Preferred Dividends

Preferred Dividends are the scheduled payments a company makes to its preferred stock holders. Think of them as a VIP pass to a company's earnings. These dividends are a defining feature of preferred shares, offering a regular, fixed income that feels more like a bond's coupon payment than the more unpredictable payouts to common shareholders. The “preferred” part is key: a company must pay these dividends in full before any dividends can be distributed to common stockholders. This seniority gives preferred investors a priority claim on the company's profits, making it a more conservative investment than common stock. The dividend amount is typically set as a fixed percentage of the stock's par value or as a specific dollar amount, providing a predictable and steady stream of income for investors who prioritize cash flow over high-growth potential.

The two defining traits of preferred dividends are their fixed nature and their place in the payment queue. Unlike common stock dividends, which can fluctuate wildly based on company performance and board decisions, preferred dividends are typically a set amount paid at regular intervals (e.g., quarterly). This predictability is backed by a crucial legal protection: priority. In the event of financial hardship where a company can only afford to pay a portion of its planned dividends, the preferred shareholders are first in line. Common shareholders only get a slice of the pie if there's anything left after the preferred investors have been fully paid. This structure significantly lowers the risk compared to holding common shares.

Not all preferred dividends are created equal. This is arguably the most important feature for an investor to understand before buying preferred stock.

• Cumulative Preferred Dividends: This is the investor-friendly version. If a company is struggling and decides to skip a dividend payment, the missed payment isn't gone forever. It accumulates as a dividends in arrears liability on the company's balance sheet. The company is legally obligated to pay back all these missed dividends to its preferred shareholders before it can resume paying any dividends to its common stockholders. This feature provides a powerful safety net.
• Non-Cumulative Preferred Dividends: This type is riskier. If the company skips a dividend payment, that payment is lost for good. There is no obligation to pay it back in the future. For this reason, non-cumulative preferred stocks often offer a slightly higher dividend yield to compensate investors for the added risk.

A value investor often sees preferred stock as a hybrid instrument, blending the characteristics of both stocks and bonds.

• Like a bond, it provides a fixed income stream and its price can be sensitive to changes in interest rates.
• Like a stock, it represents an ownership stake (albeit one that usually lacks voting rights) and its payments are dependent on the company's financial health.

This dual nature requires a careful analysis. The goal isn't just to snag a high yield, but to ensure that yield is sustainable for the long haul.

The core of the value approach is determining if the dividend is safe. A high yield is worthless if the company can't afford to pay it. To gauge this, an investor should look beyond the advertised rate and dig into the company's financial statements.

• Coverage Ratios: The most direct measure is the dividend coverage ratio. This metric shows how many times the company's earnings can cover its preferred dividend obligation. A simple version is calculated as: Net Income / Annual Preferred Dividend Payment. A ratio comfortably above 1x suggests a solid buffer. Digging deeper into cash flow statements provides an even clearer picture of the company's ability to generate the cash needed for these payments.
• Dividends in Arrears as a Clue: The presence of “dividends in arrears” on a balance sheet is a flashing red light, signaling past financial trouble. For most, it's a reason to stay away. However, for the discerning, contrarian value investor, it can sometimes signal a deep-value opportunity. If you believe the company is turning a corner, buying the cumulative preferred stock could lead to a windfall when the company becomes healthy enough to pay back all the accumulated dividends. This is a high-risk, high-reward play that requires deep investigation.