How to Calculate Preferred Stock and Common Stock
Preferred stock is a type of ownership security or equity that differs from common stock in that it doesn't provide shareholders with voting rights.3 min read
2. Common Stock vs. Preferred Stock
Updated October 28, 2020:
Wondering how to calculate preferred stock and common stock? Preferred stock is a type of ownership security or equity that differs from common stock in that it doesn't provide shareholders with voting rights. Preferred stock does pay a fixed dividend when the shares are issued that show up on the stock's prospectus, and that dividend must be paid before dividends from common stock.
How to Calculate Preferred Stock Dividend Distributions
Preferred stock is a special kind of stock traded on the exchange that acts similar to a bond. Like bonds, preferred stocks are usually purchased for their income potential, not necessarily their growth.
For the majority of preferred stocks, a company must pay dividends before paying common stock dividends. Preferred stocks are less risky for investors because they're paid before common stocks if the company runs into financial trouble. As a result, preferred stockholders take priority over common shareholders, but they're still ranked behind bondholders. Even so, preferred stock is a smart investment.
Preferred stocks and bonds are also similar in that dividends never fluctuate despite the stock's changes in market value. Instead, preferred stocks feature a fixed dividend rate passed on the stock's par value, which is generally around $25. Calculating the stock's dividends is a straightforward process, and stockholders can expect to be paid the same dividend amount every quarter.
Check the issuing company's preferred stock prospectus for more information on the stock's dividend rate and par value. Once you locate this information, you can then convert it to a decimal. For example, a 5 percent dividend rate equals 0.05. Once you have the decimal amount, multiply the rate by the stock's par value. To figure out how much you'll earn per quarter, simply divide the answer by four. You can then multiply the number by however many preferred stock shares you own.
Although preferred stock might increase over time, this growth is limited. That's why investors purchase preferred stock for the dividend income. Preferred stock prices do fluctuate with interest rates, but although a stock's prices may fall, its dividend yields tend to increase.
If you're trying to determine whether to invest in preferred stock, compare its dividend yield to the company's bond yields and other stock issues.
Common Stock vs. Preferred Stock
Whether you purchase common stock or preferred stock, you own a piece of the company and have an investment tool at your disposal. The main difference between common and preferred stock is that common stockholders usually have voting privileges at stockholders' meetings, while preferred stockholders do not.
In most cases, owning common stock gives you one vote per the number of shares you own, although this figure varies by company. Some companies grant preferred stockholders one vote per share or even more; it all depends on how the company operates.
Although common stockholders aren't required to receive fixed dividends from the company, preferred stockholders have that privilege. When you own preferred stock, you also have a bigger claim to the company's earnings and assets, which is nice when the business is doing well and distributes excess cash to its investors.
With preferred stock, you can calculate your dividends and know how much to expect at regular intervals, which isn't the case with common stock. With common stocks, the company's board of directors decide when and whether to pay out dividends.
Other characteristics worth noting about preferred stocks include:
- They are less volatile than common stocks.
- Their value declines as interest rates rise.
- They offer bond-like characteristics that lend them a sort of hybrid security between the two investment types.
- They have a callability feature that allows the issuing company to redeem market shares after they hit a predetermined value, giving investors the chance to earn significant premiums over their initial purchase price.
- They come with the same transaction costs through brokerage firms as common stock.
- They are considered a more stable investment because they provide a regular income stream.
- They can convert to a fixed number of common stock shares.
How much you'll pay for a preferred stock depends on the company issuing the stock. In general, the cost is influenced by both the stock market and the preferred dividends.
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