How To Buy Both Growth and Income in a Rate-Broken Market

Roughly a week ago, I wrote an article titled “My Favorite Preferred Stock For 6% Income And Peace Of Mind.”  As the title gave away, it was about a preferred stock with a 6% yield and a thick layer of safety.  That preferred stock is Agree Realty’s (ADC) Series A, which traded well below its call price, resulting in a yield of 6.1% and roughly 40% upside, likely to be unlocked in a scenario of falling long-term interest rates. All of it was backed by a REIT that has perfected the net lease business through exceptional financial management and tenant quality.  As I promised readers in the comments and in the subscriber chat (make sure to check it out, as I want to spend a lot more time in the Ask-Leo chat), I will spend a lot more time on preferred equity. Although I am not focused on income right now due to my age (I’m 30), there’s a lot of value to be found in the preferred equity space.  The best thing is that this is a hybrid between common equity and bonds. Like a Toyota Prius, it’s somewhat of a “hybrid.” This is what I wrote in my Agree Realty article: They have priority. They are called “preferred” because investors have a priority over common stockholders. A company that has outstanding preferred stock cannot pay a single penny of common stock dividends until preferred dividends are paid in full. Often, preferred stock is cumulative, which means preferred stockholders who do not receive dividends due to financial headwinds need to be paid in full before common shareholders can receive a dividend.  Their income is fixed. Just like bonds (coupon payments), the dividend payments on preferred equities are fixed. The benefit is that you know exactly how much money you will receive. The headwind is obvious, which means you won’t see higher payments in the future. The table below shows the main differences: [Inline image] Source: Leo Nelissen In other words, if you’re in the market for growth, preferred equity is often the wrong move. However, for everyone seeking income, they can make a lot of sense. And even from a macro point-of-view, we can make the case that preferreds make a lot of sense to own.  Why?  That’s because preferred equities are highly dependent on long-term government bond yields. After all, the higher the risk-free rate on >10 year debt, the less attractive a preferred stock becomes, as it’s not risk-free. The lower the yield on government bonds, the higher the relative attractiveness of these assets. I’m painting with a broad brush, but that’s the gist of it. The chart below shows the inverted 10-year government bond rate compared to the price of the iShares Preferred & Income Securities ETF (PFF).  [Inline image] Source: TradingView (Inverted U.S. 10Y Yield, PFF)  Ever since inflation started to bite, the 10-year (and longer) yield has been sticky at elevated levels. Despite Fed rate cuts, the Fed was unable to lower the longer end of the curve, simply because the market controls that. Without active involvement, it’s impossible for the Fed to lower rates.  That’s both a challenge and an opportunity, as Bloomberg just reported that asset managers are jumping into long-term debt due to the favorable risk/reward (and diversification benefits): For now, the longest US maturities are the only ones where yields are down to start the year, signaling there may be limits to the steepener trade. Wellington’s Brij Khurana sees long bonds playing a key role: as ballast should equities stumble. He’s modestly tilting his holdings toward lengthier tenors. “Given growth and stock-market performance and corporate profits have been supported by fiscal spending and the AI buildout, if either of those two falter then I think bonds are going to be a much better diversifier to stocks,” he said. - Bloomberg This is the part where preferred stock comes in. Today, I present a very attractive preferred equity and the