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Preferred Stock 101
In the quest for understanding the value of corporate USA, the journey to determine value will eventually uncover the category of terms used to classify and denote preferred stock. Typically located on a company’s balance sheet, the use of a preferred stock line item can offer valuable information about the company and allow you the opportunity to evaluate future options with a much more discernable eye. At its core, preferred stock represents company or corporation ownership. It is an avenue, whereby ownership can be used to guarantee dividends and a future claim on a company's assets that is above that of common shareholders. The tradeoff may be that preferred shareholders cannot vote or share other specified rights. Preferred stock pays a fixed dividend that is specified and determined in advance. Unless the stock is retired or called back, it will continue paying dividends forever. Preferred stock is usually issued with a $100 par (face) value. The dividend payments are a fixed percentage of the par. For example, if the par value of a stock share were $100 with a 6 percent annual dividend rate, the annual dividend would be $6 on that share. In recent years, some companies have also begun issuing preferred shares with variable rates tied to interest rates. The par value is the most that the shareholder will receive if the company declares bankruptcy. Preferred stock is generally issued at its par value. Characteristics “common” in preferred stock Cumulative: Most preferred issues are cumulative, meaning that dividends will accrue even if they are not actually paid. The Board of Directors (BOD) has to approve (declare) the payment of preferred and common stock dividends each quarter. In a cash crunch, preferred dividends may be suspended. Once the dividends are resumed -- and before common dividends can be paid -- cumulative preferred shareholders must be paid their accrued dividends. Redeemable: Most preferreds are also redeemable, or "callable," meaning the issuer has the right to call (redeem) the shares after a stated date. Participating/Non-participating: Participating preferred shares might receive additional dividends based on a predetermined formula using the issuer's profits, the BOD's generosity, or a combination of all three. The participation dividend will be less than the amount paid to common shareholders, but this feature can add to the value of preferred shares. Most preferreds are non-participating. Non-cumulative (straight) preferred: Is the opposite of cumulative preferred: it does not confer a steady claim on dividends in the event of a dividend suspension. Shareholders of this type may not be paid any missed dividends prior to payments being made to the common shareholders. Convertible: Convertible preferreds can be exchanged for common stock at a set price after a certain date. For example, in 1996, Microsoft issued 12.5 million shares of 2.75% convertible, exchangeable, principal-protected preferred stock that was converted in 1999 for 1.1273 common shares. [continued...] Want to know more? Download the White Paper "Preferred Stock" for just $14.95. |
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