How to Calculate Preferred Dividends

Preferred stock, also known as preference shares, is a unique class of equity security that offers distinct advantages and characteristics compared to common stock. Unlike common stock, which fluctuates in value and dividends depending on the company’s performance and board decisions, preferred stock is designed to provide a more predictable stream of income. The defining feature of preferred stock is its fixed dividend, which is typically established at the time of issuance. This fixed dividend offers shareholders a reliable income stream, making preferred stock particularly attractive to income-focused investors. Additionally, preferred stockholders have a priority claim on dividends and assets in the event of liquidation, which offers them a greater degree of security compared to common stockholders. However, this preference comes with its own set of limitations, such as the lack of voting rights and limited potential for capital appreciation.

One of the key aspects of preferred stock is the fixed dividend, which is determined at the time of issuance and is usually expressed as a percentage of the par value of the stock. The par value is the nominal value assigned to the share at the time it is issued, and it serves as the basis for calculating dividends. For example, if a preferred share has a par value of $100 and the dividend rate is set at 5%, the shareholder is entitled to receive $5 per share in annual dividends. This fixed dividend rate offers a level of predictability and stability, which is a major draw for investors seeking regular income, such as retirees or conservative investors. The fixed nature of the dividend contrasts sharply with the variability of dividends paid to common shareholders, which can fluctuate based on the company’s earnings, cash flow, and overall financial health.

Another critical feature of preferred stock is its priority over common stock when it comes to dividend payments. Preferred shareholders must receive their dividends before any dividends can be paid to common stockholders. This priority status gives preferred shareholders an additional layer of security, as they are less likely to miss out on their expected income even if the company faces financial difficulties. In periods of economic hardship or when the company experiences declining profits, common stock dividends may be suspended, but preferred stock dividends typically take precedence. This preferential treatment ensures that preferred shareholders have a more stable and predictable income stream, even during times of financial strain.

The priority in dividend payments can be particularly important for investors in industries or sectors that are prone to cyclical fluctuations, such as utilities, real estate, or manufacturing. In these sectors, companies may face periods of low earnings due to changes in demand or economic conditions. While common stockholders may experience dividend cuts or suspensions during these times, preferred stockholders can often rely on their fixed dividend payments, as long as the company remains solvent. This feature makes preferred stock an attractive option for income-focused investors who are looking for a reliable and consistent dividend, without the uncertainty that comes with common stock investments.

Preferred stock dividends are typically paid on a quarterly, semi-annual, or annual basis, depending on the terms of the issuance. These dividends are set by the company at the time the stock is issued, and they remain fixed for the duration of the stock’s life, unless the company chooses to redeem or call the stock. In most cases, companies issuing preferred stock will use a fixed rate to determine the dividend, which is usually expressed as a percentage of the par value of the stock. As mentioned earlier, to calculate the dividend for preferred stock, you multiply the par value of the stock by the fixed dividend percentage. For instance, if a company issues preferred shares with a par value of $100 and a dividend rate of 6%, each preferred shareholder will receive $6 annually per share, paid according to the specified schedule.

In addition to the fixed dividend, many preferred stocks come with other features that distinguish them from common stocks. Some preferred stocks are "cumulative," which means that if the company is unable to pay dividends in any given period, the unpaid dividends will accumulate and must be paid before common shareholders can receive their dividends. This feature further strengthens the position of preferred stockholders, ensuring that they will eventually receive their missed payments, although this could take time, especially if the company faces prolonged financial difficulties. Cumulative preferred stock can be particularly appealing to investors who are concerned about the possibility of missed dividend payments and want to ensure that they are eventually compensated.

Another important characteristic of preferred stock is that it typically does not carry voting rights. While common stockholders have the right to vote on matters such as the election of the board of directors, major corporate decisions, and mergers or acquisitions, preferred shareholders generally do not have this right. This lack of voting power means that preferred shareholders are more passive investors compared to common shareholders, as they have little influence over the company’s strategic decisions. While this may be a disadvantage for some investors, it is often a trade-off that comes with the priority in dividend payments and the generally higher level of income security offered by preferred stock.

Preferred stock also has a limited potential for capital appreciation. While common stockholders can benefit from price appreciation if the company performs well and its stock price rises, the value of preferred stock is typically more stable and less likely to increase significantly. Preferred stock is often seen as a fixed-income investment, much like bonds, and its price movements are generally less volatile than common stock prices. This can make preferred stock an attractive choice for investors who are seeking a steady, predictable return, rather than the potential for large capital gains. However, this also means that preferred stock does not offer the same upside potential as common stock, which may be a disadvantage for investors seeking high growth and capital appreciation.

The fixed dividend and priority claim on dividends make preferred stock an appealing investment for certain types of investors. For example, investors seeking steady income streams, such as retirees or conservative investors, may find preferred stock attractive because it offers a reliable, fixed return. Additionally, institutional investors, such as pension funds or insurance companies, often invest in preferred stock because it provides a stable income and a high level of security, without the risks associated with common stock. Preferred stock can also be an attractive option for individuals seeking to diversify their portfolios with income-generating securities that are less volatile than common stocks.

However, there are also some risks associated with preferred stock. While preferred shareholders have priority in dividend payments, they are still exposed to the risk of the company’s financial troubles. If a company faces bankruptcy or liquidation, preferred shareholders will be paid out only after the company’s debts have been settled. This means that in the worst-case scenario, preferred shareholders may not receive the full value of their investment. Additionally, if the company is unable to pay its dividends, preferred stockholders may experience a suspension of dividends, even if these payments are cumulative. In this case, the dividends may accumulate, but the investor may not receive them immediately, and the company may not be able to meet these obligations for an extended period.

In conclusion, preferred stock is a unique form of equity investment that offers a fixed dividend, priority over common stockholders in dividend payments, and a generally lower level of risk compared to common stock. The fixed dividend rate, calculated by multiplying the par value of the stock by the dividend percentage, provides a stable and predictable income stream, making preferred stock attractive to income-focused investors. However, this comes with trade-offs, such as the lack of voting rights and limited potential for capital appreciation. While preferred stock offers many advantages, it is not without risks, particularly in situations where the company faces financial difficulties or is forced to suspend dividends. Investors must carefully evaluate the characteristics and risks of preferred stock before incorporating it into their portfolios.

Example 1:
If the dividend percentage is 8 percent and the preferred stock was issued at $20 per share, then the annual dividend is: 8% * $20 = $1.60 per share.

Example 2:
If you owned 10,000 6.5 percent preferred shares which were issued at a par value of $50 per share, then:
The dividend per share of preferred stock = $50 * 6.5% = $3.25
Total Preferred Dividends = 10,000 shares * $50 * 6.5% = $32,500

Suppose the preferred stock is trading at $60 per share, and you want to calculate the dividend yield:
Dividend Yield Ratio = (Dividend Per Share / Market Price Per Share) * 100% = (3.25 / 60) * 100% = 5.4%