TRADER EXTRA
Preferred Picks
With income investors hard-pressed, we went back to the well: that is, to preferred stocks.
September 10, 2016
With income investors hard-pressed, given the artificially low interest-rate environment, we went back to the well: that is, to preferred stocks, last mentioned here on May 14.
The stock market’s dividend yield is just 2.2%, while the 10-year Treasury yields a mere 1.67%. Both have risks, particularly Treasuries, given that the Fed is committed to raising rates, perhaps by December—and possibly sooner, as we note above. A hike would push down bond prices. What it will do to stocks is an unknown danger, too.
Corporate preferreds are an attractive way of securing a higher yield at a lower risk, though their capital gains are likely to be more restrained, too. We returned to Douglas Christopher, an analyst at D.A. Davidson, who gave us five preferred stock picks in May, most with fixed coupons. Although all of them were already above par value then, they’ve risen in price since May.
That high valuation is a problem for investors new to the preferred scene. Fixed-coupon preferred stock prices could drop and be volatile before and after the Fed hikes rates, the analyst notes.
So, this time, he likes adjustable preferreds, most of which are selling significantly below par value (see table, above). Consequently, they could fare better than fixed preferreds if a rate hike materializes, especially if the central bank moves more quickly than markets expect.
In general, the average yield on fixed preferreds is about 5.5%, versus 4.2% for adjustables. The interest rate on adjustables can change, and that’s a risk—but rates should be rising. We’ll note that under the typical underlying terms governing adjustables, it would take a slew of hikes to raise the current coupon rates.
Nevertheless, the dollar payout levels for these five, such as a $1 per year for theGoldman Sachs Group D preferred shares (GS.D), are effectively at their minimums already. So there’s some downside protection. As in the previous batch, these preferreds come mostly from banks whose credit fundamentals and dividends are healthy.
If rates stay flat, you miss out on the better yield of the fixed-coupon preferred. Still, “if you are looking for income and a decent yield, but at a price below par, this is an attractive way to go,” Christopher observes.
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