What are preferred dividends?
Some companies offer a special type of stock called preferred shares, which come with certain benefits for investors. One of these benefits is preferred dividends, which are payments made to preferred shareholders before any payments are made to regular shareholders. If a company earns enough profit, these preferred shareholders are the first in line to receive their dividends. Even if the company can't pay all its dividends, those with preferred shares have a higher priority, meaning they get paid before others.
Preferred dividend example
Let's say a company like Volvo (the car manufacturer with its Volvo stock publicly traded), offers preferred shares to investors. These preferred shares come with a guaranteed dividend payment. For instance, if Volvo decides to pay a preferred dividend of $7.50 per share every year, this amount is locked in as long as you hold the shares. In this case, the dividend yield is 2.95%, which means you would earn $7.50 on each preferred share every year, assuming the share price stays the same.
Volvo's preferred shares work differently from regular shares (common stock). With regular shares, the dividend amount can change based on how well the company performs. In a good year, you might get a higher dividend, but in a bad year, you might get nothing. However, with preferred shares, Volvo commits to paying that $7.50 dividend each year, no matter how the company performs, as long as it has the funds. This steady payment is what makes preferred shares attractive to investors looking for reliable income.
Now, let's say Volvo has a rough year and can't pay dividends to everyone. Here's where preferred shares offer an advantage: preferred shareholders get paid before common shareholders. If Volvo only has enough money to pay some dividends, it must pay preferred shareholders first. So, if you hold Volvo's preferred shares, you would still receive your $7.50 per share, even if regular shareholders receive nothing.
In essence, what preferred shares mean is that you're prioritized when it comes to dividend payments. You might not have the same voting rights as common shareholders, but you have a more secure income stream, making preferred dividends a safer investment choice for those seeking consistent returns.
Capitalise on volatility in share markets
Take a position on moving share prices. Never miss an opportunity.
How preferred dividends work
Preferred dividends work as a regular payment that a company promises to give to its preferred shareholders. Unlike regular dividends, which can vary depending on how well the company is doing, preferred dividends are usually set at a fixed amount. This means if you own preferred shares, you know exactly how much money you'll receive each year.
Here's how it works: When a company earns a profit, it decides how to distribute that money. Before any dividends are paid to regular shareholders, the company must first pay the preferred dividends. If the company doesn't make enough money to pay all dividends, preferred shareholders are still first in line to get paid. Even if the company can't pay this year, the unpaid preferred dividends will accumulate, and the company will have to pay them in the future before giving any money to regular shareholders.
This makes preferred dividends a more reliable source of income, as they take priority over other types of payments. However, preferred shareholders typically don't have voting rights in the company, so they trade that influence for the security of getting paid first.
How to calculate preferred dividends
Calculating preferred dividends is straightforward once you know the key numbers: the dividend rate and the par value of the preferred stock. These details are usually found in the preferred stock prospectus.
To calculate the total annual preferred dividend, you multiply the dividend rate by the par value. For example, if the dividend rate is 5% and the par value is $100, the annual preferred dividend would be $5 per share (5% of $100).
If the company pays dividends in installments, such as quarterly, you would then divide the total annual dividend by the number of periods. For example, with four quarterly payments, each payment would be $1.25 per share ($5 divided by 4).
The preferred dividend coverage ratio is another important measure. It indicates how well the company can pay the dividends it owes to preferred shareholders. A high ratio means the company is in a strong position to meet its dividend obligations, while a low ratio suggests potential difficulties in making these payments.
What better way to welcome you than with a bonus?
Start trading with a $30 bonus on your first deposit.
Terms and Conditions apply
Conclusion
As you've learned, preferred dividends offer a reliable income stream for investors by providing fixed payments that take priority over common stock dividends. Unlike regular dividends, preferred dividends are set in advance, ensuring consistent returns as long as the company remains profitable. Source: investopedia.com
Want to learn more? Visit our Skilling blog for more insightful and educational content.
