. Factors can and do vary. For example, the dividend rate may shift from a fixed rate to a floating rate after the call date. Or, the dividend can be cumulative or non-cumulative which defines whether the payment will be made should distributions be skipped. Some preferred stock is convertible, meaning, under specific conditions, it can be converted into common stock. Most preferred stock is issued without a maturity date, that is it is perpetual.

So, although the factors may vary from issue to issue, they are known. In that regard, the risk in investing in preferred shares is lessened. Thats not to say there is not risk involved. The articles listed above cover well the concerns.

The primary unknown on perpetual preferred shares is whether the issuing company will redeem and retire the shares. If the shares arent redeemed, dividend payments continue. There are preferred stock issues which have beenactivefor years, a few for decades. For example, iStar Financials 8% Series DissueSTAR.PD) had a call date in 2002.

The likelihood of an issuer redeeming its preferred shares is usually determined by whether the company can lower its cost of capital by replacing the issue with a lower rate. Because there is no obligation to redeem and no maturity date, preferred stock is considered equity on a companys balance sheet rather than a debt obligation. Thus, issuing preferred shares can help a company protect its debt-to-equity ratio. However, should interest rates rise above the yield, preferred shares tend to lose value.

Understanding the basics of investing in preferred shares is actually probably easier than finding quality preferred shares for investment. The websites,, offer preferred stock information that may be accessed free of charge.

Its also pertinent to understand there is not a standard method foridentifyingpreferred shares.

On the QuantumOnline (QOL) website, and Im sure all other websites, preferred ticker symbols cause the most confusion and generate more questions than most other problems combined.

On Seeking Alpha, preferred stocks are identified by a .Pxafter the ticker where thexidentifies the issue. However, on online broker sites, they may be identified in a completely different manner. To complicate it even further, the accounting software used by my investment club identifies preferred shares by yet another qualifier.

Rather than spending weeks or months analyzing options from a list of preferred shares, I chose another approach. My clubs portfolio is notoriously shy in the Financial sector. JPMorgan Chase (JPM) has been on our watch list for a while, although theres been relatively little passion for the idea. Perhaps the decreased risk of investing in preferred shares would offset the clubs hesitation and distaste for the Financial sector.

Thus, when the financial giant introduced a new preferred,Series EEJPM.PC), in late January, it caught my eye. It will pay 6%, has a call date of March 1, 2024, has no maturity date and is non-cumulative.

The yield is not as robust as other outstanding preferred issues from JPMorgan Chase. But, the call dates on those issues are much nearer. The yield is a quarter percentage greater than its last issue,Series DDJPM.PD), in the fall of 2018.

In early February, Seeking Alphas Arbitrage Tradercomparedthe Series EE issue to other preferred stocks. It consistently fell in the middle, standing out neither to the high side nor the low. He explained the issue could be added to theS&P U.S. Preferred Stock iShares Indexif its average monthly volume, after six months, surpasses 250,000. The iShares Preferred and Income Securities ETF (PFF) benchmarks the index. He noted the ETF is in the midst of an objective shift.

Since the requirements for addition of the New Index are much likely the same as the old one (with the difference that the New Index will also include notes), with a high probability JPM-C will be included to the PFF holdings.

Many of the sources (external to SA) assessing the ownership of preferred shares recommended investing in an ETF instead. So, if JPMorgans Series EE issue were included in the PFF ETF, it could be a viable option. However, because of the six-month waiting period, waiting on inclusion to invest in something, whether it be preferred stock or ETF, would mean missing dividend payments. Furthermore, the ETFsexpense ratiois 0.46% and its five-year total return, as of December 31, 2018, was only 4.39%.

Thus, the numbers dont condone waiting. And here, its worth noting Seeking Alpha contributor, Colorado Wealth Management, specificallytargetsoutperforming PFF by investing in individual preferred stocks.

We generally have 3 goals for each year. Beat VNQ. Beat PFF. Beat 6%.

The club was receptive to the idea of expanding our investment alternatives beyond common stock. Granted, during my presentation, I did purposely mention repeatedly the magnitude of our paper loss last fall. And, even though the vast majority of that paper loss has since been recovered, the wound was still fresh enough to spark a solid interest in hedging against volatility through alternative investing options.

As well, the club was receptive to the JPMorgan Chase Series EE issue. Though, many preferred stocks trade at adiscount, we even voted to invest at a slight premium. And, yes, we are fully aware we are biting into our total return. We will simply consider it a cost of education, an expense allowing us to benefit while we search further for preferred stocks of interest.

As we learn more about the nuances of investing in preferred shares, just as an individual investor would, we have expectations and targets to tweak.

For example, we target 7-1/2% annual growth in total return for our common stock. Thus, individual investments should double in ten years. Because of the bull market, our investments have far exceeded that target. But, doubling our original investment in ten years is an unrealistic target for preferred stocks.

On the subject of total return, dividend reinvestment is a key factor in our strategy. Since this wont be an option with preferred dividend payments, well also have to decide a strategy for that cash. We can add it to the dues we collect monthly and treat it equally but lose its sourcing. Or, we could try to separate it and track it, allowing us to determine a true return on the original investment. However, that would be a manual process and it may not warrant the effort.

We also need to set a target for diversification. In our migration from GARP to DGI, we did not abandon our GARP investments. Thus, we knew we wouldnt get to a 100% income-generating or DGI portfolio. At this point, approximately 21% of our investment basis does not generate income. As we continue to follow a DGI model, this percentage will naturally decrease. Now, well need to decide a reasonable proportion for our hedging strategy.

Knowing these things in your head doesnt necessarily eliminate the gut punch when the numbers in your portfolio fall. But, it does help during the wait.

My investment club has decided having a few investments with relatively stable pricing and a steady dividend will also help. Its time to explore more preferred issues.

Disclosure:I am/we are long JPM.PC.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.