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Just about my favorite security in the stock market these days is preferred stocks. They pay high yields, they are generally very safe investments whose share prices move in a very tight range, and they are a great substitute for bonds, which pay nothing.
A quick reminder on what preferred stock actually is. It’s basically a hybrid of a bond and a stock. A bond is a loan to the company in which the investor will enjoy an interest payment in exchange for the loan. Debt always has the senior position if the company files for bankruptcy, so they get their money back first.
Why do companies issue preferred stock? To raise capital without diluting ownership of regular shareholders, but also permitting bondholders to maintain their senior position. The trade-off is a minor one, in that preferred stock doesn’t have voting rights, but offers dividend payments that are often way higher than bonds themselves. That’s because preferred stock carries more theoretical risk than bonds, but less than the common stock. The risk, though, is truly theoretical except for companies that are dangerously close to insolvency.
Here are my three favorite high-yield preferred stocks:
Public Storage (NYSE: PSA)
Public Storage has a 6.5% Series Q preferred stock. It’s a fabulous company. Our country is in need of storage, because so many folks got kicked out of their homes during the housing crisis. They needed somewhere to live and rented apartments. Well, those apartments don’t have much storage space compared to a house, so enter storage facilities.
It’s also a great business model. A storage company draws down debt to build its facility, then rents out its units. This business can be a great cash-flow generator, although competition can be fierce. Public Storage has a great brand and huge footprint.
Ashford Hospitality Trust (NYSE: AHT)
Ashford is one of my longest holdings. It offers an 8.45% Series D preferred stock.
The hotel industry is in fantastic shape right now. Hotel demand exceeds supply, so there are more hotels that need to be built, so room rates are rising. Business travel is doing fine, and people always need a place to stay on vacation.
From a business standpoint, hotel REITs generate money from all the room stays. Then the REIT pays off expenses and pay interest on the debt. Then they must distribute 90% of what’s left to shareholders.
Hotels must properly manage debt and liquidity, buy the right hotels at the right price, manage them well, and take advantage of pricing power when the economic environment permits. Ashford does all of these things better than any of its peers.
Digital Realty Trust (NYSE: DLR)
Digital Realty is also a real estate play. Some people like to buy the common shares of REITs for the dividend, but I prefer to sometimes bypass the chance for capital gains and just go for the dividend via preferred stock, as I do with Digital Realty.
Digital Realty owns properties that have essential operational activities technology industry tenants, corporate enterprise datacenter users and financial services companies. This includes Internet gateway properties, corporate data center properties, technology manufacturing properties and regional or national offices of technology companies. This is all the critical back-room stuff that, if it goes down, puts the companies in trouble.
While Digital Realty only has 75 properties, it generates solid cash flow and pays a 7% yield on its Series E Preferred Stock.
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