Preferred dividends are a type of dividend that is specifically associated with a company’s preferred shares. These dividends have unique characteristics and special privileges that differentiate them from common share dividends.
Characteristics of Preferred Dividends
Preferred dividends are paid to holders of preferred shares, which typically function as a type of hybrid security–combining elements of both equity and fixed income. Some key characteristics include:
- Priority: Preferred dividends take precedence over common share dividends. This means that if a company is distributing profits, preferred shareholders are the first to receive their dividend payments before any dividends are distributed to common shareholders.
- Fixed Rate: Unlike common dividends, which can fluctuate based on the company’s profitability and dividend policy, preferred dividends are usually paid at a fixed rate.
- Cumulative Dividends: In some cases, preferred dividends might be cumulative, meaning if a company skips a dividend payment, it must pay the missed dividend in the future before any dividends can be paid to common shareholders.
- Non-voting: Preferred shareholders generally do not have voting rights in the company, unlike common shareholders.
Types of Preferred Shares
Cumulative Preferred Shares
Cumulative preferred shares ensure that if a company is unable to pay dividends in any given year, the unpaid dividends accrue and must be paid out before any dividends can be paid to common shareholders.
Non-Cumulative Preferred Shares
Non-cumulative preferred shares do not carry forward any unpaid dividends. If the company skips a dividend payment, the shareholders lose the right to those dividends.
Participating Preferred Shares
These shares provide the opportunity to receive additional dividends based on certain conditions, typically linked to the company’s profitability, alongside the fixed preferred dividend.
Convertible Preferred Shares
Convertible preferred shares offer shareholders the option to convert their preferred shares into a predetermined number of common shares, often at prescribed times and under certain conditions.
Examples and Applications
Preferred dividends can serve as a reliable stream of income for investors seeking greater stability in their returns compared to common shares. For example, in times of economic uncertainty, preferred shares might be favored due to their fixed dividend payments.
Historical Context
Preferred shares and their dividends have been used historically to attract investors by offering higher dividend assurance than common shares. This practice dates back to the 19th century, when companies sought investment through more structured and dependable financial instruments.
Applicability in Investment Portfolios
For investors, preferred dividends offer a mix of security and predictability. They can be particularly useful for income-focused portfolios and for those looking to reduce the volatility of their investments.
Comparisons to Other Dividends
When comparing preferred dividends to common dividends, several distinctions are evident:
- Risk: Preferred dividends present lower risk for income since they have priority over common dividends.
- Flexibility: Common dividends provide more flexibility and potential for growth during profitable periods.
- Control: Common shareholders typically have more control and say over the company’s operations through voting rights.
Related Terms
- Dividend Yield: The dividend income per share divided by the share price, often calculated to assess income potential of preferred shares.
- Equity Financing: Raising capital through the sale of shares, including both common and preferred shares.
FAQs
Are preferred dividends guaranteed?
How often are preferred dividends paid?
References
- Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (3rd Edition). Wiley.
- Brigham, E. F., & Houston, J. F. (2018). Fundamentals of Financial Management (15th Edition). Cengage Learning.
Summary
Preferred dividends are an important aspect of preferred shares, offering investors a prioritized and often more stable income stream compared to common dividends. These financial instruments play a critical role in diversified and income-focused investment strategies. Understanding their unique characteristics, types, and applications can significantly enhance investment decision-making.
