Consistent income generation has always been a hot topic. For some thoughts, let’s listen in to “Preferred stock: Good income, but it’s not guaranteed:”
Preferred stock combines some characteristics of common stock and of bonds. Like bonds, preferred shares pay a set amount of cash each quarter or year. And, as with bonds, owners of preferred stock have a higher claim to the company’s cash than do holders of common stock. Specifically, a company must pay all the dividends owed to preferred stockholders before paying any dividend to common stockholders.
However, preferred stock, like common stock, takes a backseat to bonds when it comes to claims on the company’s assets in bankruptcy. And as with dividends paid on common stock, dividends paid by preferred stock can be stopped any time the company chooses.
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You can buy preferred stock issued by a single company just as you can invest in the bonds or stock of one company. But concentrating your preferred holdings in a single stock exposes you to the risk that company will run into difficulty. That’s especially troubling if you’re counting on steady and dependable income from your preferred stock.
Normally, the answer to this problem would be to invest in an exchange traded fund (ETF) or mutual fund that owns preferred stock from many companies. Many equity-income mutual funds that have a goal of generating income for shareholders own preferred stocks. And there are preferred stock ETFs, such as the iShares S&P; U.S. Preferred Stock Index (PFF). The ETF currently yields 7.4%, as you can find out here.
But the trouble with the iShares preferred stock ETF is that it’s heavily concentrated in financial stocks, says Kenneth Winans of Winans International. “It’s essentially a financial preferred,” Winans says. Investing a large portion of your portfolio in the financial industry can expose you to outsized risks, as preferred stock investors learned during the financial crisis. “I’m scared of the banks,” Winans says. “I still feel many haven’t come clean.”
Sure, while it’s a valid concern whether banks have come clean (in my view they have not) or not, it’s an unknown just like when interest rates will have to move higher.
What it comes down to is timing. You can make a decision based on fundamentals and may be right, but it may take years to prove that you were correct. My preference is to look at the technical aspects and take advantage of the trends until they end for whatever reason. That takes the guesswork out of the decision making process.
In the case of PFF, let’s look at a 2-year chart:
The trend is still up and, in fact, PFF currently has moved above its long-term trend line by +5.44%. It’s been on a fairly steady ride since May 09 and had its worst pullback on 11/3/09 when it came off its high by -8.06%. In other words, it did not participate in the other market retractions we’ve seen in the last year to any worthwhile degree.
Sporting a yield of over 7%, it may be worth your consideration. However, it’s not a buy and hold proposition, you need to follow the trend and implement a sell stop discipline. PFF may look good right now, but you can’t be complacent owning it, you have to be prepared to exit if the markets head south again.
Disclosure: We have no holdings in PFF