Do Preferred Stocks Pay Dividends?

Preferred stocks are a type of equity ownership that combines features of both stocks and bonds. They typically offer fixed dividend payments, which are distributed to shareholders before any dividends are issued to common stockholders. This structure provides a more predictable income stream for investors.

Understanding Preferred Stock Dividends

Preferred stock dividends are characterized by their fixed nature, commonly expressed as a percentage of the stock’s par value or a set dollar amount per share. For example, a preferred stock with a $100 par value and a 5% dividend rate would typically pay $5 annually. These payments are usually made at regular intervals, such as quarterly or semi-annually.

A defining feature of preferred stock is its dividend priority. Preferred shareholders have a claim to dividends before common shareholders. This means that a company must fulfill its dividend obligations to preferred stockholders in full before any distributions can be made to common stockholders. This priority provides a layer of security for preferred shareholders, particularly during periods of financial stress.

This priority ensures that if a company declares a dividend, preferred shareholders are at the front of the line for payment. The fixed nature of these dividends makes preferred stocks attractive to investors seeking consistent income.

Types of Preferred Stock and Their Dividend Implications

The dividend features of preferred stock can vary based on their specific type.

Cumulative Preferred Stock

Cumulative preferred stock is a common form where, if dividends are missed in any period, they accumulate as “arrearages.” These accumulated dividends must be paid to cumulative preferred shareholders before any dividends can be declared or paid to common shareholders.

Non-Cumulative Preferred Stock

Non-cumulative preferred stock does not accumulate missed dividends. If a company’s board of directors decides not to pay a dividend for a non-cumulative preferred share, that payment is forfeited and does not accrue.

Participating Preferred Stock

Participating preferred stock offers the possibility of additional dividend payments beyond the fixed rate. Holders of participating preferred stock receive their regular fixed dividend and may also receive an extra dividend if the company achieves certain financial goals, such as reaching a specified level of profitability or if common stock dividends exceed a certain threshold.

Preferred Stock Dividends Versus Common Stock Dividends

A primary distinction between preferred and common stock dividends lies in their payment characteristics. Preferred dividends are typically fixed, offering a predictable income stream, similar to interest payments on a bond. In contrast, common stock dividends are variable and can change based on the company’s financial performance and discretionary decisions by the board of directors.

The priority of payment also sets them apart. Preferred shareholders must receive their dividends before any dividends are distributed to common shareholders. Common stock dividends are entirely discretionary; the company’s board can easily suspend or reduce them without accumulated obligations, particularly during challenging financial times.

Common stock dividends are not guaranteed and can be eliminated entirely at the discretion of the company, reflecting the greater volatility and direct link to company earnings for common shareholders. Preferred dividends, while not guaranteed, hold a higher claim to available funds. This structural difference impacts the reliability and consistency of income received by investors.

Key Considerations for Preferred Stock Dividend Payments

While preferred stocks offer dividend priority, their payment is not an absolute guarantee. The actual payment of dividends is contingent upon the company’s financial health and the formal declaration by its board of directors. A company must have sufficient earnings or retained earnings to cover dividend payments.

Companies facing severe financial distress may suspend all dividend payments, including those to preferred shareholders, to conserve cash. While preferred shareholders maintain their priority over common shareholders, they may still experience a temporary or indefinite halt in payments until the company’s financial situation improves.

The declaration of dividends is a decision made by the board, considering factors such as cash flow availability, legal obligations, and investor sentiment. Therefore, while preferred stock offers a more stable income prospect than common stock, investors should recognize that the ability and willingness of a company to pay dividends remain crucial factors influencing actual receipt.