Can Someone Please Explain To Me Why Preferred Stocks Are Bad?

[Singuy]

After doing a lot of research, trying to get a 6-8% yield with low risks at a time when a stock market is way over valued, I came to the conclusion that preferred stocks are pretty decent.

I know that interest rate has no where to go but up, therefore bringing down the value of these stocks. Companies may never call them due to this fact but I am really not understanding the math here.

Say a non-cumulative preferred stock from a decently rated company is paying out a 7% dividend and the call value is 25. I buy it at 25 and interest goes way up, bringing the value of my stock down to 18. Sure I have "lost" value, but I am still getting a 7% dividend on 25. At a time when the value of my stock goes down, shouldn't I just go ahead and buy more at 18? Buying the stock at 18 will give me a yield of 9.7% from dividend.

I hear preferred stocks are bad because interest rate will definitely go up so the value will be guaranteed to go down..but does this matter if I am looking for a guaranteed 7% return with min risks? Are preferred stocks terrible solely because they are being compared to common stocks with 20%+ returns?

[Koolmagicguy]

I'm pretty sure that if the value of the stock goes up or down the dividend would go up or down too.

[Singuy]

That's not how these stocks work. The dividend is based on the call rate(issued rate). If interest rates are low, people would end up paying a premium for these stocks because their dividend at the call rate is higher than the interest rate they can get elsewhere. If interest rates go up(like if you can get a CD at 6%, why would anyone buy preferred stocks that is not FDIC insured at 7%?)..then the VALUE of the stock goes down to say 15/share(if call rate is 25). At 15/share, they are still paying 7% at the 25 call rate so if you do reverse math, that 7% is now actually 11.6% return IF you buy the stock at 15/share.

If you paid 25 a share and now they are worth (or sellable if you want out) at 15, then essentially you have lost money. But if you were keep the stock and ride it out, you'll always receive that 7% at the 25 price so why are these so bad?

[kv968]

There isn't anything inherently bad with preferred stocks especially if you're willing to just stick with them for their dividends if their prices drop and they are issued from a "decently rated" company as you said.

Granted, I wouldn't put all of my money in them (nor in any one type of investment for that matter) but putting some of your portfolio in them to generate income isn't a bad idea.

One thing I would be careful with is the wording associated with these securities. Like with the example you provided (I'm not sure if that's a real security you're looking at or just something you gave as an example). The one thing I would be slightly concerned with is the fact that it's a "non-cumulative" stock. Granted that may never turn out to be problem but if for some reason they do have to suspend the dividend, the preferred price will crash, you won't be getting any dividend in the meantime and if and when they do resume the dividend you won't get any of the missed dividend payments.

[Singuy]

There isn't anything inherently bad with preferred stocks especially if you're willing to just stick with them for their dividends if their prices drop and they are issued from a "decently rated" company as you said.

Granted, I wouldn't put all of my money in them (nor in any one type of investment for that matter) but putting some of your portfolio in them to generate income isn't a bad idea.

One thing I would be careful with is the wording associated with these securities. Like with the example you provided (I'm not sure if that's a real security you're looking at or just something you gave as an example). The one thing I would be slightly concerned with is the fact that it's a "non-cumulative" stock. Granted that may never turn out to be problem but if for some reason they do have to suspend the dividend, the preferred price will crash, you won't be getting any dividend in the meantime and if and when they do resume the dividend you won't get any of the missed dividend payments.

Gotcha, that's what I thought.

Yeah non-cumulative are a risk but also comes with a higher yield. I generally look at their ratings first and also the company's debt to equity ratio before jumping in.

I prefer cumulative stocks but at a time when interest rate is non-existence, cumulative stocks are only giving out 4% yield after adjusted for their higher buy in price.