Consider preferred stocks to be readily tradable bonds. Similar to bonds, corporations issue preferreds to raise cash. Usually, investors buy them for the steady dividends, which typically equate to $% to 7% yields. Capital appreciation is secondary, explains income expert Harry Domash, editor of The Dividend Detective.
Although they could be issued at any price, most firms initially price their preferreds (IPO price) at $25 per share. Because their yields are so high compared to what banks and money market funds are paying, preferreds typical trade up in price to the $27 to $29 per share range. But there’s a catch.
(Editor's note: You can download Harry's 9-page "Preferred Stocks Primer" for free from the link at the top of his website.")
Most preferreds can be called at their IPO price five years after they are issued (call date). Thus, if you pay $28 per share, you could lose $3 per share if it’s called while you hold it.
However, issuers are not required to call their preferreds on the call date; they could call them years later, or even wait for the “maturity date” which could be 25 years out. In fact, many recent preferreds have no stated maturity.
Thanks to the recent market downdraft, many $25 preferreds are currently changing hands in the $22 to $25 per share range, and some even cheaper.
If history is any guide, most preferreds 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.
For example, say that you pay $22 per share for a $25 preferred that pays a nominal 6% yield ($1.50 per share annual dividend). Doing that would net you a 6.8% market yield plus more than 13% appreciation potential should the preferreds only trade back up to their $25 call price. So, what’s the catch?
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. Preferred ticker symbols are not standardized, so use your broker’s symbol lookup function to find them.
Here are three preferreds worth considering: You don’t have to worry about the call dates on there because, in all cases, you’d be delighted to have them called at $25 per share.
Cherry Hill Mortgage 8.20% Series A Cumulative (CHMI.P.A)
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.
These preferreds 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 Holdings 7.875%% Series C Cumulative (CODI.P.C)
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. Preferred recent price $22.89, preferred market yield 8.6%, potential price appreciation 9.2%.
Fortress Transportation & Infrastructure Investors 8.25% Series A (FTAI.P.A)
Managed by private equity investor Fortress Investment Group (FTAI), Fortress Transportation & Infrastructure Investors owns and leases airplanes, airplane engines, offshore oil and gas drilling equipment, shipping containers, etc. Preferred recent price $19.49, market yield 10.6%, potential price appreciation 28.3%.
