The Case for Owing Preferred Stocks

[Wide Moat Daily]( The Case for Owing Preferred Stocks By Brad Thomas, Editor, Wide Moat Daily Nvidia (NVDA) just isn’t the big deal it used to be. So say a growing number of financial analysts and commentators after the last month or so’s movement. It might have been all they talked about for the past two years-plus, but now that Nvidia’s stock isn’t climbing astronomically anymore – and has actually seen some significant and repeated drops… They’re finally willing to acknowledge that other investment opportunities exist. To quote Yahoo Finance’s Tuesday edition of Morning Brief, “While S&P 500 has still largely mirrored the overall contours of Nvidia’s fortunes – and vice versa – the swing toward real estate, utilities, and financials since July is stark.” It then provides this chart for proof: Nvidia is that dark pink line, with: - The Technology Sector SPDR Fund (XLK) above it - The Nasdaq (IXIC) in light purple - The S&P 500 (GSPC) in the middle - The Financial Select Sector SPDR Fund (XLF) third from top - The Utilities Select Sector SPDR Fund (XLU) in second place - The Real Estate Select SPDR Fund (XLRE) taking the top spot For my part, I’ve been talking about the real estate investment trust (REIT) revival for months now. And while investors have definitely begun to pile into the sector, I don’t see it ending here. There is so much more “undervaluing” that needs to be rectified still in key commercial real estate plays. The same goes for utilities. Possibly financials too. In which case, I know a way to capitalize on all three categories with almost as much safety as a bond. Safety First, No Matter if the Bulls Are Running or the Bears Are Roaring If REITs, utilities, and financials really have more room to run, it might seem strange to focus on safety. And, for the record, I do aim to make money off the emerging bull run in these areas. I hope you’re looking to do the same. But no matter whether the bulls are running or the bears are roaring, I do believe in putting safety first. That means owning high-quality companies, buying into them at fair-value or discount prices, and diversifying across sectors, company sizes… And asset offerings. As in stocks, bonds, mutual funds, exchange-traded funds, and preferred stock. Preferreds are probably the least recognized members of that list, and that’s a shame. As I write in The Intelligent REIT Investor Guide: … 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. [More about that shortly.] Preferred stock occupies a unique space between debt and equity, displaying certain attributes of both bonds and common stock. Intrigued? You should be. This really is a great investment category to know about. It’s a type of capital equity – money raised by a company for the purpose of supporting and/or growing operations – that: - Pays regular, pre-determined dividends - Is respected below bonds but above common shares when it comes to company commitments – in the case of fiscal troubles, bond holders are paid back first, preferred share holders are paid next, and common shareholders shouldn’t expect to get anything at all - Is usually issued by large, investment-grade companies such as publicly traded financial institutions, REITs, and utilities The following chart breaks down the sectors that tend to go this route: It’s a good mix of economic interests that tend to come out ahead through thick or thin. As such, preferreds’ price points are far less volatile or even correlated with “normal” market moves. And while that means you’re probably not going to make much in the way of stock gains, if anything at all, they are a great diversification tool against most other investment categories, helping to balance your portfolio out in case of turmoil… Which always happens eventually, one way or the other. The Ins and Outs of Preferred Share Ownership This isn’t to say that the only benefit preferred stock offers is their portfolio-balancing potential. If that were the case, I probably wouldn’t be mentioning them at all. I already mentioned that they have payment priority over common stock. But that’s a worst-case-scenario advantage that has more psychological meaning than anything else; big companies like the ones that offer preffereds in the first place don’t tend to go bankrupt. Now, it should be noted that psychology does play an enormous part in individual investment choices and, therefore, profits. So, if you’re a more skittish type, preferreds might look even more appealing. However, even market stoics can appreciate how these shares tend to offer: - Higher dividend yields that are more comparative to high-yield bonds than common shares - Income that’s taxed at a lower rate than other types of income - Less sensitivity to higher interest rates Yes, I know interest rates should be coming down this month. And I’m still predicting they’ll come down again one more time this year. In which case, the interest-rate angle isn’t as tempting as it could have been. But it’s still a perk worth pointing out. There are downsides as well. There always are. But hopefully this chart by my associate, Hoya Capital Real Estate, illustrates how preferreds’ mix of risks and rewards can balance out nicely in a diversified portfolio. Another thing you’ll want to know about preferred stock is that, like bonds, they operate with fixed par amounts. Also like bonds, they can be callable, with specific dates established where the issuer can redeem them at a certain price. Overall though, they tend to have very long-dated terms, giving shareholders quarter after quarter (or month after month) of dividend payments before they “expire.” Call that system boring if you will, but I’ll own some of that monotony any day of the year. If You Need Another Nudge Toward Preferred Shares As already acknowledged, we’re almost certainly entering into a period of lower interest rates – at least compared to what we’ve been dealing with. In which case, it might seem as if preferred stock just isn’t as preferable. But you also have to consider the more shaky economic grounds we seem to be entering. That and the potential recession we’re looking at in the next few quarters could make the markets even more shaky from here. We already saw wild swings to start out this month. And all three major U.S. indices are down for the month. In addition, remember all of those banking issues we saw early last year? It might seem as if that was an age or two ago, but they haven’t gone away. There are still stressors on regional institutions (not the ones issuing preferreds) that could easily affect people’s perception of regular stocks, if not the stocks themselves. I would say that makes now a good time for investors to at least consider picking up some preferreds. But I much prefer to stress again that any time is a good time to do so. One of the biggest reasons to hold preferred shares is the same reason you hold bonds – because you never know when things could turn. And I, for one, like to be prepared. Regards, Brad Thomas Editor, Wide Moat Daily [Wide Moat Research]( Wide Moat Research 1125 N Charles St, Baltimore, MD 21201 [www.widemoatresearch.com]( To ensure our emails continue reaching your inbox, please [add our email address]( to your address book. This editorial email containing advertisements was sent to {EMAIL} because you subscribed to this service. 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