Does Preferred Stock Pay Dividends? The Answer & How It Works

Preferred stock pays dividends, which is a primary reason investors choose to include it in their portfolios. This type of stock occupies a unique position within a company’s capital structure, bridging the gap between common stock and bonds. It offers characteristics that appeal to investors seeking regular income and a different risk-reward profile compared to common equity.

Understanding Preferred Stock Dividends

Preferred stock pays dividends at a fixed rate, often expressed as a percentage of its par value. For instance, a preferred stock with a $100 par value and a 5% dividend rate would pay $5 per share annually. This fixed payment structure offers predictability for investors.

A significant characteristic of preferred stock is its dividend priority over common stock. Preferred stockholders receive their dividend payments before common stockholders. Companies must satisfy preferred dividend obligations first, provided the board of directors has declared a dividend.

While preferred dividends are anticipated, their payment is subject to the company’s board formally declaring them. The company must also possess sufficient earnings or surplus to legally distribute these payments. A company’s financial health influences its ability to meet these commitments.

Key Features Influencing Dividend Payments

One important feature influencing preferred stock dividends is whether they are cumulative or non-cumulative. Cumulative preferred stock means that if a company misses a dividend payment, those missed payments accumulate and must be paid to preferred shareholders before any dividends can be distributed to common shareholders. This provides an added layer of security for investors.

Conversely, with non-cumulative preferred stock, any missed dividend payments are lost forever and do not accumulate. If the company’s board decides not to declare a dividend, non-cumulative preferred shareholders forgo that payment. This type of preferred stock carries a higher risk regarding dividend reliability.

Some preferred stock may also be participating, meaning it can receive additional dividends beyond its fixed rate. This occurs if the company performs exceptionally well and common stock dividends exceed a certain threshold. Participating preferred stock is less common.

Distinguishing Preferred from Common Stock Dividends

A primary distinction between preferred and common stock dividends lies in their payment structure. Preferred stock offers a fixed dividend rate, providing a predictable income stream. In contrast, common stock dividends are variable, declared at the discretion of the company’s board, and often fluctuate based on profitability and financial strategy.

Preferred stockholders hold priority over common stockholders in receiving dividend payments. Preferred shareholders must receive their full dividend entitlement before common shareholders receive any payments.

Regarding corporate governance, preferred stock does not carry voting rights, unlike common stock, which grants shareholders the right to vote on company matters. This trade-off means preferred shareholders have less influence over management. Common stock has greater potential for capital appreciation, as its market value can increase with company growth and performance. Preferred stock’s value is more closely tied to its dividend yield and interest rate movements.

Factors Affecting Dividend Payments

While preferred stock dividends are more reliable than common stock dividends, their payment is not guaranteed. Sufficient cash flow and earnings are necessary to cover dividend obligations. If a company experiences financial distress, it may suspend preferred dividend payments, even for cumulative preferred stock.

The board of directors retains the ultimate authority to declare and pay dividends. The board might decide to retain earnings for reinvestment, debt reduction, or other strategic corporate purposes instead of distributing them. This decision balances shareholder returns with long-term growth and stability.

Additionally, a company’s ability to pay dividends can be restricted by loan agreements or financial covenants. These agreements often include clauses that limit dividend distributions if certain financial ratios or conditions are not met. Such restrictions protect creditors and ensure the company maintains adequate liquidity and solvency.