How To Squeeze Yields Up To 6.9% From Blue-Chip Stocks

Closeup of blue poker chip on red felt card table surface with spot light on chip

Preferred stocks are the little-known answer to the dividend question: How do I juice meaningful 5% to 6% yields from my favorite blue-chip stocks? “Common” blue chips stocks usually don’t pay 5% to 6%. Heck, the S&P 500’s current yield, at just 1.3%, is its lowest in decades.

But we can consider the exact same 505 companies in the popular index—names like JPMorgan Chase (JPM), Broadcom (AVGO) and NextEra Energy (NEE)—and find yields from 4.2% to 6.9%. If we’re talking about a million dollar retirement portfolio, this is the difference between $13,000 in annual dividend income and $42,000. Or, better yet, $69,000 per year with my top recommendation.

Most investors don’t know about this easy-to-find “dividend loophole” because most only buy “common” stock. Type AVGO into your brokerage account, and the quote that your machine spits back will be the common variety.

But many companies have another class of shares. This “preferred payout tier” delivers dividends that are far more generous.

Companies sometimes issue preferred stock rather than issuing bonds to raise cash. And these preferred dividends have a few benefits:

  • They receive priority over dividends paid on common shares.
  • Sometimes, preferred dividends are “cumulative”—if any dividends are missed, those dividends still have to be paid out before dividends can be paid to any other shareholders.
  • They’re typically far juicier than the modest dividends paid out on common stock. A company whose commons yield 1% or 2% might still distribute 5% to 7% to preferred shareholders.

But it’s not all gravy.

You’ll sometimes hear investors call preferreds “hybrid” securities. That’s because they act like a part-stock, part-bond holding. The way they resemble bonds is how they trade around a par value over time, so while preferreds can deliver price upside, they don’t tend to deliver much.

No, the point of preferreds is income and safety.

Now, we could go out and buy individual preferreds, but there’s precious little research out there allowing us to make a truly informed decision about any one company’s preferreds. Instead, we’re usually going to be better off buying preferred funds.

But which preferred funds make the cut? Let’s look at some of the most popular options, delivering anywhere between 4.2% to 6.9% at the moment.

Wall Street’s Two Largest Preferred ETFs

I want to start with the iShares Preferred and Income Securities (PFF, 4.2% yield) and Invesco Preferred ETF (PGX, 4.5%). These are the two largest preferred-stock ETFs on the market, collectively accounting for some $27 billion in funds under management.

On the surface, they’re pretty similar in nature. Both invest in a few hundred preferred stocks. Both have a majority of their holdings in the financial sector (PFF 60%, PGX 67%). Both offer affordable fees given their specialty (PFF 0.46%, PGX 0.52%).

There are a few notable differences, however. PGX has a better credit profile, with 54% of its preferreds in BBB-rated (investment-grade debt) and another 38% in BB, the highest level of “junk.” PFF has just 48% in BBB-graded preferreds and 22% in BBs; nearly a quarter of its portfolio isn’t rated.

Also, the Invesco fund spreads around its non-financial allocation to more sectors: utilities, real estate, communication services, consumer discretionary, energy, industrials and materials. Meanwhile, iShares’ PFF only boasts industrial and utility preferreds in addition to its massive financial-sector base.

PGX might have the edge on PFF, but both funds are limited by their plain-vanilla, indexed nature. That’s why, when it comes to preferreds, I typically look to closed-end funds.

Closed-End Preferred Funds

CEFs offer a few perks that allow us to make the most out of this asset class.

For one, most preferred ETFs are indexed, but all preferred CEFs are actively managed. That’s a big advantage in preferred stocks, where skilled pickers can take advantage of deep values and quick changes in the preferred markets, while index funds must simply wait until their next rebalancing to jump in.

Closed-end funds also allow for the use of debt to amplify their investments, both in yield and performance. Should the manager want, CEFs can also use options or other tools to further juice returns.

And they often pay out their fatter dividends every month!

Take John Hancock Preferred Income Fund II (HPF, 6.9% yield), for example. It’s a tighter portfolio than PFF or PGX, at just under 120 holdings from the likes of CenterPoint Energy (CNP), U.S. Cellular (USM) and Wells Fargo (WFC).

Manager discretion means a lot here. That is, HPF doesn’t just invest in preferreds, which are 70% of assets. It also has 22% invested in corporate bonds, another 4% or so in common stock, and trace holdings of foreign stock, U.S. government agency debt and cash. And it has a whopping 32% debt leverage ratio that really helps prop up the yield and provide better returns (though at the cost of a bumpier ride).

You have a similar situation with Flaherty & Crumrine Preferred and Income Securities Fund (FFC, 6.7%).

Here, you’re wading deep into the financial sector at nearly 80% exposure, with decent-sized holdings in utilities (7%) and energy (7%). Credit quality is roughly in between PFF and PGX, with 44% BBB, 37% BB and 19% unrated.

Nonetheless, smart management selection (and a healthy 31% in debt leverage) has led to far better, albeit noisier, returns than its indexed competitors. The Cohen & Steers Select Preferred and Income Fund (PSF, 6.0%) is about as pure a play as you could want in preferreds.

And it’s also a pure performer.

PSF is 100% invested in preferred stock (well, more like 128% if you count debt leverage), and actually breaks out its preferreds into institutionals that trade over-the-counter (83%), retail preferreds that trade on an exchange (16%) and floating-rate preferreds that trade OTC or on exchanges (1%).

Like any other preferred fund, you’re heavily invested in the financial sector at nearly 73%. But you do get geographic diversification, as only a little more than half of PSF’s assets are invested in the U.S. Other well-represented countries include the U.K. (13%), Canada (7%) and France (6%).

What’s not to love?

Brett Owens is chief investment strategist for Contrarian Outlook. For more great income ideas, get your free copy his latest special report: Your Early Retirement Portfolio: 7% Dividends Every Month Forever.

I graduated from Cornell University and soon thereafter left Corporate America permanently at age 26 to co-found two successful SaaS (Software as a Service) companies. Today they serve more than 26,000 business users combined. I took my software profits and started investing in dividend-paying stocks. Today, it’s almost impossible to find good stocks that pay a quality yield. So I employ a contrarian approach to locate high payouts that are available thanks to some sort of broader misjudgment. Renowned billionaire investor Howard Marks called this “second-level thinking.” It’s looking past the consensus belief about an investment to map out a range of probabilities to locate value. It is possible to find secure yields of 6% or more in today’s market – it just requires a second-level mindset.

Source: How To Squeeze Yields Up To 6.9% From Blue-Chip Stocks

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Critics:

A blue chip is stock in a stock corporation (contrasted with non-stock one) with a national reputation for quality, reliability, and the ability to operate profitably in good and bad times. As befits the sometimes high-risk nature of stock picking, the term “blue chip” derives from poker. The simplest sets of poker chips include white, red, and blue chips, with tradition dictating that the blues are highest in value. If a white chip is worth $1, a red is usually worth $5, and a blue $25.

In 19th-century United States, there was enough of a tradition of using blue chips for higher values that “blue chip” in noun and adjective senses signaling high-value chips and high-value property are attested since 1873 and 1894, respectively. This established connotation was first extended to the sense of a blue-chip stock in the 1920s. According to Dow Jones company folklore, this sense extension was coined by Oliver Gingold (an early employee of the company that would become Dow Jones) sometime in the 1920s, when Gingold was standing by the stock ticker at the brokerage firm that later became Merrill Lynch.

Noticing several trades at $200 or $250 a share or more, he said to Lucien Hooper of stock brokerage W.E. Hutton & Co. that he intended to return to the office to “write about these blue-chip stocks”. It has been in use ever since, originally in reference to high-priced stocks, more commonly used today to refer to high-quality stocks.

References:

Morrisons Shares Surge As Investors Bet On Low U.K. Supermarket Valuations

Morrisons, CD&R. Tesco, Sainsbury's, Asda

Shares in U.K. publicly-listed supermarket chain Morrisons surged by almost a third in morning trading today, after Britain’s fourth biggest grocer rebuffed a $7.6 billion takeover from U.S. private equity giant Clayton, Dubilier & Rice.

The huge spike in its valuation was prompted by emerging news over the weekend that Morrisons had become a takeover target for CD&R, potentially sparking a bidding war for the grocer.

The news prompted shares to rise across the grocery sector, as investors bet that other supermarket groups could become targets for private equity investors or that a bidding battle could erupt, with online giant Amazon AMZN -0.9% – which has an online delivery deal with Morrisons – one possible bidder for its partner.

American private equity firms Lone Star and Apollo Global Management APO +1.9% have also been mentioned as possible suitors for Morrisons, which has been battling with a declining market share, now down at 10%, from 10.6% five years ago. There is a sense that the U.K. supermarket sector could be ripe for more potential takeovers. The share price performance of the entire sector is seen as under-performing compared with U.S. grocers, for example, despite being profitable and achieving typical dividend yields of around 4%.

CD&R has history, having previously made investments in the discount U.K. store chain B&M, from which it made more than $1.4 billion.

Morrisons Rebuffs Bid But More Could Follow

Morrisons first announced on Saturday that it had turned down a preliminary bid by Clayton, Dubilier & Rice, which is believed to have been made on or around 14 June. The Bradford-based company said that its board had “unanimously concluded that the conditional proposal significantly undervalued Morrisons and its future prospects”.

CD&R had offered to pay nearly 320c a share in cash, while Morrisons’ share price closed at 247c on Friday, before its surge today as trading reopened for the first time since the announcement.

The New York-headquartered private equity firm has until 17 July to make a firm offer and to persuade a reluctant Morrisons management team to recommend that shareholders agree to the deal.

Sir Terry Leahy, a former Tesco chief executive, is a senior adviser for CD&R and, like its market-leading rival Tesco, Morrisons’ shares have been trading below their pre-pandemic levels as higher costs due to operating throughout the pandemic have taken their toll despite booming sales at essential stores across the U.K.

Morrisons currently employs 121,000 people and made a pre-pandemic profit of $565.5 million in 2019, which plunged to $278.6 million in 2020. It owns the freehold for 85% of its 497 stores. One-quarter of what it sells comes from its own supply chain of fresh food manufacturers, bakeries and farms.

CD&R has so far declined to comment on whether it will return with a higher bid, but analysts believe its approach is probably just the first salvo.

Previously, former Walmart WMT +0.9%-owned Asda was snapped up by the U.K.’s forecourt billionaire Issa brothers along with private equity firm TDR Capital in a debt-based $9.4 billion buyout. Likewise, CD&R could adopt a similar model and combine Morrisons, which has just a handful of convenience stores after a number of limited trials of smaller store formats, with its Motor Fuel Group of 900 gas stations.

There are also wider political concerns that it could emulate the Issas by saddling Morrisons with debt and selling off its real estate assets and CD&R is understood to be weighing political reaction before determining whether or not to come back with a higher bid.

Supermarket Takeovers More Likely Than Mergers

For tightly-regulated U.K. competition reasons, takeovers or mergers between supermarket groups appear increasingly complex. The competition watchdog blocked a proposed $9.7 billion takeover by Sainsbury’s for rival Asda two years ago, determining that the deal threatened to increase prices and reduce choice and quality.

However, comparatively relaxed rules on private equity bids mean few such restrictions apply to takeovers. Private equity firms have acquired more U.K. firms over the past 18 months than at any time since the financial crisis, according to data from Dealogic, and Czech business mogul Daniel Křetínský has established a 10% stake in Sainsbury’s, the U.K.’s second biggest supermarket chain. Having failed in an attempt to take over Germany’s Metro Group last year, he could yet make an offer for a British grocer.

AJ Bell investment director Russ Mould added in an investor note this morning that Morrisons’ balance sheet looks highly attractive, in particular to a private equity firm looking to sell business assets to release cash.

“Morrisons’ balance sheet has plenty of asset backing and the valuation was relatively depressed before news of private equity interest,” he said. “The market value of the business had weakened so much that it clearly triggered some alerts in the private equity space to say the value on offer was looking much more attractive.”

Follow me on Twitter or LinkedIn. Check out my website.

I am a global retail and real estate expert who looks behind the headlines to figure out what makes consumers tick. I work as editor-in-chief for MAPIC and editor for World Retail Congress, two of the biggest annual international retail business events.  I also organise, speak at, and chair conferences all over the world, with a focus on how people are changing and what that means for the retail, food & beverage, and leisure industries. And it’s complicated! Forget the tired mantra that online killed the store and remember instead that retail has always been dog-eat-dog: star names rise and fall fast, and only retailers that embrace the madness will survive. Don’t think it’s not important, your pension funds own those malls!

Source: Morrisons Shares Surge As Investors Bet On Low U.K. Supermarket Valuations

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Critics:

Wm Morrison Supermarkets plc (Morrisons) (LSEMRW) is the fourth biggest supermarket in the United Kingdom. Its main offices are in Bradford, West Yorkshire, England.The company is usually called Morrisons. In 2008, Sir Ken Morrison left the company. Dalton Philips is the current head. The old CEO was Marc Bolland, who left to become CEO of Marks & Spencer.

As of September 2009, Morrisons has 455 shops in the United Kingdom. On 15 March 2007, Morrisons said that it would stop its old branding and go for a more modern brand image. Their lower price brand, Bettabuy, was also changed to a more modern brand called the Morrisons Value. This brand was then changed again in 2012 as Morrisons started their low price option brand called M Savers.

In 2005 Morrisons bought part of the old Rathbones Bakeries for £15.5 million which make Rathbones and Morrisons bread. In 2011, Morrisons opened a new 767,500 square/foot centre in Bridgwater for a £11 million redevelopment project. This project also made 200 new jobs.

References:

  1. “Morrisons Distribution Centre Preview”. Bridgwater Mercury. Retrieved 6 July 2012. This short article about the United Kingdom can be made longer. You can help Wikipedia by adding to it.
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