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Don't buy common stock in banks, buy preferred stock or bonds



May 12, 2009 – Comments (9)

I had a quick thought this morning as I was making breakfast for my kids. 

The earnings per share of banks are going to be a complete joke for a long time to come.

Think about it.  Banks are diluting the he-two-sticks out of common shareholders right now by issuing new shares out the wazoo.  So EPS would be lower than it in the past if things return to "normal" already.

Compounding this fact is that it turns out that the "normal" earnings that banks put up over the past several years weren't really normal at all.  They used tons of leverage and other tricks and trinkets puff up their EPS.

Throw some terrible toxic assets, oops I mean "legacy" assets, into the mix.

Mix well.

And Ta Da, you have a recipe for terrible earnings per share for banks for years to come.

I have invested in banks during this crisis, but I did so using preferred stock and bonds.  I own Goldman / JPMorgan Chase / B o f A / AmEx bonds and Wells Fargo / B of A / Goldman preferred stock.  I have been making smaller bets and spreading them around.  I'll be darned if I am going to watch the government piss away my tax dollars and not come a long for the ride. 

The yields on these instruments are fantastic. Banks may not be able to make a lot of money per share for common shareholders in the future, but they are contractually obligated to continue to pay interest and dividends on the things that I own as long as they are in business (I know that simplifies things a little bit and they certainly aren't without risk, but you get the idea).

Owners of common stock grumble every time they get diluted with new share issuances, but as a preferred stock / bondholder every time I hear about one in a company that I am invested in I do a little dance.

That's all for now.  I'm running late.


9 Comments – Post Your Own

#1) On May 12, 2009 at 7:32 AM, kaskoosek (30.28) wrote:


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#2) On May 12, 2009 at 7:50 AM, jszoke01 (26.85) wrote:

So what happens if we have several more IndyMacs, and the administration decides that they want to save the common stockholders by making everyone an equal creditor in bankruptcy court?  They did it at Chrysler, I don't see why they wouldn't do it anywhere else they would feel it was in the interest of the common shareholder.

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#3) On May 12, 2009 at 8:36 AM, russiangambit (28.70) wrote:

I used have PGF, but then I sold because I didn't understand how the conversion of preferreds into common to raise capital would affect PGF. Any thoughts on that?

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#4) On May 12, 2009 at 9:19 AM, Gemini846 (34.32) wrote:

And furthermore what happens when the Fed comes in and forces banks like C to convert to common and you get a less favorable conversion rate than the Saudis?

Now the banks you listed (save maybe BoA) seem to be on a little better footing, but the risk of dillution is still there.

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#5) On May 12, 2009 at 9:43 AM, TMFDeej (97.54) wrote:

You two are right, preferred stock is not without risk.  To be honest, nothing is.  But I would much rather take my chances higher up the capital ladder than with common stock.

I made my small B of A preferred investment, one of the smallest positions in my portfolio, with my eyes wide open.  There's a lot of risk and a tremendous reward in the form of the sky high dividend yield that I am receiving on the B of A preferred that I picked up several months ago.  To me, the risk justifies the reward.

IndyMac and Chrysler filed for bankruptcy.  While bankruptcy risk is always there, particularly for Citi, all of the banks outside of B of A are in pretty decent shape.  Besides for whatever reason, the Fed and the Treasury are determined to prop up zombie banks come hell or high water. 

If the banks that I mentioned start dropping like flies then we're all in big, big trouble and my small stake in preferred stock or bonds is the least of my problems.

I'm not saying for anyone to stick their whole portfolio in bank preferred stock.  I'm just saying that for me several months ago and possibly again in the future the yields on preferred and bonds in the financial sector made the risk of placing a small portion of my total portfolio in them worth it.  Your mileage may vary. 


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#6) On May 12, 2009 at 9:46 AM, TMFDeej (97.54) wrote:

Hey Russian.  I'm long PGF in CAPS only because it is next to impossible to buy preferred stock and bonds in this system.  In real life I prefer to know exactly what I am buying and to do so directly rather than through ETFs. 

ETFs definitely spread out risk by diversifying, but if you buy stocks and bonds right and diversify on your own that's not really an issue.  ETFs are a little black-boxish for my taste, but many people like them.


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#7) On May 12, 2009 at 11:40 AM, supershef (< 20) wrote:

Hi, I'm a reporter with a leading U.S. newspaper, and am looking to speak with individuals who own preferred shares/ETFs, for a story I'm writing. Would you be willing to speak with me for this story? If so, please email me at: I look forward to hearing from you at the soonest! Thanks. S.A.

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#8) On May 12, 2009 at 11:45 AM, WhartonFool11 (50.57) wrote:

What's a good website to view quotes on preferred stock?  I couldn't find them on Yahoo Finance.

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#9) On May 12, 2009 at 5:25 PM, walt373 (99.85) wrote:

Banks are clearly going to lose a lot of earning power in the future. Yet JPM and WFC are actually up from July 2008. Why is this? There are only two reasons I can think of:

1) Banks were really freaking undervalued in July 2008. Somehow I doubt this because a lot of the problems in the financial system were revealed afterwards.

2) People are very optimistic about their prospects going forward. Although their ROE will no doubt be lower due to less leverage, they did make some acquisitions that will increase their revenues. Bear Stearns was acquired at a relatively low price and Buffett did say some nice things about WFC. Also, the competition is much weaker now.

Just offering some food for thought. In my opinion though, I think the coming negative changes to the economic landscape, especially for financials, will far outweigh any of these factors.

But I think you are right, they will still be able to pay interest.

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