11.4 Preferred Stock
2 min read•june 18, 2024
is a unique financial instrument that blends characteristics of both stocks and bonds. It offers fixed payments and priority over common stockholders during liquidation, making it an attractive option for income-seeking investors who want a balance of stability and potential growth.
Understanding is crucial for grasping the complexities of corporate capital structures. Its features, such as cumulative dividends, callability, and convertibility, provide companies with flexibility in managing their finances while offering investors various ways to participate in a company's success.
Preferred Stock
Key characteristics of preferred stock
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- Represents ownership in a company and provides priority over common stockholders during liquidation
- Offers fixed payments (similar to interest on debt) that are paid before any dividends to common stockholders
- Dividends can be cumulative, requiring unpaid dividends to accumulate and be paid in the future ()
- does not require unpaid dividends to be paid later
- May be callable or redeemable by the issuing company at a predetermined price after a specified date
- Some preferred stocks can be converted into a specified number of common shares ()
- Generally lacks unless specified or when dividends are in
- Can be perpetual, with no fixed maturity date ()
Intrinsic value calculation for preferred stock
- of preferred stock calculated using the formula:
- Annual Dividend: fixed annual dividend payment per share
- Dividend Yield: market-determined yield investors require for the given level of risk
- Example: Preferred stock with a $5 annual dividend per share and a required 4% dividend yield
- Intrinsic Value = \frac{\5}{0.04} = $125$
Preferred stock vs common stock
- Similarities
- Both represent ownership in a company and have the potential for capital appreciation
- Traded on stock exchanges
- Differences
- Dividend payments
- Preferred stock: fixed dividends paid before common dividends
- Common stock: variable dividends dependent on company performance and board approval
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- Preferred stockholders are paid before common stockholders during liquidation
- Voting rights
- Common stockholders typically have voting rights
- Preferred stockholders generally do not, unless specified or when dividends are in arrears
- Callability and convertibility
- Some preferred stocks may be callable or convertible
- Common stocks are typically not callable or convertible
- Dividend payments
Types of Preferred Stock
- : allows holders to receive additional dividends beyond the stated rate if certain conditions are met
- : dividend rate adjusts periodically based on changes in a specified benchmark interest rate
- : hybrid securities that combine features of preferred stock and corporate bonds, often issued by bank holding companies
Investment Options
- Investors can gain exposure to preferred stocks through individual securities or , which offer diversification across multiple preferred stock issues
Key Terms to Review (21)
Adjustable-Rate Preferred Stock: Adjustable-rate preferred stock is a type of preferred stock where the dividend rate is periodically reset, typically based on a reference interest rate or index. This allows the dividend yield to fluctuate over time in response to changes in market conditions, providing issuers with more flexibility in managing their capital structure and investors with exposure to variable income streams.
Arrears: Arrears refers to an amount that is overdue or unpaid, typically in the context of financial obligations or payments. It denotes a state of being behind or in debt with respect to scheduled payments or dues.
Callable Preferred Stock: Callable preferred stock is a type of preferred stock that gives the issuing company the right to redeem or buy back the shares from shareholders at a predetermined price and time. This feature provides the company with the flexibility to retire the preferred stock when it is advantageous to do so.
Convertible Preferred Stock: Convertible preferred stock is a type of preferred stock that can be converted into a predetermined number of common shares of the issuing company. This unique feature allows investors to potentially benefit from the upside of the company's common stock while still enjoying the downside protection and dividend preferences of preferred stock.
Cumulative Preferred Stock: Cumulative preferred stock is a type of preferred stock that gives shareholders the right to receive any missed or unpaid dividends before common stockholders can receive dividends. This ensures that preferred shareholders are compensated for any past missed dividend payments before common shareholders receive any distributions.
Dividend: A dividend is a payment made by a corporation to its shareholders, usually in the form of cash or additional stock. Dividends are typically derived from the company's profits and are distributed periodically.
Dividend: A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. Dividends are a key consideration in the Dividend Discount Models (DDMs) and are a defining feature of preferred stock.
Dividend yield: Dividend yield measures the annual dividend income an investor receives from a stock relative to its current share price. It is expressed as a percentage and helps investors evaluate the income-generating potential of a stock investment.
Dividend Yield: Dividend Yield is a financial ratio that measures the annual dividend paid per share relative to the current market price of the share. It represents the return an investor receives from a company's dividend payments, expressed as a percentage of the stock's price.
Intrinsic value: Intrinsic value is the perceived or calculated true worth of a stock, based on future earnings or dividends. It is often used by investors to determine if a stock is overvalued or undervalued compared to its market price.
Intrinsic Value: Intrinsic value refers to the inherent worth or true value of an asset, security, or investment, independent of its market price. It represents the fundamental or underlying value of an investment, calculated based on an analysis of its financial and operational characteristics.
Liquidation Preference: Liquidation preference is a contractual right that gives certain shareholders, typically preferred stockholders, priority over common stockholders in the event of a company's liquidation or acquisition. It determines the order and amount of payouts to shareholders when a company's assets are distributed.
Non-Cumulative Preferred Stock: Non-cumulative preferred stock is a type of preferred stock where the issuing company is not required to pay any missed or unpaid dividends to preferred stockholders in the future. Unlike cumulative preferred stock, the missed dividends do not accumulate and become owed to the preferred shareholders at a later date.
Participating Preferred Stock: Participating preferred stock is a type of preferred stock that not only receives its stated dividend, but also participates in additional dividends or liquidation proceeds alongside common stockholders once a certain threshold is met. This unique feature provides preferred shareholders with the potential for greater returns compared to traditional non-participating preferred stock.
Perpetual Preferred Stock: Perpetual preferred stock is a type of preferred stock that has no maturity date, meaning the shares do not have a predetermined date when they will be redeemed by the issuing company. This type of preferred stock provides the holder with a steady stream of dividend payments in perpetuity, as long as the company remains in operation.
Preferred stock: Preferred stock is a type of equity security that gives shareholders preferential treatment regarding dividends and asset liquidation. It typically does not provide voting rights in corporate decisions.
Preferred Stock: Preferred stock is a type of equity security that provides shareholders with certain preferences over common stockholders. These preferences typically include priority in dividend payments and asset distribution in the event of liquidation.
Preferred Stock ETFs: Preferred Stock ETFs are exchange-traded funds that invest primarily in preferred stocks, which are a type of equity security that has characteristics of both stocks and bonds. Preferred stocks typically offer higher dividend yields than common stocks, but have less upside potential in terms of capital appreciation.
Redeemable Preferred Stock: Redeemable preferred stock is a type of preferred stock that can be repurchased or redeemed by the issuing company at a predetermined price and time. This feature provides the company with the flexibility to retire the preferred shares when necessary, often to manage its capital structure or to take advantage of changing market conditions.
Trust Preferred Securities: Trust preferred securities are a type of hybrid security that combines features of both debt and equity. They are issued by a trust, typically a subsidiary of a company, and provide the issuer with tax-advantaged financing while offering investors a security that has characteristics of both preferred stock and subordinated debt.
Voting Rights: Voting rights refer to the legal ability and privilege of shareholders to participate in the decision-making process of a company, particularly in the context of preferred stock. This includes the right to vote on important corporate matters, such as the election of directors, mergers, and other significant business decisions.