Preferred Stock Investing-The Good , The Bad and The In Between 2015 - 2020

[Golden sunsets]

It's rather brazen of me to start a string on something I know very little about, but at least a few of us seem interested and a few of us have ventured into this type of investing. I for one would love to see the topic vetted and I'd like to know a little more on the ins and outs of preferred stock investing.

For example:

Do you stay away from issues that are not cumulative preferred?
What sources beyond Quantum on Line are good to research issues?
How do you find out which issues are "fenced in"?
What are the mechanics of the purchase/sale process when an issue is thinly traded? (If I were to place a limit order how does a potential seller become aware of my bid?)
What general Due Dilligence do you perform?

Thanks in advance for sharing.

 

[Golden sunsets]

I just thought of another question. I could be wrong but it seemed to me that there is a wide discrepancy between yields on various issues from the same issuer and issuers with similar ratings. I would have thought that all Preferred's from the same issuer would have similar yields.

 

[Mulligan]

It's rather brazen of me to start a string on something I know very little about, but at least a few of us seem interested and a few of us have ventured into this type of investing. I for one would love to see the topic vetted and I'd like to know a little more on the ins and outs of preferred stock investing.

For example:

Do you stay away from issues that are not cumulative preferred?
What sources beyond Quantum on Line are good to research issues?
How do you find out which issues are "fenced in"?
What are the mechanics of the purchase/sale process when an issue is thinly traded? (If I were to place a limit order how does a potential seller become aware of my bid?)
What general Due Dilligence do you perform?

Thanks in advance for sharing.

I will play Golden while drinking my morning Joe. 1) At first, I was very insistent on looking for cummulatives, but have relaxed that a bit now. Many good preferred issues today are non cumulative including the banks. Cumulative only is meaningful if it is a good company and wont go bankrupt anyways. Besides they just cant say "screw you we decided not to pay". A quality non cumulative is way better than an iffy cumulative issued company.
2) Im not a crack auditor, but I do look at the annual financial reports and filings. But to be honest this is why I stick close to electric utilities as their model is easy to understand, along with wide moat, guaranteed rate of return on equity, etc.
3) The "fenced in part" I just get from online researching of company. Annual reports will also mention certain clues in their such as max debt/equity allowed so the acquiring companies cant load them up with debt. Since these buyouts occur frequently and approval is needed for the consummation, I wouldn't be surprised if most have those protections to protect local citizens electricity safety/reliability.
4) https://eresearch.fidelity.com/eresearch/evaluate/quote.jhtml?symbols=WFC/PL
Link above under "detailed quote" section gives current best bid, best ask price. A lot of "Oz behind the curtain" thing goes on I don't quite frankly understand. You can always raise your bid later. Believe me they find the bid. Some leave the bid in que for months hoping to snag a good deal. Google stock history of symbol. CNBC has a good app that shows 20 year plus history of the price and dividend.
Other due diligence includes reading the local paper and make sure they got their latest rate increase and see what Moodys are rating the bonds. Common stockholders need growing earnings for appreciation..Preferred stockholders just need stagnant earnings. Preferreds in utilities generally are only 1-2% of capital structure so earnings of company cover the dividend of Preferreds many, many times over.


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[Mulligan]

Preferred Stock Investing-The Good , The Bad and The In Between

I just thought of another question. I could be wrong but it seemed to me that there is a wide discrepancy between yields on various issues from the same issuer and issuers with similar ratings. I would have thought that all Preferred's from the same issuer would have similar yields.

Most of the current era issues of preferreds from various company's do tend to track closely together. Electrical utilities there can be wide yeild differences. My best guess.... The preferreds of one company were issued in different allotment in different decades. The 1940s and 50s issued Preferreds generally are lower as interest rates were alot lower. The 60s one and on have higher rates. Many have been called. If a past call 6% yield utility stock price rose to lower the effective yield, it would expose someone to a huge call loss. Now it works the opposite for the 40s and 50s issues. If price of those dropped to increase effective yield, it would be so far below par price that if it was called you would make a capital gains killing on it.
Generally the older the issues, the more the protections. I wouldnt get to worried about which preferred has priority (though you can read it in the prospectus) in payment as we are dealing with a tiny sliver of the captial structure to begin with.
Now with those shipping stock preferreds and gas/oil I would damn well want to know, but Im not smart enough to catch the "gotchas" so I just stay away.


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[Totoro]

Just wanted to encourage Mulligan (and others with knowledge) - thanks for sharing!

 

[Golden sunsets]

Thanks Mulligan for your thoughtful reply. I'm attaching a pdf of Merrill Lynch's current Preferred Letter. I haven't digested all of it yet, other than to notice that the Yield to Worst on most of the issues is less than the 6-6.5% that you look for.

I also wonder about the selection criteria used of UW-30% or better. Wouldn't that mean that the screen they use requires that analysts ratings be that the stock of the issuer is underweight 30% or more? I don't quite understand that.

Hmmm - tried to attach a pdf but although it shows uploaded it doesn't show up in the post. Oh well!!!

 

[eta2020]

Thanks Mulligan for your thoughtful reply. I'm attaching a pdf of Merrill Lynch's current Preferred Letter. I haven't digested all of it yet, other than to notice that the Yield to Worst on most of the issues is less than the 6-6.5% that you look for.

That surprises me because Index Fund PFF has 6% plus yield.

I do not own Preferred Stocks but if I did I would do it via PFF just as I would stay away from individual stocks and instead buy Index Fund. Then you do not need answers to your questions and you are likely to make better return then picking individual securities.

Time to buy PFF may not be good unless you believe that rates will not go up. PFF will suffer just like long term bonds once rates start going up.

 

[Golden sunsets]

Right - I have purchased PFF for my Mom's account which I manage. As Mulligan puts it, he owns individual issues to avoid the expense ratio and also is not interested in whether the price fluctuates (unless it is due to credit risk I assume) but is using/or will use at some point the dividends to fund his expenses. He never intends to sell them but to add to his positions and grow the dividends over time. I am considering investing a small portion of our portfolio in preferreds, that would not be part of the core of our fixed income but add a little juice to our overall fixed income return.

 

[eta2020]

I think you would have to be way above average investor if you want to buy individual securities.

I learned over my lifetime that nice index fund combined with discipline will outperform even professional money managers. So buying PFF would be the way to go. Forget about individual securities.

 

[Mulligan]

I think you would have to be way above average investor if you want to buy individual securities.

I learned over my lifetime that nice index fund combined with discipline will outperform even professional money managers. So buying PFF would be the way to go. Forget about individual securities.

Yes and No.... I cant fault your reasoning and if no one has interest in researching at all I agree..But preferreds are a bit different than trying to pick winning stocks. Winning stocks usually need some type of growth in earnings. Preferred stocks don't. Remember they get fed before the commoners do. They just need a small sliver of earnings to maintain payout due to the small amount of capital structure they have. PFF does give you diversity in companies, but not in sector as its about 80% financial. Of course 80% of my purchases are electrical utilities which are way easier to understand.
As I think though, I am actually in more agreement with you than I thought. There are many many preferreds I do not understand so I stay completely away from them. But if you do have interest in researching and stick with safety and away from certain areas such as shipping and gas/oil exploration it isn't real complicated to find good individual company preferreds.
If a person wanted true diversity in sectors they would have to go out an purchase individual ones as PFF is not sector diversified. PFXF is a little different animal and adds diversity, but it stretches what a definition of preferred is. A person could allocate a certain percentage to PFXF and PFF for some sector diversity.
My father decided to go that way 50/50 FWIW. He also fully understands these could and will drop if rates rise. But he is interested only in income now.


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[Mulligan]

Thanks Mulligan for your thoughtful reply. I'm attaching a pdf of Merrill Lynch's current Preferred Letter. I haven't digested all of it yet, other than to notice that the Yield to Worst on most of the issues is less than the 6-6.5% that you look for.

I also wonder about the selection criteria used of UW-30% or better. Wouldn't that mean that the screen they use requires that analysts ratings be that the stock of the issuer is underweight 30% or more? I don't quite understand that.

Hmmm - tried to attach a pdf but although it shows uploaded it doesn't show up in the post. Oh well!!!

Yield to worst can be misleading. I bought one that was minus 20% YTC, but it wasn't really negative at all as dividend was already declared but not released yet. That alone made it positive even with an immediate 30 day call which did not happen and still hasn't. Something to be aware of though.


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[eta2020]

Yes and No....

So how much yield do you get on your portfolio of Preferred stocks?

 

[LiveBelowMeans]

Web site that discusses and highlights preferreds

Not sure if anyone is interested, however here is a web site that I have used to find preferreds with qualified distributions. Also discusses other income ideas on other tabs.

Preferred Stocks with Qualified Distributions | The Yield Hunter

 

[MooreBonds]

1) At first, I was very insistent on looking for cummulatives, but have relaxed that a bit now. Many good preferred issues today are non cumulative including the banks. Cumulative only is meaningful if it is a good company and wont go bankrupt anyways. Besides they just cant say "screw you we decided not to pay". A quality non cumulative is way better than an iffy cumulative issued company.

If your universe is limited to utilities and banks, then this could be a valid approach. However, for those of us that reach for some more yield with the accompanying risk, I only stick with cumulative issues. Yeah, it's not THAT likely that we would see another 2009 crash....but many issues did halt the dividend (even some banks). So having to go without any dividend for a year or two can impact your yield over a long holding period. I'd rather have the safety knowing it will accrue if things get nasty for a while.

So how much yield do you get on your portfolio of Preferred stocks?

Because I do some nose-holding and reaching among those who are less than top-notch preferreds, my yields are a bit higher. Current average among all preferreds is 8.1% among current values and those paying (or 7.8% if you include the preferreds that have gone belly-up over the past 5-6 years, mostly finance-related ones in the financial crisis). But that includes some bank preferreds that are relatively "safe" yet yield 7%-8%+. So not all high yielding is junk. (and not all junk is high yielding....)

 

[Mulligan]

So how much yield do you get on your portfolio of Preferred stocks?

Averaging them all together I would say around 6.6%My electrical ones probably average 6.3%. As previously noted, the electrical ones show very little movement in relation to others. In the past for example people were paying $51 for CNLPL when treasury was over 4% and is now just $2 higher with a 2% and change treasury. I have added a few "yield spicers", but not that dangerous. Many view CHSCL as investment grade without the official rating, and I along with a few others here got close to 7.5% this winter. I should have backed up the truck!
Since Moorebonds chimed in I have to personally thank him for steering me this way and showing me the ropes. Though more aggressive than I, he also diversifies better for the risk.


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[Mulligan]

Thanks Mulligan for your thoughtful reply. I'm attaching a pdf of Merrill Lynch's current Preferred Letter. I haven't digested all of it yet, other than to notice that the Yield to Worst on most of the issues is less than the 6-6.5% that you look for.

I also wonder about the selection criteria used of UW-30% or better. Wouldn't that mean that the screen they use requires that analysts ratings be that the stock of the issuer is underweight 30% or more? I don't quite understand that.

Hmmm - tried to attach a pdf but although it shows uploaded it doesn't show up in the post. Oh well!!!

Golden I reread post and will finish my thoughts on your yield to worst. First of all it is something to be aware of. I read on another forum some idiots had bid up a preferred to $37 and it was called at $25. People who bought above $30 took a nice A$$ whopping! What brain dead people would do that?
But.... YTW is also just an assumption that it will be called. I have one that has been callable since the 1970s so YTW doesn't always mean it will happen. Some high rate preferreds have to be assumed they will be called. But if you buy less than one declared dividend above par you cant be hurt by a call.
If some are several dollars above par, but aren't callable for 10 years it MAY still make since to buy the yield and take the small haircut 10 years down the road on a call if it would happen.


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[Mulligan]

Preferred Stock Investing-The Good , The Bad and The In Between

I think you would have to be way above average investor if you want to buy individual securities.

I learned over my lifetime that nice index fund combined with discipline will outperform even professional money managers. So buying PFF would be the way to go. Forget about individual securities.

Eta, in case you are curious an author on preferreds Doug K Le Du wrote this in an article in Seeking Alpha about buying preferreds in ETF's.


Author’s reply » I am not a fan of preferred ETFs for three reasons.

(1) The objective of the ETF fund manager is to change the composition of the fund such that the market price of the fund moves in a way that matches an index. The objective of the income investor, on the other hand, is to earn relatively safe and reliable dividend income. In other words, the objectives of the fund management have absolutely no relationship to the objectives of those buying shares.

(2) In order to achieve their index-matching objective, fund managers include speculative grade securities within the mix of the fund. While such securities provide the fund manager with an excellent tool for manipulating the price of fund shares in order to match the target index, risk-averse investors are exposed to the risks of securities that they would otherwise be very unlikely to purchase on their own.

(3) The ETF model was invented by Wall Street to allow individual investors who are not experts in an industry segment or a commodity with a way of investing in that segment or commodity. Preferred stocks are neither an industry segment nor a commodity; they are a type of equity security (hence problems #1 and #2 above).


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[eta2020]

Averaging them all together I would say around 6.6%My electrical ones probably average 6.3%. As previously noted, the electrical ones show very little movement in relation to others. In the past for example people were paying $51 for CNLPL when treasury was over 4% and is now just $2 higher with a 2% and change treasury. I have added a few "yield spicers", but not that dangerous. Many view CHSCL as investment grade without the official rating, and I along with a few others here got close to 7.5% this winter. I should have backed up the truck!
Since Moorebonds chimed in I have to personally thank him for steering me this way and showing me the ropes. Though more aggressive than I, he also diversifies better for the risk.


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So you get 6.5 yield versus PFF ETF 6.05. That is noticeable difference, but I am not sure I would be willing to do my own work to get this difference versus getting ETF.

(1) The objective of the ETF fund manager is to change the composition of the fund such that the market price of the fund moves in a way that matches an index. The objective of the income investor, on the other hand, is to earn relatively safe and reliable dividend income. In other words, the objectives of the fund management have absolutely no relationship to the objectives of those buying shares.

(2) In order to achieve their index-matching objective, fund managers include speculative grade securities within the mix of the fund. While such securities provide the fund manager with an excellent tool for manipulating the price of fund shares in order to match the target index, risk-averse investors are exposed to the risks of securities that they would otherwise be very unlikely to purchase on their own.

So you are telling me PFF is not tracking S&P U.S. Preferred Stock Index but it buys some other securities? I did not carefully review their prospectus but that looks odd to me.

 

[Winemaker]

I have been investing in preferred stocks for over 10 years and been extremely pleased with an 8+% return over the years. I considered my preferreds as part of MY fixed income portfolio and the individual stocks as mini-bonds.


I purchase individual preferreds that are priced below par, banks, REITS, industrials, and utilities,( and have considered energy stocks but never pulled the trigger, more on this later.)


I purchase no more than $5,000 of each issue, most I purchase in the $22-23 area and purchase 200 shares to diversify.


As with bonds, some issues fluctuate greatly around the ex-dividend date, or with bonds the date interest is paid.


I also own PGX and PFF, both preferred ETFs, but the PFF has been a laggard as compared to the rest of my preferred portfolio.


When I FIRED in October 14, I took $100K in a Rollover acct. and purchased over 20 issues using the methodology described above, it is now at $107K.

I recently had a 5.05% utility preferred called, paid $22.21 per share 9 years ago, picked up all the divvies along the way, and got $25 per share for being patient .



I have only been burned twice in the preferred arena and those issues were purchased in my SPECULATION portion of my portfolio. I had purchased some GM and some Freddie Mac shares at about $8.00 and $12.00 before the Great Recession. I received some nice divvies for a while but lost it all when the bankruptcies occurred. Never thought that the GM pensioners would move ahead of me in the succession line and the Freddie Mac issue is still not resolved. Someone is still accumulating those shares for pennies the last time I looked.

 

[eta2020]

I also own PGX and PFF, both preferred ETFs, but the PFF has been a laggard as compared to the rest of my preferred portfolio.

For educational purpose can you tell us is the yield taxed at reduced rate just like with regular equities or is some of this taxed at higher income rate (like CDs or Bonds)

 

[eytonxav]

I think individual preferreds can make sense if you do your homework on what to buy and get them at par value, usually $25/share, otherwise, my advice is stick with the etf versions. Here is a list of etf preferred stocks if you are interested:

Top 9 Preferred Stock ETFs

I held several individual preferred issues during the 2008 collapse and was really concerned at how much value they lost. Also, they can be called and redeemed at par, so you may not realize the income stream you were contemplating and could lose if you paid above par.

 

[Mulligan]

So you get 6.5 yield versus PFF ETF 6.05. That is noticeable difference, but I am not sure I would be willing to do my own work to get this difference versus getting ETF.







So you are telling me PFF is not tracking S&P U.S. Preferred Stock Index but it buys some other securities? I did not carefully review their prospectus but that looks odd to me.

It says in its prospectus that it "tracks an index" so it can use different ones I assume. But just as importantly the index itself will always change based on calls, new issuances of securities, and size limit. Thus they are forced to buy in some areas high volume crap because they cant buy into small quality issues.
But to me the importance is this. I am damned well not going to give nearly 10% of my yield to an index fund expense ratio, when no research is even being done. Thats crazy to me. However, I put all my stock money into 2 index funds of Total Stock and Total International and do not own individual common stock. Remember you are investing for yield not total return so expense ratios really matter so you have to take that off the top of their claimed yield.


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[Mulligan]

I think individual preferreds can make sense if you do your homework on what to buy and get them at par value, usually $25/share, otherwise, my advice is stick with the etf versions. Here is a list of etf preferred stocks if you are interested:



Top 9 Preferred Stock ETFs



I held several individual preferred issues during the 2008 collapse and was really concerned at how much value they lost. Also, they can be called and redeemed at par, so you may not realize the income stream you were contemplating and could lose if you paid above par.

Very true.


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[MooreBonds]

Since Moorebonds chimed in I have to personally thank him for steering me this way and showing me the ropes. Though more aggressive than I, he also diversifies better for the risk.

As long as you don't curse me when rates go up and your equity value drops!

I purchase no more than $5,000 of each issue, most I purchase in the $22-23 area and purchase 200 shares to diversify.
...
Never thought that the GM pensioners would move ahead of me in the succession line and the Freddie Mac issue is still not resolved. Someone is still accumulating those shares for pennies the last time I looked.

That's also my strategy - I typically buy just 100 shares for diversification. If I REALLY feel safe with it (like a few bank issues, a few finance companies), I might buy 200-400 shares total.

however, sometimes I do buy above-par, if the callable date isn't for a few years, and/or if it's a limited term security (i.e. final maturity is defined, so I know the max term I would be locked in for). Because of current rates, I'm willing to buy some Preferreds and baby bonds from mostly BDCs with 3-8 year final maturity terms with yields of about 5%-7%...since it beats the pants off of anything else with that maturity range, gives me a decent income, is somewhat safe (since the BDCs have a high Net Asset Value per share on the common, so plenty of assets to cover the preferreds if it were liquidated), and also reduces my interest rate risk, assuming rates FINALLY move up like everyone is expecting, and allows me to reinvest at a (presumably) higher rate in 3-8 years.

On those Freddie Mac securities, it might just be someone covering a massive short position, since it could be tough to find someone to sell those preferreds. Also, sometimes there is hope when all seems lost. One of my positions that was a bad one was Impac Mortgage Holdings (IMPHP and IMPHO, or formerly IMH Class B and C). It was a mortgage REIT, that floated debt at one rate, and used that debt proceeds to issue mortgages. It got caught with some Alt-A mortgage and other bad loans in 2008, and essentially went just about worthless (common and prefrred).

But there was some value in the ashes, as the preferreds (I own 100 of each class) have slowly risen from under $1/share to currently at about $8-$9. Par is $25. Some have speculated that some of the underlying assets still have value, and that in order for the common stock to start paying dividends again, the preferreds have to start paying. so ther's a chance it could rise back up to $25 and resume the dividend (or get called).

Another preferred had a similar action, when it went to under $1 in the crisis. The common did go bankrupt, and the preferreds eventually got a final cash-out payment of maybe $2.50/share. SO still a loss...but sometimes there is a little value left in a preferred, and everyone stampedes the price down to under $1 as they want to get just anything for it now, versus rolling the dice and seeing what residual value there might be in X years when the dust settles.

 

[Mulligan]

For educational purpose can you tell us is the yield taxed at reduced rate just like with regular equities or is some of this taxed at higher income rate (like CDs or Bonds)

Generally speaking the preferreds that pay the low 15% tax are the ones paying out with the retained earnings. The "normal preferreds" if you will. These are the ones that issue the dividends that the company has paid the income tax on. The ones that are taxed as "like CDs or Bonds" are actually in effect "baby bonds" or bank "trust preferreds" just lazily being called preferreds. These are a step higher in bankruptcy claiming. Ticker symbols will not tell you anything. You really need plug the symbol into Quantum to find out which it is.
For example with Exelon (who has various issues), you have BGLEN which pays 15% preferred and BGE-B which does not. I have BGE-B in my Roth.
Winemaker didn't mention this but I am sure he will not mind. He also owns several adjustable rate preferreds which may mitigate loss of capital on interest rate rises, as those are tied into Libor, 3 month, or 10 year treasury rate plus a predetermined amount in addition, with a minimal floor set.


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