3 Hand-Picked Preferreds For The High Yield Investor

As I explained in my book, The Intelligent REIT Investor Guide,

“Benjamin Graham was not a fan of preferred stock as he once said, “really good preferred stocks can and do exist, but they are good in spite of their investment form, which in an inherent bad one.”

As I explained, Graham felt as though “the typical preferred shareholder is dependent for his safety on the ability and desire of the company to pay dividends on its common stock.”

He believed that “once the common dividends are omitted, or even in danger, his own position becomes precarious, for the directors are under no obligation to continue paying him unless they also pay on the common.”

He seemed most guarded, with regard to preferred issues because

“…the preferred stock carries no share in the company’s profits beyond the fixed dividend rate. Thus the preferred holder lacks both the legal claim of the bondholder (or creditor) and the profit possibilities of a common shareholder (or partner).”

I can see why Graham was not a fan of preferred stocks because he was the quintessential value investor, he believed they “they (preferred stocks) should be bought on a bargain basis or not at all.” As I explained in my book,

“…unlike Graham I believe that preferred stock is an attractive asset class as it generally offers relatively high yields while providing the protection of a fixed dividend, along with seniority over common stock both with regard to dividends and in liquidation. Preferred stock occupies a unique space between debt and equity, displaying certain attributes of both bonds and common stock.”

In addition, most preferred stock is issued by large investment grade publicly traded issuers such as banks, insurance companies, utilities and REITs. Moreso, the universe of preferred stock is much larger today and offers investors a broad base of opportunity…

According to an article from Institutional Investor,

“In a report expected to be published on Monday, Cohen & Steers found that preferred securities often have strong performance after rate hikes, outstripping other types of fixed income products like investment-grade and high-yield bonds.

Since 1990, they have achieved an average 12-month return of 12.7 percent after rate hikes, compared to 10.2 percent for investment-grade bonds and 9.9 percent for junk bonds, according to the report.”

3 Hand-Picked Preferreds

Morgan Stanley (MS) is a multinational investment management firm providing services such as: wealth management, investment banking, and sales and trading. With a market cap over $146 billion and over $50 billion of net revenue.

Morgan Stanley is one of the top banks on Wall Street.

With this mix of the assets, earning power, and prominence within the global financial markets, Morgan Stanley has a A- credit rating from S&P – firmly within the investment-grade class.

One issue of Morgan Stanley preferreds, Series K, is currently yielding over 6.50% and priced more than a dollar below par. We feel that this represents a great opportunity to get heavily discounted investment-grade exposure within preferreds.

Edison International (EIX) is a major power provider in California which distributes electricity over 50,000 square miles throughout southern and central California.

In addition, Edison International owns and operates renewable power projects and energy storage facilities. EIX currently has a BBB credit rating from S&P and is considered an investment grade issuer.

Preferreds represent approximately 6.80% of EIX’s capital structure and EIX’s $1,000 par preferreds average a current yield of 6.50%. EIX operates much of its California business through a subsidiary, SCE, which has public $25 par preferreds.

One of these, Series H, has a current yield of 7.50% – about 100 basis points more than the $1,000 par preferreds.

Necessity Retail REIT (RTL) is a publicly traded REIT with a real estate portfolio of single and multi-tenant retail and distribution properties. Within their multi-tenant portfolio, about 23% of the properties are grocery-anchored and 56% are considered power centers – large retail strip malls with multiple big box anchor tenants.

We feel that exposure to these necessary retail stores (big box and grocery) provides RTL, and its preferreds, with a sufficient buffer in times of macroeconomic uncertainty.

Equity and preferred stock represent approximately 20% and 8% of the capital structure, respectively. RTL is rated BB by S&P and BB+ by Fitch, which makes RTL a non-investment grade issuer.

RTL has 2 issues of preferreds and its Series P issue is yielding approximately 9.30%.

In Closing

Many investors seeking higher yields have become interested in preferred stocks.

Keep in mind, preferred dividend rates are set when the shares are first issued, remain fixed for as long as the shares are outstanding and, therefore, preferred shares have little, if any, appreciation potential in normal market conditions.

Accordingly, holders of preferred shares will not participate in the company’s earnings growth over time.

It’s also important to know that an issuer can typically redeem its preferred shares after a period of time, usually five years after issuance, at the original issue price.

As a result, if interest rates fall and the issuer chooses to redeem the shares, the preferred shareholder may be deprived of an attractive, high-yielding investment.

In a mild recession, where there is an orderly decline in the stock market and a decline in long term interest rates, investment grade preferred securities are likely to be relatively stable or even appreciate slightly as the decline in interest rates offsets the increase in spread associated with rising default risk.

Investors should analyze preferred stocks carefully, however, as the call features and credit quality of these securities can affect the attractiveness of the securities dramatically and the securities are subject to stock market risk and interest rate risk.

Author’s note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.