Key Takeaways
- Fixed dividends paid before common stockholders.
- Cumulative dividends accumulate if missed payments occur.
- Offers predictable income with priority in payouts.
- Callable and convertible features affect dividend terms.
What is Preferred Dividend?
A preferred dividend is a fixed payment made to holders of preferred stock, giving them priority over common stockholders in dividend distributions. This payment is typically based on the stock’s face value and offers investors a more predictable income stream compared to common dividends.
Preferred dividends often combine features of equity and debt, providing stability similar to bonds while representing ownership without voting rights.
Key Characteristics
Preferred dividends have distinct features that differentiate them from common dividends:
- Priority Payment: Preferred shareholders receive dividends before any distribution to common stockholders, enhancing income reliability.
- Fixed Amount: Dividends are generally fixed based on the stock’s par value and dividend rate, unlike variable common dividends.
- Cumulative vs. Non-Cumulative: Cumulative dividends accumulate if not paid and must be settled before common dividends; non-cumulative dividends do not accrue.
- Callable and Convertible: Some preferred stocks are callable, allowing issuers to repurchase shares, while convertible types can be exchanged for common shares.
- Tax Advantages: Many qualify as qualified dividend income, taxed at favorable rates compared to ordinary income.
How It Works
Preferred dividends are paid at a fixed rate calculated by multiplying the par value of the preferred stock by the dividend rate. Payments are often made quarterly, providing a steady income stream.
If the issuer misses a dividend payment on cumulative preferred stock, those dividends accumulate and must be paid before any dividends can be issued to common shareholders. Callable preferred stock can be redeemed by the company at a predetermined price, sometimes including unpaid dividends.
Examples and Use Cases
Preferred dividends are commonly used by companies to attract investors seeking stable income with less risk than common shares. Here are some examples:
- Airlines: Companies like Delta issue preferred stock to raise capital while offering investors predictable dividends.
- Dividend Investing: Income-focused portfolios often include preferred shares highlighted in guides such as best high-yield dividend stocks to maximize steady returns.
- Capital Structure: Preferred dividends affect a company’s paid-in capital and balance sheet, providing financing without diluting common shares.
Important Considerations
Preferred dividends offer income stability but come with limitations such as limited capital appreciation and lower voting rights compared to common stock. Investors should assess the type of preferred stock, especially whether dividends are cumulative or callable, to understand risk and return.
When evaluating dividend stocks, comparing preferred shares to common dividends and bonds helps you balance yield with risk. Check out our guide on best monthly dividend stocks for strategies incorporating preferred dividends into income portfolios.
Final Words
Preferred dividends offer a reliable income stream with priority over common stock, making them a valuable option for income-focused investors. Consider comparing different preferred stock options and assessing cumulative features to align with your risk tolerance and income goals.
Frequently Asked Questions
A preferred dividend is a fixed payment made to holders of preferred stock, which takes priority over common stock dividends. It provides investors with more predictable income and often accumulates if missed.
Preferred dividends are typically fixed and paid before any dividends to common shareholders. They offer more stability and priority in payouts, whereas common dividends can vary and are paid after preferred dividends.
Cumulative preferred dividends accrue if the company misses payments, meaning those unpaid dividends must be paid out before any common stock dividends. Non-cumulative preferred dividends do not accumulate if skipped.
Issuing preferred stock allows companies to raise capital without increasing debt or diluting common stock ownership too much. They also have flexible terms, like callability, which lets them repurchase shares if market rates change.
Preferred dividends are calculated by multiplying the stock's par value by its fixed dividend rate. For example, a $100 par value stock with a 5% rate pays $5 annually, often distributed quarterly as $1.25 per share.
Many preferred dividends qualify as qualified dividend income (QDI), which means they are taxed at lower capital gains rates, usually around 20%, rather than higher ordinary income tax rates.
Preferred dividends offer limited capital appreciation and are subordinate to bondholders in claims. While they provide steady income, investors may miss out on the growth potential that common stocks offer.
Preferred dividends can be cumulative or non-cumulative, and preferred stocks may be callable (can be repurchased by the issuer) or convertible (convertible to common shares). There are also participating preferred stocks that may earn extra dividends if profits exceed certain levels.
