It wasn't his typical style. Buffett usually refrains from naming names, but on the topic of preferred stock, he had no such filter: "Noncumulative has certain defects, and preferred holders of Freddie Mac and Fannie Mae are finding that out. They are a terribly weak form of security."
The terrible weakness
Preferred shareholders ordinarily receive preferential treatment; hence, the name. Preferred shareholders are supposed to receive their dividends first, before common shareholders can stake their claim.
Cumulative preferred shares should have an even greater advantage over noncumulative preferred shares. If dividends are skipped in any given year, they're to be repaid later when a company can pay a dividend. Fannie and Freddie preferred shares are noncumulative, however, and thus, all the dividends that should have been paid since September 7, 2008 are simply lost.
If Fannie Mae and Freddie Mac are ultimately returned to the hands of public owners, then preferred shareholders may, once again, collect a dividend. They won't, however, collect all the dividends previously skipped.
Why it matters
As a war builds over who should legally own Fannie and Freddie, normal preferred dividend distribution days are passing by. The amounts are growing significant by the day. In just a few months, preferred shareholders will have waited six years for any dividend at all.
And while Fannie Mae or Freddie Mac shareholders would ultimately stand to make massive returns if the government releases them to private hands, and shares trade back to par, there's no disputing the fact that the icing on the cake -- dividends in arrears -- will never come.
If there's something to be learned from Fannie Mae and Freddie Mac, it's that noncumulative preferred and cumulative preferred shares have their commonalities; but when it really matters, it's the differences that truly count.
Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.