Preferred Stocks?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
Tatala
Posts: 39
Joined: Sat Jan 19, 2019 9:28 pm

Preferred Stocks?

Post by Tatala » Sun Jun 23, 2019 1:31 pm

I have my 3 fund portfolio , have a friend who is recommending Preferred Stocks ? Claims 5-6 % with little risk since the preferred have to be paid before the common. He is suggesting I invest a small portion of my portfolio. Are things safe as an investment or are they junk bonds???

Tat

Broken Man 1999
Posts: 2745
Joined: Wed Apr 08, 2015 11:31 am

Re: Preferred Stocks?

Post by Broken Man 1999 » Sun Jun 23, 2019 1:48 pm

Here is a link to a previous discussion of preferred stocks:

viewtopic.php?t=238048

Enjoy!

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven than I shall not go. " -Mark Twain

User avatar
Dialectical Investor
Posts: 510
Joined: Mon Dec 03, 2018 11:41 pm

Re: Preferred Stocks?

Post by Dialectical Investor » Sun Jun 23, 2019 1:55 pm

Still behind debt holders, limited chance for capital appreciation, may have call provisions, long duration interest-rate risk, dividends don't have to be paid, etc., etc., etc.

I never know what people mean by "safe" anymore, but I can't think of any version of the word I'd apply to preferred stocks. But no reason to call them junk bonds when you can call them what they are--preferred stocks.

I think some people are drawn to them because they feel like they enter an exclusive club by purchasing something with the word "preferred" in the name. I'd prefer not to buy them.

jbranx
Moderator
Posts: 1451
Joined: Thu Feb 09, 2017 6:57 pm

Re: Preferred Stocks?

Post by jbranx » Sun Jun 23, 2019 1:57 pm

You might find this article in the Wiki helpful: https://www.bogleheads.org/wiki/Preferred_stock.

There are also many previous discussions of preferreds you can find in the search box. There are no free lunches in stocks or these hybrid securities in my experience. You are taking more risk because 1) most preferreds are issued by banks, utilities and reits, so sector concentration; 2) most preferreds have low ratings, many barely investment grade with the exception of closed-end fund preferreds that are AAA because regulations require 2X coverage; 3) preferreds are issued when conditions are favorable to corporations and called when favorable to corporations, thus creating a catch 22 for the individual investor; 4) preferreds are not undiscovered, so many now sell above the call price; 5) many preferreds trade at low volume with wide spreads; 6) a lot of preferreds are non-cumulative, meaning they can skip the dividend, and 7) check the performance of preferreds during the last market crash if anyone assures you they are low risk. A good way to have an unknown fixed income duration is to mix in some preferreds callable at the corporation's best advantage.

I've invested in preferreds for decades and can't come up with a list of seven good features quite as easily. If your research shows them to have advantages for your portfolio, you might look into two of the largest preferred ETFs: PFF and PGX. Rick Ferri, I believe, has in the past recommended a portion of preferreds in some of his portfolios. Vanguard long ago had a preferred stock fund and closed it. If you want to look at individual preferreds, quantumonline.com is a good resource.

Here is a link to an excellent discussion of preferreds at philosophical economics: http://www.philosophicaleconomics.com/2 ... ed-stocks/. I own both the Wells and Bank America preferreds he recommended. They now both sell at very substantial premiums to the call price of $1000. Notice the date on the article is two years ago. WFCPRL and BACPRL both now sell at approximately 35% premiums to call and yield a measly 5.3% or so. (Ignore "the Security has been Called for: Monday, January 1, 1900" in red today on quantum.com on both of these; someone is having fun with a little hack. Quantum uses the symbols WFC-L and BAC-L for these).

Warren Buffet has done well in preferreds: he buys them from investment banks and desperate corporations when they are on the street with tin cups begging for survival. Usually he demands at least an 8-9% dividend and a warrant to buy the common stock at firesale prices when the stock has substantially increased. The only/maybe comparable opportunity for an individual investor would be to have bought a preferred closed-end fund in the last crisis at a very substantial discount to NAV. FFC and FPF are two that have gone from wide discounts to normal discounts. They are both highly leveraged, hugely ER expensive, and highly touted, as most preferreds are, on sites like Seeking Alpha. Highly touted and highly leveraged are highly unlikely to equal good value.

User avatar
nedsaid
Posts: 11882
Joined: Fri Nov 23, 2012 12:33 pm

Re: Preferred Stocks?

Post by nedsaid » Mon Jun 24, 2019 1:14 pm

I have never invested in Preferred Stocks myself, had a (now deceased) friend who had Preferreds in a managed account. His comment was the yield was great but the price kept going down. This is a good caution regarding high yielding investments, part of that "yield" might be return of principal. One reason that you can stretch for yield a bit but not by too much, either on the equity side or the fixed income side. Yields are often high for a darned good reason.

Preferred Stocks are also not recommended here and as I remember Larry Swedroe did not recommend them. They also do not draw a lot of attention in the financial press and perhaps for someone willing to do research, there might be "gold in them thar preferreds". My guess is these act a lot like high yield bonds. My suspicion is that analysis of these would be more difficult than first believed. First place to look would be the bonds of the same company that issued the preferred stock, that should tell you a lot.
A fool and his money are good for business.

balbrec2
Posts: 201
Joined: Mon Nov 13, 2017 3:03 pm

Re: Preferred Stocks?

Post by balbrec2 » Mon Jun 24, 2019 7:01 pm

Tatala wrote:
Sun Jun 23, 2019 1:31 pm
I have my 3 fund portfolio , have a friend who is recommending Preferred Stocks ? Claims 5-6 % with little risk since the preferred have to be paid before the common. He is suggesting I invest a small portion of my portfolio. Are things safe as an investment or are they junk bonds???

Tat
preferred stock have tax advantages for corporate holders, of which you are probably not going to be.
Why invest in something you don't really understand and wasn't designed for you anyway?

capjak
Posts: 71
Joined: Fri Sep 22, 2017 8:58 am

Re: Preferred Stocks?

Post by capjak » Tue Jun 25, 2019 6:28 pm

I have approximately 6% of Portfolio in preferred stock. The yield is 5% to 6.3%. I do not intend to sell them. They can be called but several are 10-20 years past call and continue to pay dividends. There is little to no growth 3-10% above my purchase price, mostly utilities/financials. During the great recession they tanked below call, but kept producing dividends. I only buy "Qualified" dividend preferred.

Seems to work and will be gifted after I pass or are called.

User avatar
grabiner
Advisory Board
Posts: 24594
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Preferred Stocks?

Post by grabiner » Tue Jun 25, 2019 9:41 pm

nedsaid wrote:
Mon Jun 24, 2019 1:14 pm
I have never invested in Preferred Stocks myself, had a (now deceased) friend who had Preferreds in a managed account. His comment was the yield was great but the price kept going down. This is a good caution regarding high yielding investments, part of that "yield" might be return of principal. One reason that you can stretch for yield a bit but not by too much, either on the equity side or the fixed income side. Yields are often high for a darned good reason.
Another part of the risk is the infinite maturity, which leads to a very long duration and thus very high interest-rate risk. If rising rates cause the yield on an intermediate-term bond fund to rise from 3% to 4%, you lose 5% of the fund value. If rising rates cause the yield on a preferred-stock fund to rise from 5% to 6%, you lose 17% of the fund value.
Wiki David Grabiner

User avatar
nedsaid
Posts: 11882
Joined: Fri Nov 23, 2012 12:33 pm

Re: Preferred Stocks?

Post by nedsaid » Wed Jun 26, 2019 8:27 am

grabiner wrote:
Tue Jun 25, 2019 9:41 pm
nedsaid wrote:
Mon Jun 24, 2019 1:14 pm
I have never invested in Preferred Stocks myself, had a (now deceased) friend who had Preferreds in a managed account. His comment was the yield was great but the price kept going down. This is a good caution regarding high yielding investments, part of that "yield" might be return of principal. One reason that you can stretch for yield a bit but not by too much, either on the equity side or the fixed income side. Yields are often high for a darned good reason.
Another part of the risk is the infinite maturity, which leads to a very long duration and thus very high interest-rate risk. If rising rates cause the yield on an intermediate-term bond fund to rise from 3% to 4%, you lose 5% of the fund value. If rising rates cause the yield on a preferred-stock fund to rise from 5% to 6%, you lose 17% of the fund value.
I had not thought of the infinite maturity issue. Yes, that would make Preferred Stock extremely interest rate sensitive. My conversation with my now deceased friend happened probably in the late 1980's or the very early 1990's. The whole period of 1982-2013 was a bond bull market but it is possible that interest rates ticked up temporarily and caused the phenomenon that my friend saw. My guess is that his full service broker foisted upon him securities that the firm didn't want anymore for its own account.
A fool and his money are good for business.

not4me
Posts: 597
Joined: Thu May 25, 2017 3:08 pm

Re: Preferred Stocks?

Post by not4me » Wed Jun 26, 2019 1:33 pm

nedsaid wrote:
Wed Jun 26, 2019 8:27 am
grabiner wrote:
Tue Jun 25, 2019 9:41 pm
nedsaid wrote:
Mon Jun 24, 2019 1:14 pm
I have never invested in Preferred Stocks myself, had a (now deceased) friend who had Preferreds in a managed account. His comment was the yield was great but the price kept going down. This is a good caution regarding high yielding investments, part of that "yield" might be return of principal. One reason that you can stretch for yield a bit but not by too much, either on the equity side or the fixed income side. Yields are often high for a darned good reason.
Another part of the risk is the infinite maturity, which leads to a very long duration and thus very high interest-rate risk. If rising rates cause the yield on an intermediate-term bond fund to rise from 3% to 4%, you lose 5% of the fund value. If rising rates cause the yield on a preferred-stock fund to rise from 5% to 6%, you lose 17% of the fund value.
I had not thought of the infinite maturity issue. Yes, that would make Preferred Stock extremely interest rate sensitive. My conversation with my now deceased friend happened probably in the late 1980's or the very early 1990's. The whole period of 1982-2013 was a bond bull market but it is possible that interest rates ticked up temporarily and caused the phenomenon that my friend saw. My guess is that his full service broker foisted upon him securities that the firm didn't want anymore for its own account.
Your guess in the last sentence makes a sound case! But, for the benefit of those who may read, I did want to point out a couple of things. If your guess is right, it sounds as if we're talking about individual stocks -- not a fund. Once issued, the distribution for an individual stock won't change. Funds would have different behavior. Also note that the "infinite" maturity issue has some qualifiers. Preferred stocks can be either 1) perpetual, 2) non-perpetual. Case #2 obviously wouldn't have an infinite maturity. Even with case #1, there are likely call provisions that offset that. Assuming the stock bought after initial issuance, the buyer would pay either a premium or a discount to the callable price (meaning the call provisions would affect different buyers differently). I tried a quick google to see what percentage were perpetual, but nothing jumped out at me. Perhaps another reader will have that. Really hard to guess what was going on at the time.

Preferreds are much more common in interest rate sensitive companies & so that is likely a larger impact. Also, that lack of diversification may be a reason to avoid.

acompton5
Posts: 13
Joined: Fri Jun 07, 2013 4:23 pm

Re: Preferred Stocks?

Post by acompton5 » Wed Jun 26, 2019 9:28 pm

I have a little NLY-F in my portfolio. It’s Annaly Capital, leveraged mortgages with most implicitly guaranteed by Fannie and Freddie. The common shares are volatile and subject to swings related to mortgage prepayments and rising interest rates. The volatility of the preferred shares are usually less than the annual dividend making it difficult to have a negative return for a year.

The dividend is cumulative. The yield is fixed to floating. In 2022, the shares will either be called or switch to 3 month Libor + 4.99% minimizing interest rate risk.

Most of the reasons to avoid preferreds don’t apply to NLY-F. Then again any mortgage reit or bank with leverage could blow themselves up and you would lose your investment reaching for a ~7% yield. Stock-like returns with minimal volatility doesn’t mean there isn’t risk.

Here’s the prospectus: https://www.sec.gov/Archives/edgar/data ... d424b5.htm

User avatar
nedsaid
Posts: 11882
Joined: Fri Nov 23, 2012 12:33 pm

Re: Preferred Stocks?

Post by nedsaid » Thu Jun 27, 2019 1:26 am

not4me wrote:
Wed Jun 26, 2019 1:33 pm
nedsaid wrote:
Wed Jun 26, 2019 8:27 am
grabiner wrote:
Tue Jun 25, 2019 9:41 pm
nedsaid wrote:
Mon Jun 24, 2019 1:14 pm
I have never invested in Preferred Stocks myself, had a (now deceased) friend who had Preferreds in a managed account. His comment was the yield was great but the price kept going down. This is a good caution regarding high yielding investments, part of that "yield" might be return of principal. One reason that you can stretch for yield a bit but not by too much, either on the equity side or the fixed income side. Yields are often high for a darned good reason.
Another part of the risk is the infinite maturity, which leads to a very long duration and thus very high interest-rate risk. If rising rates cause the yield on an intermediate-term bond fund to rise from 3% to 4%, you lose 5% of the fund value. If rising rates cause the yield on a preferred-stock fund to rise from 5% to 6%, you lose 17% of the fund value.
I had not thought of the infinite maturity issue. Yes, that would make Preferred Stock extremely interest rate sensitive. My conversation with my now deceased friend happened probably in the late 1980's or the very early 1990's. The whole period of 1982-2013 was a bond bull market but it is possible that interest rates ticked up temporarily and caused the phenomenon that my friend saw. My guess is that his full service broker foisted upon him securities that the firm didn't want anymore for its own account.
Your guess in the last sentence makes a sound case! But, for the benefit of those who may read, I did want to point out a couple of things. If your guess is right, it sounds as if we're talking about individual stocks -- not a fund. Once issued, the distribution for an individual stock won't change. Funds would have different behavior. Also note that the "infinite" maturity issue has some qualifiers. Preferred stocks can be either 1) perpetual, 2) non-perpetual. Case #2 obviously wouldn't have an infinite maturity. Even with case #1, there are likely call provisions that offset that. Assuming the stock bought after initial issuance, the buyer would pay either a premium or a discount to the callable price (meaning the call provisions would affect different buyers differently). I tried a quick google to see what percentage were perpetual, but nothing jumped out at me. Perhaps another reader will have that. Really hard to guess what was going on at the time.

Preferreds are much more common in interest rate sensitive companies & so that is likely a larger impact. Also, that lack of diversification may be a reason to avoid.
Yes, I am talking about individual preferred stocks.
A fool and his money are good for business.

Post Reply