How to Calculate Preferred Dividends
Demystify preferred dividend calculations. This guide provides clear steps to accurately determine preferred shareholder payments, essential for investors and financial professionals.
Preferred dividends are a form of income distribution for investors, distinct from common stock dividends. They are characterized by a fixed payment rate and hold a priority claim over common stock dividends when a company distributes earnings. Understanding their calculation is important for investors seeking predictable income streams and for financial professionals managing corporate distributions. Companies issue preferred stock to raise capital, offering investors a more stable return compared to common stock, which can fluctuate with company performance.
Essential Information for Calculation
Calculating preferred dividends relies on several fundamental pieces of information. The “par value” is a nominal amount assigned to each share of preferred stock, serving as the base for the dividend calculation.
The “dividend rate” is a fixed percentage applied to the par value, determining the annual dividend payment per share. This rate remains constant, providing a predictable income. The “number of preferred shares outstanding” then dictates the total dividend amount a company must pay; the per-share dividend is multiplied by the total shares held by investors.
A significant characteristic influencing preferred dividend calculation is the “dividend type,” specifically whether the stock is cumulative or non-cumulative. This feature determines how a company handles any missed dividend payments from prior periods.
Performing the Basic Dividend Calculation
The core formula for calculating preferred dividends involves multiplying the par value by the dividend rate, then multiplying that result by the number of preferred shares outstanding. This calculation yields the total annual dividend payment required. For instance, if a preferred stock has a par value of $50 and a dividend rate of 6%, the annual dividend per share is $3.00.
To determine the total annual dividend obligation, this per-share amount is then multiplied by the total number of preferred shares issued. If a company has 10,000 preferred shares outstanding, the total annual preferred dividend payment would be $30,000. This basic calculation applies to a single period, assuming all dividends are paid as scheduled and there are no complexities from prior periods.
Calculating Cumulative Dividends and Arrears
Cumulative preferred stock carries a distinct feature: if a company misses a dividend payment, that unpaid amount accumulates and must be paid in the future. These accumulated, unpaid dividends are known as “dividends in arrears.” Companies issuing cumulative preferred stock are obligated to settle all dividends in arrears before any dividends can be distributed to common stockholders.
When the company is able to resume dividend payments, it must first pay the current period’s preferred dividend, and then all accumulated arrears from previous periods. Only after these obligations are fully met can common shareholders receive any dividend distribution. This priority ensures that cumulative preferred stockholders eventually receive all promised dividends.
Step-by-Step Calculation Examples
Consider Company A, which has 5,000 shares of non-cumulative preferred stock with a par value of $100 per share and a 4% dividend rate. The annual dividend per preferred share is $4.00 ($100 par value × 0.04 dividend rate). The total annual preferred dividend required is $20,000 ($4.00 per share × 5,000 shares). If Company A declares this dividend, it is paid to preferred shareholders, and any remaining funds can be distributed to common shareholders.
Now, consider Company B, which has 8,000 shares of cumulative preferred stock with a par value of $75 per share and a 5% dividend rate. The annual dividend per preferred share is $3.75 ($75 par value × 0.05 dividend rate), leading to a total annual preferred dividend requirement of $30,000 ($3.75 per share × 8,000 shares). If Company B did not pay preferred dividends for the previous two years, the accumulated dividends in arrears would be $60,000 ($30,000 per year × 2 years).
In the current year, if Company B decides to pay dividends, it must first pay the current year’s preferred dividend of $30,000, plus the $60,000 in arrears. This means a total of $90,000 must be paid to preferred stockholders before any common stockholders receive dividends. This example illustrates how the cumulative feature necessitates the payment of all past and current preferred dividends before common stock distributions can occur.