The dividend yields on preferred shares are often very attractive when compared to the common share dividends of the same company. As an added benefit, preferred shares get their name from the preference in the pecking order for dividend payments. However, the dividend rate for almost all preferred stock issues will not vary, which means that even if the company does well and increases dividends for common shareholders, the preferred dividend will remain the same.
Preferred Stock Shares
A company issues preferred stocks shares with a set dividend yield based on a specific share price. For example, a preferred share issue could be for $25 a share with a $2 annual dividend. At that dividend and price, the preferred shares will yield 8 percent. Dividends are usually paid quarterly, so these preferred shares will pay 50 cents per share four times a year. The dividend rate will not change as long as the preferred issue is outstanding -- which could be indefinitely. However, some preferred shares give the company the option to skip or defer dividend payments during tough times.
More Like Debt Than Equity
Investors should view preferred stock shares more like debt investments rather than common stock equity. Companies issue preferred shares as an alternative to selling bonds, not as an alternative to selling more common stock. Preferred shares pay a fixed dividend more in line with the fixed amount of interest a bond would pay. The main difference from bonds is that preferred shares usually do not have a maturity date. A benefit is that preferred stock will have a higher yield than the bonds of the same company would pay.
Evaluating Preferred Shares
The yield of a preferred stock is the annual dividend rate divided by the current share price. If the shares of the $2 dividend preferred stock have increased to $30, the yield is 6 percent. Preferred shares trade on the stock exchange, and the value can move up or down. Preferred dividends must be paid before common stock shares, putting preferred share investors in front of common stock investors for dividend payments. Many large, stable companies have raised money through preferred stock issues, and these shares are a good source for safe, attractive yields. They are not a good source for growing dividends, however.
The main factor affecting preferred share prices is market interest rates. If interest rates increase, the price of a preferred stock will decline to keep the yield in line with the rest of the market. Falling interest rates will result in higher share prices. An investor buys preferred shares to get that dividend stream paid into his brokerage account. With no potential for dividend growth, the entire investment decision is based on the current yield and the financial strength of the issuing company.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.