Preferred stocks have stabilized in 2014—up 3.4% as of mid-February (see chart below)—after a down 2013. While it was a great year for common stocks, the S&P U.S. Preferred Stock Index declined more than 5% last year.
Perhaps more important for preferred investors, the yield component of many preferred stocks remains strong, particularly when measured against common stocks. To wit, the market median yield of preferred stocks is currently 6.6%, compared with a 2.1% dividend yield for the S&P 500® Index .1
Will preferred stocks continue their momentum? And are there opportunities for investors right now? If you’ve got an appetite for income-oriented investments, here are a few preferred ideas to consider.
Looking for high yielders
While preferred securities generally pay higher dividends than most common stocks, they are not likely to produce much in the way of capital gains. That may be fine if you gravitate toward preferreds for the income they offer. In fact, a common strategy for some preferred stock investors is to search for the highest-yielding instruments.
As of February 24, 2014, the highest-yielding preferred stocks are The Dolan Company (DOLNP), with a dividend yield of 85.8%, Molycorp, Inc., featuring a dividend yield of 47.2%, and Supertel Hospitality, Inc. (SPPRO), which has a dividend yield of 19.2%.
High income and a strong balance sheet
Looking only for the highest-yielding preferred stocks might not be a sound strategy, though. In exchange for the outlier high yield, you may be taking on additional risk because these companies may not be in very good financial shape. Instead, you might want to seek out high-yielding preferred stocks offered by financially healthy companies.
Fidelity offers the Preferred Securities screen, provided by Zachs Investment Research. The goal of this filter is to find financially strong companies with preferred securities that seek to offer above-market dividend yields.
As of February 24, the top preferred stocks produced by the screen are Cys Investments, Inc. (CYS/PB), yielding 8.85%, Northstar Realty Finance Corp. (NRF/PB), yielding 8.66%, and Amtrust Financial Services, Inc. (AFSI/PA), yielding 7.74%.
Preferred stock typically trades within a narrow band, anchored by its original issue price. These stocks don’t typically participate in the price surges that a common stock might see.
Nevertheless, preferred stock can experience price appreciation. Preferred stocks showing the most acceleration in the last five days versus the last month (1-week performance divided by 4-week performance) are Intelsat SA (I/PA), Goldman Sachs Capital I Securities Backed Series 2004 Class A 1 (GS/PA), and Unisys Corp. (UIS/PA).
Where to find preferred stock
Similarities to bonds
Screens like the ones above can help you find specific candidates. You may be wondering where there is a high concentration of preferred opportunities. Any company can issue preferred stock; indeed, you can find preferred stock in every quadrant of the market. However, utility companies, banks, and other financial institutions tend to offer preferreds, more so than others.
When volatility is on the rise, as it has been through the early part of 2014, preferred utility stocks in particular can provide several benefits. Utilities are a defensive sector that tends to outperform when the market is under pressure. Couple that with the income component of preferreds, and utility preferreds have the potential to help limit the impact of volatility on your portfolio.
Of course, utility preferreds are generally not as resistant to the effects of downturns as most bonds. That said, utility preferred stocks—along with other defensive preferred sectors like consumer staples and health care—can offer some measure of protection, compared with common stock, when the market hits a rough patch.
Instead of getting tactical with specific sectors, you may want to consider obtaining broad exposure to the preferred market by investing in ETFs such as the iShares S&P U.S. Preferred Stock Index (PFF), which is the largest preferred-stock ETF, as well as the PowerShares Preferred Portfolio (PGX) and Global X SuperIncome Preferred (SPFF).
Watch out for rising rates, credit risk
Preferred stock risks
One of the big risks to be aware of in the preferred space is the possibility of rising rates. Preferred stock typically declines in value when interest rates rise, and vice versa. The U.S. Treasury 10-year-note interest rate was as low as 1.6% in 2013, and has risen above 3.0% in recent months. The rise in rates likely played a role in last year’s underperformance in the preferred space. While the Fed has committed to keeping rates low for the foreseeable future, investors should keep in mind the possibility that rates could float up.
In addition to rising rates, credit quality is another risk factor that preferred investors may want to be mindful of. Using the Fidelity preferred stock screener, the highest-yielding preferred stocks that are rated AAA (the strongest credit rating available) by S&P Capital IQ, as of February 24, are Gabelli Dividend & Income Trust (GDV/PD), yielding 5.9%, Gabelli Healthcare & Wellness RX Trust (GRX/PA), at 5.7%, and Gabelli Equity Trust Inc. (GAB/PH), yielding 5.5%.
Past performance is no guarantee of future results.
Because of their narrow focus, sector funds tend to be more volatile than funds that diversify across many sectors and companies.
ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.
In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.
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