What Are Preferred Dividends?
Introduction
Imagine getting paid regularly just for holding a stock. Sounds dreamy, right? Welcome to the world of preferred dividends—a little-known, yet powerful income stream for investors who crave stability over surprises. While common stocks get all the buzz, preferred shares have been quietly making investors money since the 1800s. In fact, the first major issuance of preferred stock in the U.S. happened back in 1836 by the New York and Harlem Railroad. Let’s dive in and break it all down, no fancy finance degree required.
Understanding the Basics
What Are Preferred Shares?
Preferred shares are like the middle child between common stock and bonds. They give you a fixed dividend, kind of like interest on a loan, but you don’t get a say in company decisions. You’re basically the quiet investor who gets paid first when the pie is sliced.
As of 2023, companies in the U.S. had issued over $600 billion worth of preferred stocks. That’s a massive chunk of capital raised without giving away control.
How Do Preferred Shares Differ from Common Shares?
Here’s the deal—common shareholders get voting rights. Preferred shareholders get dibs on dividends. Let’s say a company only has $5 million to distribute and owes both common and preferred shareholders. The preferred folks get paid first. Common shareholders? They might get zilch.
Preferred Shares and Dividends: The Key Connection
Most preferred shares come with a promised dividend. It’s often fixed—like 6% annually. That means if you buy a $1,000 preferred share, you get $60 every year. Rain or shine (unless the company is broke, but we’ll get to that later).
Preferred Dividends Explained
What Exactly Is a Preferred Dividend?
It’s a set cash payment made regularly to holders of preferred stock. Think of it like a paycheck, but without clocking in. Most are paid quarterly. If your dividend rate is 5% on a $1,000 share, you’ll get $12.50 every three months.
Fixed vs. Variable Preferred Dividends
Not all preferred dividends are created equal. Some are fixed—like a steady paycheck. Others float based on interest rates. For example, if LIBOR (a global benchmark interest rate) was 1.5% in 2018 and a floating rate dividend is LIBOR + 3%, then you’d earn 4.5%.
Cumulative vs. Non-Cumulative Preferred Dividends
Cumulative means if a company skips paying your dividend this quarter, they owe you double next time. Non-cumulative? You snooze, you lose. In the 2008 crash, many banks like Citigroup paused preferred payouts. Cumulative holders eventually got paid. Non-cumulative folks…not so lucky.
Participating vs. Non-Participating Dividends
With participating preferred shares, you can earn more if the company makes extra profits. Imagine getting your 6% plus a slice of leftover earnings. Rare, but it exists. Most are non-participating, so you just get your fixed rate and that’s it.
How Preferred Dividends Work in Real Life
Real-World Example of Preferred Dividends
Take Bank of America’s Series L preferred shares. They were issued at $1,000 each with a 7.25% dividend. That means $72.50 a year per share. These have been popular since 2009, especially after the financial crisis when investors craved safer returns.
Dividend Priority Over Common Shares
In tough times, companies must pay preferred dividends before a single dime goes to common shareholders. In 2020, due to COVID-19, multiple airlines suspended common stock dividends but kept paying preferred shareholders to maintain trust and creditworthiness.
Dividend Yield on Preferred Stocks
In 2022, average preferred yields hovered around 5.8%, while the S&P 500 dividend yield was closer to 1.7%. Big difference, huh? It’s no wonder income-focused investors often lean toward preferred shares.
Why Companies Issue Preferred Shares
Attracting Investors with Stable Returns
Preferred stock is a magnet for conservative investors. A company can lure in capital by offering stable returns without diluting voting power.
Raising Capital Without Giving Up Voting Power
Let’s say a company needs $200 million but doesn’t want activist investors meddling. Issuing preferred shares keeps control in the boardroom while still getting the money.
Tax Advantages for the Issuer
In the U.S., corporations that own preferred shares in other companies may get up to 70% of dividends tax-free thanks to the DRD (Dividends Received Deduction). This rule has been around since the 1986 Tax Reform Act.
Benefits of Preferred Dividends for Investors
Predictable Income Stream
Imagine you bought $50,000 worth of preferred shares at 6%. That’s $3,000 annually, or $750 every quarter, which could cover a car lease, monthly groceries, or weekend getaways.
Lower Risk Than Common Stocks
Preferred stocks usually don’t drop like a rock during market panics. In March 2020, when the Dow Jones tanked 38%, preferreds only fell around 12%.
Less Volatility in Market Conditions
Preferreds are often issued by financial giants like JPMorgan or utilities. These industries don’t swing wildly. It’s the tortoise-and-hare story—and preferreds are your steady tortoise.
Risks and Drawbacks
Lack of Voting Rights
You don’t get a seat at the table. No voting on mergers, no CEO approval. If you love influencing a company’s direction, preferreds might not be your jam.
Inflation Risk and Fixed Payments
If inflation rises like it did in 2022 (up 6.5%), your 5% fixed dividend suddenly feels like a loss. Your buying power shrinks over time.
Redemption Risk and Callable Shares
Companies can call (buy back) your shares, often at the original issue price. If rates drop, they may redeem your 7% shares and reissue at 4%. Ouch.
Tax Treatment of Preferred Dividends
How Are Preferred Dividends Taxed?
In the U.S., many preferred dividends qualify as “qualified dividends,” meaning they’re taxed at 15% or 20% instead of regular income rates. That said, not all qualify. Check the company’s filing.
Differences Between Jurisdictions
In Canada, preferred dividends may get a favorable tax credit. In Germany, taxes can exceed 25%. Always research your country’s rules—or better yet, ask your accountant.
How to Invest in Preferred Stocks
Direct Stock Purchase
Sites like E*TRADE and Fidelity allow you to buy preferred shares directly. Look for tickers ending in “P”—like “JPM.PD”.
ETFs and Mutual Funds with Preferred Stocks
Funds like PFF (iShares Preferred and Income Securities ETF) pool dozens of preferreds. In 2021, PFF held over $18 billion in assets and yielded around 4.6%.
Evaluating Preferred Stock Metrics
Before buying, check credit ratings from Moody’s or S&P. Also, peek at the dividend coverage ratio—how well earnings cover payouts. A 2x ratio? Solid. Under 1.2x? Risky.
Preferred Dividends vs. Bond Interest
What’s the Difference?
Bonds are debt—you lend money. Preferreds are equity—you invest. Bonds must be paid back; preferred dividends can be skipped (though not without consequence).
Which One Is Better for You?
If you’re 65 and want stable income, bonds might work better. But if you’re looking for higher yields and don’t mind a little risk, preferreds could be a smart play.
When Companies Skip Preferred Dividends
Legal and Financial Implications
Companies can skip dividends, especially non-cumulative ones. But if it’s cumulative, they owe you back-pay. In 2009, Ford suspended preferred dividends, only to resume them in 2011.
Impact on Stock Price and Investor Confidence
Skipping a dividend sends a red flag. In December 2008, when GM halted payouts, preferred stock plummeted 48% within days. Investors hate surprises—especially bad ones.
How Preferred Dividends Affect Company Financials
Balance Sheet Considerations
Preferred dividends appear on the income statement, reducing net income available to common shareholders. That’s why they’re crucial in calculating earnings per share (EPS).
Earnings Per Share (EPS) Adjustments
Say a company earns $100 million and pays $10 million in preferred dividends. Only $90 million counts toward EPS for common stock. This affects stock valuations and investor interest.
Who Should Invest in Preferred Stocks?
Retirees and Income Seekers
Retirees in their 60s and 70s often love preferreds. The steady income can cover essentials without touching their savings.
Conservative Investors
Those who want income without roller-coaster risk may find preferreds the perfect middle ground. They’re not as safe as government bonds, but not as wild as tech stocks.
Tips for Evaluating Preferred Stocks
Look at Credit Ratings
Stick with companies rated BBB or higher by S&P. Below that? You’re in junk territory. Risk goes up—so do potential returns, but proceed with caution.
Check Call Dates and Terms
Many preferreds become callable after five years. If issued in 2020, that call could come in 2025. Be prepared.
Analyze Dividend Coverage Ratio
Higher coverage means safer dividends. For example, a bank with $3 billion in earnings and $1 billion in preferred payouts has a 3x ratio—plenty of cushion.
Conclusion
Preferred dividends might not be the flashy celebrity of the investing world, but they’re the reliable accountant—steady, smart, and always on time. Whether you’re new to investing or just looking for something more predictable in your portfolio, preferred stocks can offer a sweet mix of income and security. Know what you’re buying, read the fine print, and enjoy those regular dividend checks like a financial pro.