Buffett Loves These Misunderstood Investments

During the market’s darkest days of fear and uncertainty last October, Warren Buffett wrote a bullish op-ed piece in The New York Times arguing in favor of U.S. stocks.

Those reassuring comments helped quell anxiety far more than any government intervention.

Buffett was putting his money where his mouth was. Ever the opportunist, he took advantage of the panic-driven sell-off by putting Berkshire Hathaway’s (NYSE: BRK-B) mountainous cash stockpile to work. And with a limitless array of investment options, there was one asset class at the very top of his shopping list.

Bear Stearns and Lehman Brothers, investors dumped their shares. Other banks flooded the market with newly-minted preferreds to strengthen Tier 1 capital ratios on their weakened balance sheets.

Naturally, that gush of supply overwhelmed an already weakened market. As with any supply/demand imbalance, prices were driven sharply lower, which sent yields shooting in the opposite direction — peaking at 19.6% in March.

Since then, investors have realized that the sky isn’t falling and any remote threat of a systemic collapse has been averted. Confidence and liquidity have flooded back into the preferred stock sector, sending prices higher.

For example, Wells Fargo Cap IV 7% (NYSE: WSF) hugged the $25 mark for years before plummeting to around $10 back in March.

At that price, the annual payments of $1.75 per share (which were meant to provide a 7% yield) suddenly represented a colossal payout of 17.5%.

But the shares quickly found their way back home to $25 — providing a gain of +150% on top of the dividends.

There’s a similar story behind most other preferred stocks.

Some of the upside potential in preferreds is already gone, but investors who missed the boat can still find many preferreds still trading at sizeable discounts.

The rally in preferreds isn’t over. With generous payouts above 8% (the highest you’ll find from sound, investment-grade companies), any further capital appreciation will just be icing on the cake.