What are Preferred Dividends?
A dividend that is both accrued and paid on the preferred shares of a company is known as a preferred dividend or preferred stock dividends. Suppose that a company is not able to pay off all its dividends, then investor claims to preferred dividends are prioritized over the investor claims to dividends for common shares. Hence, the main benefit of preferred stocks is that it normally pays higher in dividends than the commonly available stock from the same company.
Based on both the par value and dividend rate of the preferred stock, one can issue preferred dividends. While they are issued at a rate that is fixed based upon par value of the stock, preferred dividends might become unfavorable in periods of high inflation. The fixed rate of payment for the preferred dividends are based on the real rate of interest. This rate is often not adjusted for inflation.
Anytime a preferred stock is issued it contains the par value of the preferred stock’s prospectus as well as the equity’s ividend rate. This rate is multiplied by the par value which becomes the annual preferred dividend. Suppose the total dividend that is to be received is paid out in quarterly installments, the issuer will divide the total preferred dividends by the number of periods which will yield an approximate installment.
Features of Preferred Stock Dividends
Here is how we can distinguish between the features afforded to investors when they choose preferred stock over common stock in a company. There are key differences in features for the same. The differences are as follows:
– A shareholder who holds preferred stock receives the right to rally for preferential treatment regarding dividend payouts. This right is offered to the shareholder in exchange for their right to share in the company’s earnings in case it were to issue an excess of dividends.
– Certain preferred shareholders also get a right to participate in the decisions made by the company. The right of participation often implies that the dividends of these stockholders just aren’t restricted to the fixed rate of interest.
– However, when compared to common stock, the majority of preferred stocks are issued as non-participating in nature. This means investors do not get voting rights when they buy preferred stock, like they would if they bought common stock.
– Preferred stock that is callable in nature results inpreferred dividends that are higher. Investors sacrifice their long term security in exchange for preferential payment of dividends.
– If one’s preferred stock retires at its call price, anypreferred dividends that are applicable in the future are included in the repurchase of that preferred stock.
– In comparison to callable preferred stock, preferred stock that is convertible has lower preferred stock dividends. The investor receives the additional feature of converting the preferred share into common shares if they wish to.
Preferred Dividends Example
As a preferred dividends example, consider Anisha who is the CEO of a huge company — a massive, public retailer, which sells ownership through stocks. Anisha has planned a large expansion for her company and in order to do so needs to raise around ₹1 crore. To raise that amount of money, her options to attract more investors are the following: issue fresh preferred stocks that allow investors to get preferred dividends or issue even more traditional stock than the company already has.
What Anisha decides to go forward with matters as the cost of raising the necessary capital will make or break the future of the company. After talking with her bpaar of directors and teammates, Anisha has weighed both the drawbacks and benefits of each choice. When it comes to traditional stocks, the cons are that Anisha would be offering up a piece of her company via voting rights, as well as creating a greater cost of capital because of that ownership.
Alternatively, if they were to issue preferred stock, this ownership would not have to be given up and the cost of capital would be lower in comparison. Hence, Anisha and her board of directors go ahead with issuing preferred stock. Preferred stock with its annual preferred dividends will reduce the retained earnings that need to be paid out annually. Anisha and her team firmly believe that the expansion will make up for the reduced earnings. This is because preferred stocks are very attractive to investors; more so than common stock.
Preferred dividends are paid out to preferred stockholders. These shareholders are those who receive priority in dividend payments in exchange for their non-participating and inflexible ownership in the company.