A company can choose many ways in which to raise money, from issuing bonds and taking out loans, to issuing common and preferred stock. While each form of debt provides its own obligation and repayment, stocks provide corporations with the flexibility to manage their assets as needed. Companies can also provide dividends to common stock holders when they post a profit. Preferred and common stocks function differently in the order of dividend payment and how dividends are calculated. Understanding the earnings structure for types of stock is essential for investors.
1. Determine a company’s net income. This is its profits for the reporting period, which is roughly calculated as revenue minus expenses and other debt obligations, and is commonly reported on financial statements. For example, assume a company has $5.1 million in revenue, but posts income of $1.1 million.
2. Calculate preferred stock dividends by multiplying the number of preferred shares by their guaranteed dividend. Preferred stock guarantees its owner a constant, periodic dividend – such as $10 each year per share. Continuing with the example from the previous step, assume the company issued 10,000 shares of preferred stock with a dividend of $10. That means it owes its preferred stockholders a total of $100,000.
3. Subtract preferred dividends from the net earnings. Preferred stock holders receive dividends before common stockholders, and must be paid if the company receives enough income to meet their obligations. If it doesn’t receive enough income to pay preferred stockholders, a lack of preferred dividends is less harmful than defaulting on bond debt. After paying $100,000 to preferred stockholders, the company has $1 million in earnings left.
4. Subtract retained earnings from remaining earnings to calculate the total amount available for dividends. A company’s board decides whether to retain earnings to reinvest back into the business, or to pay out the earnings to shareholders in the form of dividends. In the example, assume the board moves to retain $500,000 in earnings to repurchase bond debt, and is left with $500,000 in earnings to split among common stockholders.
5. Divide the total number of common stock shares by the amount of earnings remaining for dividends to get the dividend per share. The example company issued 300,000 shares of common stock, resulting in a per-share dividend of $1.67 per share.
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