The Two Best “Stock-Bond Hybrids” for Rising Interest Rates

Preferred stock shares feature a mix of common stock and debt security traits.

In other words, they’re the best of the stock and bond worlds, and offer excellent, secure yields… if you understand how they work.

So today, let’s dig into that – and see the two best preferred stocks to buy today…

Preferred stocks pay a fixed dividend rate. A declared coupon rate will be based on a $25 par value. For example, a preferred with a 6% coupon will pay a $0.375 per share dividend every quarter. When interest rates rise, preferred share prices will fall, just like bond prices. If the hypothetical preferred stock trades for $20, then, the current yield would be 7.5%.

Preferred stocks can be callable but do not usually have a mandatory redemption date. This means you may hold a preferred stock position for years and years, collecting nice quarterly dividends. You receive the $25.00 par value if the shares are called in.

With the Federal Reserve raising interest rates, many preferred stocks currently trade for well below their par values. These low prices mean you can lock in very attractive yields. The point to remember is that you don’t know when or if a particular preferred stock issue will be called in. I tell my subscribers that when they buy preferred stocks, they should think of it as buying a long-term income stream. If shares are purchased for $20 and called in at $25, that would be an unexpected, serendipitous event.

With preferred stock prices down, there are some interesting ways to invest in the sector.

The Virtus InfraCap U.S. Preferred Stock ETF (PFFA) pays stable monthly dividends and yields 9.2%. That yield is greater than PFFA’s stable mate, the InfraCap MLP ETF (AMZA), which now yields 8.3%. Historically, AMZA, which invests in energy sector MLPs, carried a much higher yield than the more secure PFFA. The reversal tells me that PFFA is an attractive income investment, now available “on sale.”

Some preferred stocks have fixed coupon rates until their first call date and then switch to a floating coupon rate. The floating rate will be the secured overnight financing rate (SOFR), plus additional interest. SOFR recently replaced LIBOR and will track the Fed Funds target rate. When SOFR/LIBOR was near zero, the change to a floating rate would result in a dividend cut. Now, with rates increasing, if preferred issues let the rates go to the floating rate, the dividends will likely go up. Or the companies will call in the shares.

So, if you buy a fixed to floating rate preferred stock below par, you have the potential for a win-win when the rate switches to floating or the shares are called in. Here are a couple of examples…

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