Preferred stock is an investment that provides ownership in a company, similar to common stock, and typically pays a fixed dividend, similar to a bond’s interest payment. If preferred stock has no maturity date, it is essentially a perpetuity, which is an investment that pays a stream of cash flows indefinitely. You can determine the value of a share of preferred stock as a perpetuity using its annual dividend and the rate of return you require on the investment. This value represents an estimate of the preferred stock’s fair price, which you can compare with its actual market price.
Find a preferred stock’s par value and annual dividend rate in a company’s Form 10-K annual report. You can download a Form 10-K from the investor relations section of a company’s website or from the U.S. Securities and Exchange Commission’s online Electronic Data-Gathering, Analysis and Retrieval, or EDGAR, database. For example, assume a preferred stock has a $50 par value and a 7 percent annual dividend rate.
Multiply the par value by the dividend rate to determine the annual dividend. In this example, multiply $50 by 7 percent, or 0.07, to get a $3.50 annual dividend.
Determine the annual rate of return you require to invest in the preferred stock. This rate of return should be the same as the return you could earn on a similar investment with equal risk. In this example, assume you require a 9 percent annual rate of return to invest in the preferred stock.
Divide the annual dividend by the required rate of return to determine the preferred stock’s value. Continuing the example, divide $3.50 by 9 percent, or 0.09, to get a $38.89 value. This means you can pay up to $38.89 per share for the preferred stock to earn your required annual rate of return. If you pay any more, you will earn a lower annual return than you require.
- A company is not obligated to pay dividends to preferred stockholders. It can suspend payments at any time for any reason, which would negatively impact your annual rate of return.
- If preferred stock has additional features, such as the ability to be converted into common stock, you would need additional information to accurately estimate its value.