Time to Prefer Preferreds?

Warren Buffett has seized on the financial crisis to start buying preferred stocks by the armload, and individuals may be tempted to follow suit.

You can see why. True, ordinary investors can't get the kind of sweetheart deals available to the Oracle of Omaha. But even publicly traded preferreds now offer dividend yields well into double digits.

Coming at a time when the yield on safe Treasury bonds is on the floor, this can be especially appealing.

"There are a tremendous number of opportunities in preferreds," says John Miller, chief investment officer of Nuveen Asset Management in Chicago. "The asset class has been heavily beaten up -- the events of September really contributed to that."

You can find preferred stocks from highly rated blue-chips like J.P. Morgan Chase & Co., Wells Fargo & Co. and General Electric Co. that have fallen so far they are yielding 10% or better. Mr. Buffett just bought some GE preferred stock, and is a longtime investor in Wells Fargo common stock. The market has been ever more severe with banks perceived to be under heavier pressure such as National City Corp. and Capital One Financial Corp. In many cases you can find yields over 20%.

Of course, no investment comes without risk, and these are no exception. Preferred stocks are a peculiar hybrid. They rank above the common equity, but below bonds. They tend to pay a fixed dividend in perpetuity. Most are issued by financial institutions, which explains some of the current distress.

Associated Press

Warren Buffett is buying up preferred stocks, which carry risks as well as fixed rewards.

Any private investors looking to buy individual preferreds had better bring a helmet and a pickax: The field is complex, requires a lot of digging and can be treacherous to the unwary. Many preferreds come with their own set of clauses and rules, offering extra profits or perhaps extra risks. You need to do your homework.

At the best, you may find you have locked in an annual yield of, say, 10%, with not too much risk and the potential for gains if the company's fortunes improve.

On the other hand, you may find you are taking pretty much the same gamble as the buyers of the common stock, with far less upside. If a company's fortunes improve, the sky is the limit for the common stock. For the preferreds, the payouts are fixed.

Nonetheless, the recent selloff raises the strong suspicion that there is value among preferred stocks now.

There are broadly based funds that will do your mining for you. Nuveen Preferred Securities Fund, an open-ended fund, has a yield of nearly 10%. The iShares U.S. Preferred Stock Index Fund, an exchange-traded fund that simply tracks the entire asset class, yields 8.7%.

And a number of investment firms, including Nuveen, BlackRock Inc., and John Hancock, a division of Manulife Financial Corp., offer closed-end funds that invest in preferred stock as well. Closed-ends themselves have been going through a massive selloff because of the financial crisis, and many now sell for well below net asset value.

Write to Brett Arends at brett.arends@wsj.com