Preferred Stocks: A Preferred Avenue for Income Investors

Includes: F, JPM, KO, PFF, PGF, PGX
by: Jim Trippon
Dividends. Yield. Two big buzz words that have been ushered to the forefront of the investment lexicon in 2010 and rightfully so. By now, most investors know about the paltry yields offered by U.S. Treasuries and they also know this low interest rate environment has encouraged plenty of blue-chip companies to issue bonds at less-than-inspiring yields. Did you hear about Coca-Cola's (NYSE:KO) plans to issue $4.5 billion in bonds at or near a record low rate of 0.75%?

So while the search for yield these days oftens leads investors back to common dividend stocks, there is another option to consider. I'm talking about preferred stocks, an asset class that is still somewhat undiscovered by the ordinary investor.

When I talk about preferreds with clients, I find the biggest problem isn't misinformation, it's a lack of information. Since preferreds usually aren't as liquid or as volatile as their common stock counterparts, they don't get much air time in the mainstream financial press.

In the essence of keeping things simple, I like to tell clients that preferred stocks usually feature healthy yields and payouts that are as close to guaranteed as an investor can get. Simply put, a company that misses a dividend payment on preferred shares risks incurring damage to its credit rating and that could lead to higher borrowing costs for that company.

So there's a bond component with preferreds and investors should note that as preferred shareholders, they're higher up on the food chain in terms of getting some compensation in the event the company goes bankrupt. The downside is preferred shareholders exchange voting rights and the potential for capital appreciation that are afforded to common stock owners.

That's the bad news. The good news is that many preferreds give investors the best of both worlds: Robust yields and dividends that are practically guaranteed. In addition, the right preferreds can be perfect for conservative investors looking to escape volatility. For example, JPMorgan Chase (NYSE:JPM) issued preferred shares in 2002 that are still trading today. Those preferreds have a 52-week trading range of less than $2, but the indicated annual dividend is $1.75 with a yield of 6.9%. Obviously, the common stock is nowhere near competitive with the preferred in terms of dividends and yield.

One preferred issue that has gotten a lot of press is the Ford Capital Trust II Cumulative Convertible Preferred. The dividend here is $3.25 with a yield in the area of 6.5% all with a kicker: Each of these preferreds is convertible to about 2.8 Ford (NYSE:F) common shares. As the charts below illustrate, this particular preferred issue would NOT have represented a sacrifice in capital growth.

Preferred Stocks: A Preferred Avenue For Income Investors

(Click to enlarge)

Another option to consider is ETFs. There are several ETFs that focus exclusively on preferred stocks and the advantage here is that the ETF does stock-picking legwork for you. Here's a look at the recent returns of several ETFs that focus on preferreds.

Preferred Stocks: A Preferred Avenue For Income Investors

No matter if you go with an individual preferred stock or an ETF, embracing this asset class can prove to be a profitable move for income-minded investors.

Disclosure: No positions