In our last issue we covered two preferred stocks that offered higher yields than common stocks and were less volatile, providing a degree of security against dividend cuts.

This time we’re going to a look at convertible preferred shares. These are preferred stocks, which in addition to offering extremely attractive yields can be converted into common shares. The advantage is that they offer a fixed rate of return because they are preferred shares, plus have the potential for capital appreciation as they can be exchanged for common shares. This generally can be done at the holder’s option after certain conditions are met.

Whether you’re better off holding convertible preferreds or swapping them for common stocks depends on your circumstances. Use the conversion ratio to determine if making the trade is potentially advantageous by dividing the current price of a convertible by the number of common shares you would receive in exchange. If that ratio is lower than the price of the common stock, you should profit from the swap.

Ring a Bell

Cincinnati Bell is a regional telecom, providing wireline, Internet and cellular-phone services in the greater Cincinnati, Ohio, area, including parts of Indiana and Kentucky. Like most regional providers, the telecom struggled to grow due to competition from national operators. It also faced competition from cable companies, such as Time Warner Cable, which now offer phone and Internet services.

But while the company’s common stock had difficulty  moving higher, its Cincinnati Bell 6.75% Cumulative Convertible gained about 2.6% over the trailing year and currently yields 6.8%.

The shares became callable back in 2000, which means the telecom has the option of liquidating them and paying shareholders $50 a share. But that seems unlikely, as it would drain the company’s limited cash significantly. That said, there is enough cash flow to continue covering the $0.84 quarterly dividend on these shares, so the risk of default is small.

If you were so inclined, each of these convertible shares can be exchanged for 1.44 shares of common stock at any time, but for the swap to be profitable, the stock would need to trade at more than $34 per share. Unfortunately, the common stock is nowhere near that price right now and currently trades around $4.

Cincinnati Bell’s common shares have been moving higher though, largely because of Charter Communications’ announced takeover of Time Warner Cable. As that deal grinds through the shareholder and regulatory approval process, odds are Time Warner won’t invest heavily in expanding and upgrading its network in the area. In the meantime, Cincinnati Bell continues to grow and improve its fiber-to-the-home broadband services so that it has more of a competitive advantage.

Regardless of how all of this plays out, holders of Cincinnati Bell 6.75% Cumulative Convertible (NYSE: CBB-B) will continue receiving their $0.84 dividend and likely enjoy more upside on the shares.

Buy Cincinnati Bell 6.75% Cumulative Convertible under $50.

Healthy Yield

National HealthCare Corp Series A Convertible Preferred offers a bit more long-term growth potential. Its quarterly payout is $0.20, and these shares currently yield 10.3%.

The company operates 74 skilled nursing homes with more than 9,000 beds, 36 home-care programs, 18 assisted-living communities and five independent living centers, primarily in the southeastern United States.

Mostly because of the aging American population, the company’s revenues have been growing by more than 5% annually over the past decade. And earnings have been growing at an annualized 4.8% over the past 10 years.

Like Cincinnati Bell’s convertibles, National HealthCare Corp Series A Convertible Preferred (NYSE: NHC-A) shares are currently callable. But with the shares now trading around $15.50 and nearly 11 million of them outstanding, calling them in would take a significant bite out of National HealthCare Corp’s $222 million of cash on hand. The company is also fairly judicious in its use of debt, so it’s unlikely to take on loans to call in the convertible shares.

Convertible stockholders may want to swap their shares for common stock soon, though. These are convertible into 0.24204 shares of common stock. With the convertible shares trading at around $15.50, you could benefit by converting if the price of the common stock rises much above $64.

In the past year alone, National HealthCare’s common stock appreciated more than 11% and currently trades at just over $63. The common shares also currently pay a $0.34 quarterly dividend, for a yield of 2.3%. Buy National HealthCare Corp Series A Convertible Preferred under $15.75.