Understanding the Dividends per Share of Preferred Stock

Introduction to Preferred Stock

Preferred stock is a unique financial instrument that combines elements of debt and equity. While it is part of a company's equity, it often enjoys certain debt-like characteristics, such as priority in dividend payments and a claim on assets in the event of liquidation. This flexibility makes preferred stock an attractive option for investors seeking a mix of income and capital preservation.

Distinguishing Features of Preferred Stock

Preferred stock typically lacks voting rights and does not have a fixed repayment date. However, it is generally higher in the capital structure than common stock but lower than unsecured debt. This higher ranking in terms of payment priority means that preferred shareholders have a higher claim on a company's earnings and assets, outperforming common stockholders in the event of financial distress.

Finding the Dividends per Share

Dividends per share (DPS) for preferred stock are determined similarly to how dividends for common stocks are calculated, but with a few key differences. Since preferred stock is usually a non-cumulative or non-participating class, the calculation and payment can be more straightforward when compared to common stock.

Factors Influencing Dividends per Share of Preferred Stock

1. Credit Risk and Interest Rates: Preferred stocks are seen as lower risk than common stock but higher risk than debt. Therefore, their dividends, known as preferred dividends or coupuns, are tied to the credit risk and prevailing interest rates. Higher credit risk typically results in higher preferred dividends to compensate investors for the additional risk.

2. Market Conditions: Prevailing market conditions and economic trends strongly influence the level of preferred dividends. In a growing economy, higher interest rates can lead to higher dividends. Conversely, in a tightening market, preferred dividends may fall to attract investors.

3. Dividend Policy: The dividend policy of a company is a significant factor. Companies with strong cash flows and stable operations are more likely to maintain or increase their preferred dividend payouts. Conversely, companies facing financial difficulties may reduce or suspend preferred dividends to conserve capital.

4. Market Demand: The demand for preferred stocks affects their price and, consequently, the dividends paid. If there is high demand for preferred stocks, companies may have more flexibility to raise the dividend level to attract investors. Low demand may lead to lower dividends to keep the stock price stable.

Valuing Preferred Stocks

Preferred stocks can be valued similarly to perpetual bonds, as there is no maturity date. The value of preferred stock is determined by discounting the expected future dividends to their present value. This is done using the current interest rate and the credit spread appropriate for the preferred stock.

Using a simple valuation formula, the price of preferred stock (P) can be calculated as:

P D / (r - g)

Where:

D Dividend per share r Required rate of return (market interest rate) g Growth rate of dividends (usually assumed to be zero for preferred stocks)

The discount rate (r) is influenced by market interest rates and the credit risk of the preferred stock. A higher credit risk will result in a higher discount rate, reducing the present value of the future dividends and, consequently, the price of the preferred stock.

Conclusion

Dividends per share of preferred stock are a critical metric that investors consider when evaluating the value of these securities. Understanding the factors that influence their level, such as credit risk, interest rates, market conditions, and dividend policy, is essential for making informed investment decisions.