Bonds Are Dead. Long Live Preferred Stock!

I see no reason to hold bonds right now. I see no reason to hold them for the next few years. I’m talking about any government-issued bond that pays less than 3%. For most investors, such bonds serve no purpose.

Inflation will erode any yield under 3%, possibly higher. Capital gains on bonds assume that prices will go even higher, which also means that people would be chasing lower and lower yields. Ain’t gonna happen.

So, what’s an investor to do, especially one who relies on fixed income from bonds to fund retirement or augment annual income?  The answer is to buy preferred stock, lots and lots of it.

Preferred stock is the unsung hero of portfolio asset allocation, if you ask me. I’ve dumped all bonds and bond funds, and replaced them with preferred stock and preferred stock ETFs.

Preferred stock trades like any other stock. It tends not to move much in price because most investors aren’t aware of preferreds, and because their intrinsic value is closer to a bond than an equity. Preferred stock has no voting rights (as if you vote anyway), is ahead of common equity in the event of a bankruptcy and usually pays a dividend between 5% and 9%.

If a company cuts its dividend, it must cut its common stock dividend first. Furthermore, most preferred stock is cumulative, so that in the event that a preferred dividend does get cut, if it gets reinstated the investor gets all the suspended dividends paid back.

I like to choose preferreds in companies that are generally quite solid, but I’ll even go for preferreds from companies that are struggling — yet not so badly that there’s any real risk of bankruptcy. The result is that these companies’ preferred stocks are thus trading below their offering price — which is basically like par for a bond. So, if the company recovers, you also enjoy capital gains.

I tend to avoid preferred stock in financial services firms, however. There’s just no reason to take on the risk associated with this sector when so many others pay so well. Here’s a sampling of preferreds that are worth considering, or can at least get you started thinking along these lines:

Ashford Hospitality Trust (NYSE:AHT) is a premier hotel REIT. The underlying stock is great and even pays a 5% yield. It’s Series D and E preferreds pay 8.45% and 9%, respectively.

Brandywine Realty Trust (NASDAQ:BDN) is an industrial office REIT, also yielding 5% on the common and 7.3% on the preferred D.

CHS (NYSE:CHSCP) is an unusual company — it’s a farming co-op. It has cash equal to debt, and is so solid that its 8% preferred stock is yielding 6.3% — because its preferred share price is 20% above its offering price.

CubeSmart (NASDAQ:CUBE) is a public storage REIT, also in good financial shape, with a compelling preferred yielding 7.75%.

DuPont Fabros Technology (NYSE:DFT) is a REIT of a different kind — it handles large-scale data center facilities. All that data that people push back and forth across the Internet needs to travel through a system, and that’s where data centers come in.  The company’s preferred B pays 7.625%.

Goodyear Tire & Rubber (NYSE:GT) surprised me. I didn’t expect a company this venerable to have a preferred, but it does, and it pays 6.68%.

If you want a basket of preferreds, then look at iShares S&P U.S. Preferred Stock Index (NYSE:PFF). It has more financials than I’d like, but because it’s a diversified ETF, you aren’t too badly exposed — and it yields 5.8%.

These are just a few plays in this very attractive arena, and as I find more interesting ones, I’ll pass them on to you.

Lawrence Meyers does not presently hold shares in any company mentioned.

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