A Closer Look At iShares Preferred Stock Index

A reader wanted to know if the iShares S&P U.S. Preferred Stock Index (PFF) might be ripe for the purchasing. He was intrigued by an online quote of a 20% dividend.

The PFF had been languishing near 52-week lows of 41 -- a 15%+ decline from its peak price of 50. In addition, with the possibility that financials had hit bottom, PFF's 3/4 weighting in financials could contribute to capital appreciation.

Having just recovered from the flu, I wasn't familiar with a 20% dividend on any preferred stock index. My mind could only recollect the 7% yield on the PowerShares Financial Preferred Fund (PGF).

So... an investigation was in order.

The PFF had served up a special year-end distribution that had thrown off the reported yield on a number of financial web sites. However, the accurate number is closer to the SEC's 30-day yield of 9.2%.

Nevertheless, a 9.2% dividend is nothing to sneeze at! Nor is a 7% yield. In fact, we're talking about baskets of preferred stocks that have already experienced bearish results in the sub-prime crisis. Is there a whole lotta downside risk left?

The questions to answer are these: (1) Has the financial segment come close to bottoming out? (2) Will the financial segment be at least at the same place at he end of 2008 as it is today?

If one is inclined to answer, "Yes," then one would have to take a serious look at the PGF and the PFF.

Think about it. If common stocks of financial companies sank another 20% in 2008, these indexes might fall 8%-10%. The yield alone would offset the capital depreciation. In contrast, if common financial stocks went flat on the year, the preferred indexes would produce a steady monthly income stream. And, should financial stocks lead the pack in 2008 -- a distinct possibility with the rate-cutting activity -- preferred indexes could garner venerable capital appreciation as well as an attractive yield.

A reasonable buy? Yes, I think that it is.

Downside risk? The markets could enter a bear, and all of the Fed stimulus/Congressional stimulus/foreign country stimulus fails. (And the financial system derails entirely.) I doubt that.

I think that there’s been a great deal of pain already. By reeling in some of the preferreds, the risk-reward relationship is quite reasonable. I feel a similar sense of opportunity when it comes to the Dow Jones Dividend Index (DVY).