What are Preferred Dividends?
Definition: Preferred dividends are a type of dividends that are paid out to the shareholders who are owners of a company since a share is a unit of ownership. Shares are usually categorized as ordinary shares and preferred shares. The latter is the option that provides preferred dividends to shareholders owning shares of that type.
Companies usually offer shares internally or to the general public when publicly listed, and this is usually as a means of raising capital for the firm. The shares then allow shareholders to earn a share of the company’s profit based on their shareholding. The share profit earnings are known as dividends. Shares are usually divided into categories; in this case, we will focus on preferred dividends which are issued through preferred shares.
Preferred shares are seen as an attractive option because they allow shareholders that own them to earn preferred dividends, which are usually issued at a higher rate that the dividends issued to the shareholders that hold the common shares. Preferred dividends also come with a guarantee, which means that preferred shareholders should expect the dividends on a regular basis.
The guaranteed nature of preferred dividends makes preferred shares more appealing than common shares. If the company’s board announces that there will be no dividends for a specific duration, then the preference dividends that shareholders would have received are pushed back so that they are paid at a later date. The situation is different for shareholders that own common stock. If there are no dividends for a specific period, then there are no dividends in arrears.
Shareholders that own preferred shares have to be paid any dividends that are in arrears before common stock shareholders receive any dividends. This means that preferred dividends are ideal for the investor that wants a low-risk and stable returns.
The major disadvantage to preferred shares is that those who own them do not have voting rights. That is not necessarily a major drawback considering the many advantages that are offered by preferred shares. Another disadvantage to preferred shares is that the preferred dividend has a fixed rate, which might be a disadvantage if the stock gains value or if the market experiences high levels of inflation. Preferred stock shareholders would, therefore, be at a disadvantage if the two scenarios were to play out.
Preferred Stock Payments
Preferred dividend payouts can be cumulative or non-cumulative, depending on how investors or shareholders negotiate their rights with the firm. The cumulative option is perhaps the best option for investors because they will receive the dividends in a lump sum if the company winds up its operations or if the investor decides to redeem his/her shares.
The fact that the company is obligated to pay out preferred dividends, including the skipped payments, makes it a very appealing investment option. It also helps that companies are obligated to prioritize preferred dividend payment over common shares dividends.
The non-cumulative dividend option is where shareholders receive dividends when the firm has a dividend payout. This means that the company is not obligated to pay dividends in arrears at a later date. Nevertheless, the preferred shareholders are still given priority over the common stock shareholders when there is a dividend payout.
Types of Preferred Stock
Participating and non-participating preferred stock
Participating preferred shares usually facilitate priority dividend payout before the common stock shareholders receive dividends, especially when a company is going through liquidation. Once preferred stock shareholders are paid, any of the liquidation proceeds remaining are then paid out to common stock shareholders, and preference stock shareholders also get a cut.
Non-participating preferred stock
they facilitate the issuance of dividends before the common stock shareholders, but preference shareholders do not get an extra share of the proceeds from the liquidation.
Callable preferred stock
This is where a company issues preferable stock that it can buy back at a specified date and a specified price.
Convertible preferred stock
These are stocks that a company issues to shareholders with the option of converting them to a fixed amount of common stock at a specified date. Convertible preferred shares have lower dividends because the conversion option is an advantage to shareholders. However, the advantage depends on the common shares market price at the time of conversion.
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