Should you consider preferred stock?

You probably recall the recent great deal Warren Buffett got in preferred stock of General Electric (GE) and Goldman Sachs (GS), those shares netting him a dividend yield of 10 percent.

Of course, most of us aren’t Warren Buffett and won’t get that type of deal.

But there are still decent yields to be found in preferred stock.

There are risks, too, however.

The latest edition of Fortune magazine carries an article entitled, “Be Like Buffett? The Case for Preferred Stock.”

In it, Oppenheimer & Co. analyst Meredith Whitney says she likes preferred shares of strong financials like J.P Morgan Chase, Bank of America and Wells Fargo, even though she’s been bearish on financials overall.

Preferred shares in those “strong” financials have been yielding between 8 percent and 9 percent, according to the article.

Similar to bonds, preferred shares carry a commitment by the company to pay a certain amount of interest to shareholders.

However, preferred shareholders are next in line behind bondholders for payment, should a company encounter problems. Therein lies one of the risks.

Preferred shares can also be a bit of a hassle to research. Pour enough money into the preferred of a company that suddenly hits the skids and you may be left holding the bag with defaulted shares.

Also, preferred shares are often subject to more volatility than other fixed-income assets.

Even so, a May article in USA Today looking at preferred shares noted that the equities had returned a 7.4 percent annual rate of return since 1900. That was less than common stock returns of 10 percent, but better than the 6.4 percent earned by corporate bonds.

Bottom line: If nothing else, preferred shares can be a good diversifier for those looking for income yield.

And like every other investment class, there’s an exchange-traded fund, or ETF, that can give you preferred share exposure with little hassle.

The Fortune article notes iShares S&P U.S. Preferred Stock ETF (PFF).

Morningstar says the ETF is a good option for investors looking for extra fixed-income yield, as long as they are comfortable with more volatility.

A Morningstar analyst also suggests a strong stomach for exposure to financials, since 74 percent of the ETF’s holdings were in that sector as of September.

“Prior to July, iShares U.S. Preferred Stock ETF had held up considerably better than the common equity of financial stocks, but fears surrounding bank failures and a continued collapse of the mortgage market put even the security of structurally superior preferred shares in doubt,” the analyst wrote. “Although things have settled down quite a bit, this should serve as a reminder to any would be investor that there is still a decent amount of risk inherent in this ETF.”

Morningstar also mentions as preferred stock ETF options the PowerShares Financial Preferred Portfolio (PGF) and the PowerShares Preferred (PGX). The latter also has a high concentration in financials, about 70 percent.

If you want to check out individual preferred shares, QuantumOnline.com allows you to do so with free registration.

Send me your ideas

As always, I’m looking for your stock picks and ideas.
Please e-mail me at bneill@bradenton.com or post a comment here.

Brian