What Are Preferred Stock Dividends?
Grasp the fundamentals of preferred stock dividends: understand their fixed income, payment priority, and diverse structures for investors.
Preferred stock dividends offer a unique investment perspective, differing significantly from common stock dividends. These payments are a key feature that distinguishes preferred stock, making it an attractive option for certain investors. Understanding preferred stock and how its dividends operate is important for anyone considering this type of investment.
Understanding Preferred Stock
Preferred stock represents a class of shares signifying ownership in a company, similar to common stock. A primary distinction is that preferred stockholders do not possess voting rights in corporate governance matters. This equity is appealing to investors because it offers fixed dividend payments, providing a predictable income stream.
Preferred stock also holds a higher claim to a company’s assets and earnings compared to common stockholders. In the event of a company’s liquidation, preferred stockholders have a claim on assets before common stockholders, although after bondholders. Each preferred stock has a par value, a nominal value used to determine its fixed dividend payment.
How Preferred Stock Dividends Function
A characteristic of preferred stock is its fixed dividend rate, a set amount or percentage of its par value. This contrasts with common stock dividends, which are variable and depend on a company’s profitability and board discretion. The fixed nature of preferred dividends provides investors with a predictable income stream.
Preferred stockholders receive their dividends before any payments are made to common stockholders. This priority extends to dividend payments and asset distribution in the event of a company’s liquidation. The company’s board of directors must formally declare the dividend before it can be paid. If declared, preferred dividends must be satisfied in full before any dividends can be distributed to common shareholders.
The primary difference between preferred and common stock dividends lies in their predictability and payment hierarchy. Common stock dividends are discretionary and can fluctuate or be suspended based on financial performance. Preferred dividends are fixed and must be paid out before common shareholders receive anything. This structure positions preferred stock as a hybrid security, blending characteristics of both debt instruments and equity.
Types of Preferred Stock Dividends
The structure of preferred stock dividends can vary, with cumulative and non-cumulative being the most common types. Cumulative preferred stock includes a provision where if a company misses a dividend payment, those unpaid dividends accumulate and become “dividends in arrears.” These accumulated dividends must be paid to cumulative preferred shareholders before any dividends can be distributed to common shareholders. For example, if a company skips two years of dividends, it must pay three years’ worth (the two missed and the current) to cumulative preferred shareholders before common stockholders receive any.
Non-cumulative preferred stock does not accrue missed dividends. If a company’s board of directors decides not to pay a dividend in a given period, those dividends are forfeited by the non-cumulative preferred shareholders and do not need to be paid in the future. This means that once a non-cumulative dividend is missed, it is permanently lost, offering less security to investors compared to cumulative preferred stock.
Participating preferred stock offers shareholders the potential for additional dividends beyond the fixed rate. These additional dividends are paid if the company meets certain financial goals or if common stock dividends exceed a specified amount. Participating preferred shareholders receive their fixed preferred dividend and can also share in additional profits alongside common stockholders under defined conditions.