Companies sell stocks as a way to generate capital for new business investments. In exchange for shares, buyers receive dividends on profits made by the company. Stock issues can vary depending on the types of benefits granted to the buyers. When companies pay dividends on stock issues, holders of preferred stock have certain entitlements not granted to holders of common stock.
Stock dividend payments result from net profits made by the issuing company. As stockholders, buyers purchase a percentage of ownership in a company, which entitles them to a portion of any profits made. Since stockholders share ownership, stock issues function as a liability for companies and not an expense, meaning dividend issues only appear on a company’s balance sheet and not the income statement. Companies issue stocks in two basic forms, known as common stock and preferred stock. When a company declares a stock dividend, holders of preferred stock receive payment before holders of common stock. In effect, common stock dividend payouts cannot occur until preferred holders receive their dividend share.
Common Stock vs. Preferred Stock
Buyers of stock receive certain benefits that correspond to the type of stock purchased. Owners of common stock have voting rights when it comes to electing company board members, whereas preferred stock holders do not. Common stock owners can also vote for or against stock splits. Dividends paid for common stock can fluctuate based on the amount of profits earned by the company. Preferred stock owners receive a fixed dividend amount regardless of the amount of profits earned by the company. In terms of ownership rights, preferred stock holders have a larger claim on the issuing company’s assets. This means, if a company goes bankrupt, preferred stockholders must receive payment in full and common stock holders receive what’s left.
Par values refer to the current market value of a company’s stock. When calculating dividend amounts for preferred stock shares, each share equals a percentage of the stock’s par value. So, if a preferred share of stock has a market value of $20 and the company issues 10 percent per share, shareholders receive a $2 dividend for each share owned. Market demands for preferred stock rates also impact the pricing of a company’s stock shares. So, a market demand for a 10 percent preferred stock will cause the company’s shares to sell at or near its $20 par value. In effect, preferred stock dividend amounts rely on the market value of a stock while at the same time influencing the price a particular stock can draw.
Preferred Stock Options
As common stock issues offer certain benefits that preferred stocks don’t, some companies will offer additional benefits comparable to those offered with common stock issues when selling preferred shares. Rather than limiting preferred dividends to a fixed amount, some companies will offer participating preferred stock; meaning dividend amounts may exceed the standard fixed percentage amount. Companies may also give preferred stock holders the option of converting their shares into common stock shares, which can pay considerably more in dividends depending on a stock’s market performance. Companies can also offer preferred stock issue on a cumulative basis, which ensures that owners receive back payments or dividends. This condition protects preferred holders in cases where a company runs into a period of low cash reserves and can’t pay dividends.