Income investors have long been attracted to preferred stocks for above-average yields. In light of recent market turbulence, many preferreds now also offer the potential for capital gains. Five top income experts, and contributors to MoneyShow.com, offer an overview on preferred stock and some favorite investments in this market.
Although preferred stocks could be issued at any price, most firms initially price their preferreds (IPO price) at $25 per share. Thanks to the recent market downdraft, many $25 preferreds are currently changing hands below that level and will trade back up to the $25+ range when the market normalizes. Thus, buying them now affords you the opportunity to net higher yields plus significant capital gains potential.
The main risk of holding preferred stocks is that the issuer runs short of cash to pay the specified preferred dividends. Many preferreds are designated as "cumulative" meaning that the issuer remains on the hook for any missed dividends. By contrast, non-cumulative preferred issuers can skip the dividends at will (in all instances, preferred dividends must be paid before common stock dividends).
In practice, cumulative preferred issuers can wait five years to pay skipped dividends and even then you probably won't collect the dividends if the issuer files for bankruptcy. Bottom line: play it safe, stick with preferreds issued by corporations with sufficient cash to pay the dividends.
Here are three preferreds worth considering: You don't have to worry about the call dates on them because, in all cases, you'd be delighted to have them called at $25 per share.
Cherry Hill Mortgage (CHMI) is a REIT that invests in residential mortgages and related securities. While many mortgage issuers are currently on the ropes, all of Cherry Hill's assets are government insured, so there is less risk here.
The Cherry Hill Mortgage 8.20% Series A Cumulative (CHMI-A) recently traded at $20.23 per share, pays $2.05 per year (quarterly payments). So, market yield is 10.1% and potential price appreciation to the $25 call price is 23.6%.
Compass Diversified (CODI) invests in and operates middle-market niche businesses in both the consumer and industrial sectors. Probably many of its holdings will take hits, but it's paying an 8.5% common stock dividend that it would have to suspend before touching its preferred payouts.
Compass Diversified Holdings 7.875%% Series C Cumulative (CODI-C) recently traded at a price $22.89, offering a market yield of 8.6% along with potential price appreciation of 9.2%.
Private equity investor Fortress Investment Group (FTAI) owns and leases airplanes, airplane engines, offshore oil and gas drilling equipment, shipping containers, etc.
Fortress Transportation & Infrastructure Investors 8.25% Series A (FTAI-A) , my recommended preferred issue, recently traded at $19.49, with a market yield 10.6% and potential price appreciation of 28.3%.
SVB Financial Group (SIVB) is a bank holding company based in Santa Clara, CA. Since inception, the company has assisted innovators in the technology and biotech sectors, along with their investors.
The bank has historically achieved strong growth, driven by the exceptional growth of its clients and their related industries. The company reported first-quarter 2020 net income of $132.3 million or $2.55 per share, missing analysts' $3.07 estimates.
Results were down sharply, due to higher loan loss provisions on top of the expected increase in realized loan losses, tied to weakening economic conditions arising from the Covid-19 pandemic.
Despite the likelihood of higher loan loss provisions and lower earnings throughout 2020, we are constructive on SVB's outlook, given the banking company's strong capital position and present low level of non-performing loans.
Our recommendation in the Forbes/Fridson Income Securities newsletter is for the SVB Financial Group 5.25% Fixed Rate, Non-Cumulative Perpetual (SIVBP) . This issue has a par value of $25.00 and an annual cash dividend of $1.3125.
At the recent price of $24.82, this issue offers a current annualized yield 5.29%; the call date is 02/15/25 and the yield to call is 5.42%. Dividends on this issue are taxed at the 15%-20% rate.
This preferred is split-rated between investment grade and non-investment grade. However, senior debt ratings are investment grade by both Moody's and S&P. As a result, we recommend this issue for low- to medium- risk taxable portfolios. Buy up to $25.50 for a 5.15% current yield and a 4.79% yield to call.
The stock market crash provides us with an opportunity to pick up preferred shares at steep discounts to their normal values. Although preferred shares give a higher level of dividend safety compared to common stock dividends, many preferred issues have crashed alongside the related common shares.
I believe that preferred stock investments will lead the share price recovery when investors again start to believe in a positive future for American companies and stock market values.
Let's focus on making investments into this category for high yields and strong price appreciation potential. I am adding one more attractive REIT preferred issue here.
RLJ Lodging Trust Cumulative Convertible Preferred A (RLJ-A) is the only preferred issue of hotel lodging REIT RLJ Lodging Trust (RLJ) . I like RLJ Lodging as one of the better-managed lodging REITs with a more valuable portfolio.
On March 18, in response to the coronavirus outbreak effects on the travel industry, RLJ reduced its common stock dividend from $0.33 per share to $0.01 per share.
Maintaining a common share dividend means the preferred share dividend of $1.95 per share per year ($0.4875 quarterly) is secure. In this stock market crash, RLJ-A has fallen from $28 to a $16.50 per share before bouncing. The issue has a current yield of 10.3%.
The preferred shares went ex-dividend on March 30, so it will be a quarter before we earn a dividend. The primary investment goal is to ride RLJ-A back up above $25. Be aware that stock symbols for preferred stocks are not uniform across financial websites and brokerage firms.
Don't let the sleepy name of Flaherty & Crumrine Dynamic Preferred & Income Fund (DFP) put you to sleep. This go-to preferred CEF (closed-end fund) is an 8% payer that just recently raised its dividend.
The managers and analysts at DFP run their own internal credit research. They are experts at "avoiding strikeouts," which, again, is key in today's soon-to-be-bankruptcy-laden world. Only high-quality preferred securities make it into DFP.
Preferred security selection is no joke. Their database is quite comprehensive, with specific terms, interest rates, credit quality, and so on -- so I'm happy to "outsource" this research to F&C!
The firm charges a 1.06% expense fee, which would be quite high if it were an ETF, not a CEF. However, when it comes to picking preferreds, we get what we pay for. Since we added DFP to our CIR portfolio way back in October 2015, we've collected $8.39 in dividends -- 38%! -- on our initial $22.26 purchase.
Meanwhile our fee was essentially "comped" because we were able to buy the fund at a discount to its net asset value (NAV). (Remember, fees for CEFs are debited directly from their NAVs. Every yield you see quoted is net of these fees.)
And because CEFs can trade at discounts to their NAVs, a benefit of the inefficiencies we can "exploit" in this underappreciated market, we can get our fees comped by purchasing funds when they trade at discounts to their NAVs. In order to buy shares of this closed-end fund at a discount, we recommend buying at prices below $22.50.
Preferred ETFs are a smart way for income-oriented investors to earn 5%-7% yields while weathering the Covid-19 market volatility. One such ETF is iShares Preferred and Income Securities ETF (PFF) . This fixed-income ETF provides exposure to U.S. corporate bonds and focuses on broad credit securities.
As a result, this ETF has strong liquidity and tight spreads, making it cost-competitive with its peer funds. PFF is especially recognized for strong block-trading liquidity, which makes it an appealing fund choice for large traders.
PFF currently is the most popular preferred stock ETF with $14.86 billion in assets under management, according to ETF.com. The fund has an expense ratio of 0.46% and has a dividend yield of 5.70%.
Though its year-to-date performance is around -7%, PFF is making an upward climb after dipping significantly in mid-March. The fund's May 6 open of $34.07 still was well within its 52-week range.
This specific fund targets preferred securities regardless of credit rating, providing a broad and diversified portfolio. The majority of PFF's holdings are allocated to the utilities sector, which currently consumes 70.92% of the fund's portfolio.
The ETF's top holdings include preferred shares of Broadcom (AVGOP) , 2.02%, Wells Fargo & Co. (WFC-L) , 1.63%, Bank of America (BAC-L) , 1.48%, Crown Castle International (CCI-A) , 1.38%, and Citigroup Capital (C-N) , 1.27%.
In summary, preferred ETFs may be the way to go for investors seeking some additional income, as it provides potential upside and a strong yield. iShares Preferred and Income Securities is an ETF that may be worth consideration to add to an income-oriented equity portfolio. It is a competitive fund among others in the same sector, and its strong liquidity is helping it to navigate the uncertainties of the current market.