Which Preferred Stocks Deserve A Permanent Place In Your Income Portfolio?

When the coronavirus pandemic triggered a stock market crash in the first quarter of 2020, I added individual preferred stocks to the Dividend Hunter recommendations list for the first time. Now, more than five years since I first recommended an individual preferred stock, I am more convinced than ever that preferred stock investments—whether individual stocks or a fund—provide important diversification for your income-focused portfolio.

Note: I use the terms preferred stock, preferred shares, and preferreds interchangeably. They all mean the same thing.

A public corporation issues two types of securities: equity and debt. Common and preferred stock shares are equity or ownership in a corporation, while bonds are debt securities issued by various entities, including corporations.

Common stock shareowners have ownership stakes in a company. They vote on items like the company’s board of directors, corporate resolutions, and merger agreements. Preferred stock shareholders do not have voting rights.

Preferred shares are named such because they have a preference over common stock shares when the corporation pays dividends. The company cannot reduce or suspend preferred share dividends while paying common stock dividends. Put another way: as long as a company pays dividends to common shareholders, the preferred dividend payments are safe.

Preferred Share Features and Definitions

Preferred stock shares can be issued with potential features that you should be aware of. Each preferred issue will have its own set of these elements.

Price and Yield: Preferred stock shares are issued at a $25.00 par price with a set yield or coupon rate—for example, the Rithm Capital Preferred Series D (RITM.PD) shares have a 7.0% coupon rate. Multiply the yield times the par price to get the annual dividend rate. In this case, 7.0% of $25 yields a yearly dividend of $1.75 per share, or $0.4375 per quarter.

Callable: A callable feature allows the issuing corporation to call or redeem the preferred shares at their $25.00 par value. Newly issued preferreds have call protection until a set date—the RITM.PD shares cannot be called until after November 15, 2026. Almost all preferred stock issues will be callable., but just because a preferred stock is callable doesn’t mean it will be called. Many preferreds listed to trade on the stock market are years beyond their call dates.

Fixed-to-Floating: A preferred stock issue may convert to a floating rate at a future date after the issue date, as in our example, RITM.PD, which converts to a floating rate after November 15, 2026. After that, the variable rate will be the five-year Treasury rate plus 6.223%. A preferred issue will convert from fixed to floating; if it has that feature, it also becomes callable at the same time.

Cumulative: If preferred shares have a cumulative feature, the issuing corporation must make up all missed preferred dividends if both the common and preferred stock dividends have been suspended. The company cannot resume paying common share dividends until the preferred stock investors have paid all the skipped preferred dividends.

Convertible: Preferred shares with a convertible feature can be exchanged at a fixed ratio for common stock shares. Whether to convert is at the discretion of the preferred share owner. 

Investment Considerations

Typically, preferred stocks trade around par value, with yields close to the coupon rate. Prices will fluctuate to reflect changes in market interest rates for similar securities. Again using RITM.PD as our example, this preferred stock was issued in September 2021. The share price has mostly ranged from $22 to $25, with a dip to less than $18 during the 2022 bear market.

We invest in individual preferreds for stable, high-yield income. Once you buy shares, expect to hold them for the long term. Reasons to sell would be shares trading well above par and callable, or if something materially changes with the issuing company. Additionally, it is possible, but not guaranteed, that preferred shares will be called in.

Preferred Stock Investments in Your Portfolio

In the recommendations list of my Dividend Hunter newsletter there are individual preferred stocks and a preferred stock ETF.

The recommended individual preferred stocks are included in the Fixed Income category of the Dividend Hunter recommended portfolio. The safety of preferred dividends is the most crucial feature concerning the overall portfolio.

Preferred stocks offer a very safe and high-yield income stream. That level of safety may be necessary for someone well into retirement, and income stability is the priority. Since we will all hopefully reach that retirement stage someday, accumulating preferred shares will help build an income cushion over time.

If you have a smaller portfolio and are building for the long haul, you can start getting preferred stock exposure with PFFA.

Preferred share dividends are fixed and will not change. They won’t be reduced or increased. The income stability is why you have a portion of your portfolio in preferred stocks. The more you want that stability, the larger portion of your portfolio can be invested in preferred shares.

For high yields plus safe dividends, look for preferred shares issued by REITs. Since a REIT must pay out 90% of net income as common stock dividends, REIT preferred shares offer a high degree of safety. Here are a couple to check out:

Annaly Capital Management Preferred 8.875% series J (NLY.PRJ), currently yielding 8.7%.

UMH Properties Preferred 6.375% Series D (UMH.PRD), currently yielding 7.3%.