Rationale for the stock selection
Since the shares of preferred stocks have dividends that must be paid out before bonuses to the common shareholders, they are the class of ownership in a corporation. Thereby, possessing high claims on the company's assets, common stock, and earnings. It does not carry voting rights. Additionally, the preferred shares more rights as compared to the ordinary shares. Therefore, the rationale for selecting this stock rely on the ability of companies to retain the issue options of buying the common shares at an exercise price with a reasonable discount from the prices of the preferred securities. The accounting and tax laws have been severe previously particularly on the valuation of the ordinary stocks. Consequently, companies used to value their preferred stocks over five times more valuable than the ordinary shares before the initial public offer (IPO). This implies that an investor should purchase preferred shares to get rights, preferences as well as some privileges to the previous common stocks. That is my rationale for the preferred stocks are inclusive of the provisions for the voting as well as the protection of anti-dilution.
Financial importance
The preferred stocks combine characteristics of the debt since it pays for the perpetual dividends and equity. It also contains the appreciation potential concerning the prices. However, the facts about each preferred securities depend on its issue. Its shareholders have the over the ordinary stockholders, particularly when it comes to dividend payments that normally have high yields than the common shareholder. Moreover, payments can either be remitted every month or quarterly with fixed dividends that are set regarding the benchmark of interest rates. The rates for preferred securities are adjustable to specify some factors that may influence the dividend yield. Alternatively, the participating shares are capable of compensating extra bonuses that were to be computed using the common stock dividends, or the profits of the organization.
Economic importance
The preference for liquidation is the most important economic privilege of the preferred shares and the ability to make recoveries on the investments, especially upon the company liquidation. Similarly, during tough economic times, the preferred shareholders are the favored over the common stockholders. It implies that preferred shareholders will receive their dividends before other stockholders. For instance, when an organization fails to declare any payment, the ordinary shareholders will get their dividends and the preferences will always provide the right to share the extra earnings of the firm. It is evident that dividends on preferred are stated as a percentage of the par value. Therefore, the par price of the preferences will enjoy some economic significance. For example, if Apple Inc. issues 10% of the preferred shares with a par value of $ 1000, the stockholders will get $ 100 every year. Therefore, the par value is economically significant because it acts as a factor that determines the number of dividends.
Question two
Profile of the client
Since the customer is a long term investor with a diversified financial market, holder of fixed income as well as an income-oriented investor, preferred stocks best suits him to compliments the fixed income due to the high returns it provides. The investor should make a consideration on the preferred securities for the diversification of investments in his portfolio because it acts as a composite stock. Similarly, it can be an additional source of earnings besides just purchasing the bonds.
Reasons why preferred stock is good for investment
According to the above outline of the customer, preferred stocks is the most appropriate for his investment purposes due to the following:
The shares are appealing to the investors who are income oriented due to high yielding hybrids. This is because it usually comes with trade-offs that always deserve a close supervision.
The stock has status. This implies that is less volatile as compared to the common stocks: thereby, offering free flow of income
It has a positive correlation with enduring treasures that rely on the financial status of the issuing corporation.
Question three
EPS
The earnings per share ratio are the measurement of the net income of an organization that is available for paying the ordinary shareholders (Khan, 2010). Any firm with high EPS can generate a substantial dividend for the stock depositors. Moreover, such companies will reinvest the capitals into its business operations for more growth. The EPS of Apple Inc. is 9.58, 6.74, and 5.88 for 2015, 2014, and 2013 respectively. As per the values, the company is more worthwhile regarding investments in 2015 as compared to the remaining financial periods. This is due to fair stock values of Apple in 2015. The firm is valuable throughout the three fiscal years since the trend of the ratio is positive. It means that Apple Inc. is making an increasing value on its earnings when purchasing the stock.
P/E
This ratio is applied during the periods of company valuations. Therefore, it measures the present share price of the organization concerning its earnings per share. Apple Inc. recorded a low P/E ratio as represented by the current and future performance of the company. That is it indicates poor investment decisions. The P/E ratio show much an investor may pay in common stock for every dollar of the current earnings. The P/E ratio of Apple Inc. increased from 2013 with a slight decrease in 2014 and 2015 (Apple Inc., 2016). Regardless of the lowest ratio in 2014, the EPS of Apple Inc. Increased steadily and this indicates an increase of the market share. The P/E ratio of the company is high, and this is an indication of a prospective performance because the investors are willing to make additional payments for the shares of Apple Inc. Consequently, there is an anticipation of future performance and growth.
Current ratio
This ratio shows that there is the availability of adequate current assets that can be used to settle the current liabilities of the company (Loth, 2007). The current for Apple Inc. are 1.11, 1.08, and 1.68 in 2015, 2014, and 2013 respectively. According to the calculations, Apple Inc. had sufficient cash to pay for the current obligations since it was above one across the three fiscal periods.
Acid test ratio
Apple Inc. recorded a quick ratio of 1.08, 1.05, and 1.64 across 2015 to 2013. This indicates that it was above the thumb rule over the three financial periods showing best improvements.
Net profit margin
It is the net income earned by any organization over the net sales. Based on the calculations in the Appendix, the profit increased slightly from 2013 to 2015. Thus, showing that the net income of Apple Inc. increased steadily though with a slight margin.
Ratio analysis is an essential examination that is usually associated with income statement, balance sheet, and statement of cash flows of a company (Lohrey, 2016). Therefore, financial ratios provide significant records that need to be compared to the service sector in which Apple Inc. operates. By ratio application, investors can feel free particularly to the attractiveness of the organization, but upon the competitive advantage, financial power, and profitability. According to ratio analysis based on calculations in the appendix, the profitability of Apple Inc. is favorable since it has a reasonable profit margin ratio. Also, the liquidity state of Apple is good throughout the three fiscal years of analysis (2015, 2014, and 2013). Both current and acid test ratio that represents the efficiency shows that the corporation is efficient in its business activities.
Question four
Risk level of preferred stocks
Maturity
The maturity period of the preferred stocks that usually take longer time is problematic. Therefore, the historical evidence of the risk and rewards of the fixed return investment involves the known extension of maturities for the poorest characteristics. This will lead to low returns for any hazardous level. This stock normally has less call provisions that are either perpetual with no maturity date or characterized by long-term maturity date, usually more than three decades. Other issues also do arise with the stated maturity like the choice of the issuer that is extending for extra years. Alternatively, the financiers that are considering to buy preferred stocks need to consider the choices of buying a bond from companies from the same industry to pay similar interest rates with 100- year maturity. However, this might be dangerous because the expiry period is too long.
Compensation
Since investment in preferred stocks is considered as technical, it is standing behind the debt holders especially in the line-up of credit. Although the preferred investors normally get the priority over the ordinary stockholders, in the event of bankruptcy, the common shareholders will receive the share before the preferred stockholders. The ordinary shareholders benefit from any slight increase in the value of the organization. However, the proceeds from preferred shares act as a function of security or a variable of a dividend yield. The long-term maturities that possess stable yields provide a hedge against a deflationary condition.
Call-up
The problem with the preferred securities is that the features of the call always negates the gains of the longer maturity by decreasing the situation of the interest rate (Swedroe, 2012). Thus, its holders will not enjoy the increasing value that is occurring with non-callable and secure stock rates in a falling setting rate case. It denotes that if the issuer is not in a position to call in the preferred shares, then it is due to the worsening credit, and this will put the key investors at risk.
Negative yields
Another challenge of the preferred stock market is the frequency of the securities that are having negative earnings. These are the stocks with the upcoming call dates or those that are currently callable to generate negative incomes. That is if preference shares are bought on a secondary market at above par value and it had been called by the issuer after that, the entire income will be unfavorable (negative).
Strategies
Call provisions
When a company like Apple Inc. is experiencing systematic risks for a long time as the interest rate increases, the future call will put a lid returns with the decreasing rates. Consequently, the preferred stocks will hardly trade above the issue price. Thus, the fully callable shares will at par. Thereby, there will be an extreme possibility when stocks are purchased at par. However, the protection from the calls is suitable for the investors with income-oriented objectives because the callable methods will present a reinvestment risk. Moreover, the reinvesting risks for the proceeds of the called assets will be at a low rate. Through calls, the investor may not access high streams of income. So the incremental portion of the preferred stock yields that is almost unsalable and issued as a debt in the enterprise will be compensated for permitting the issuer to make a call in the debt when the rate proves to be positive. Preferred securities are nearly callable with the decreasing interest rates. Therefore, such stocks are called to provide room to refinance risk during low interest rates in the business environment.
An active approach
The preferred stock is a niche market, and it may be difficult to invest is such securities. Due to the complexity of the market, the active method is preferable when investing in an exchange trade to track the index as well as controlling the investment accounts in preferred separately.
Recommendation
In a scenario where there are many income-oriented investors, prolonged periods that are characterized by low interest rates will promote such stockholders to look for investments that are likely to deliver high returns. So in the mission for other well-paying investments, they should consider purchasing the preferred stocks. Hence, it is an ideal investment at first particularly to those that are looking for income producing funds. Since it always delivers high returns as compared to the common stocks, and corporate bonds, there are more alternatives for its consideration. An investor should understand the make-up of the preferred securities that is dissimilar from the common stocks plus other yielding stocks before making any investment decisions.
References
Apple Inc. (AAPL) | Valuation Ratios. (2016). Stock Analysis on Net. Retrieved 6 September 2016, from https://www.stock-analysis-on.net/NASDAQ/Company/Apple-Inc/Valuation/Ratios
Khan, J. (2010). Management Accounting (5th ed.). Tata McGraw-Hill Education.
Lohrey, J. (2016). Smallbusiness.chron.com. Retrieved 6 September 2016, from http://smallbusiness.chron.com/importance-ratio-analysis-financial-planning-80600.html
Loth, R. (2007). Liquidity Measurement Ratios: Current Ratio | Investopedia. Investopedia. Retrieved 6 September 2016, from http://www.investopedia.com/university/ratios/liquidity-measurement/ratio1.asp
Swedroe, L. (2012). Why you should avoid preferred stocks. Cbsnews.com. Retrieved 6 September 2016, from http://www.cbsnews.com/news/why-you-should-avoid-preferred-stocks/
Appendix
Calculation of ratios-Apple Inc.
Links for financial statements of Apple Inc.
http://investor.apple.com/secfiling.cfm?filingid=1193125-14-383437
https://www.sec.gov/Archives/edgar/data/320193/000119312515356351/d17062d10k.htm
http://investor.apple.com/secfiling.cfm?filingid=1193125-12-444068
