In many ways, preferred stock in a company doesn't live up to its name because it isn't always preferable to common stock. Preferred shares usually don't have any voting rights, and they don't increase in value the way common shares can. But one instance in which preferred shares really are preferred is in the payment of dividends. When a company pays dividends, holders of preferred shares get their money before common stockholders do.
Companies can distribute profits to their shareholders through dividends. Dividends on common stock are up to the discretion of the board of directors. If the board doesn't want to pay a dividend to common shareholders, it doesn't have to, no matter how much profit the company makes or how much cash it has on hand. It's different with preferred shares, whose dividends are usually mandatory. If the company has the money to pay dividends to preferred shareholders, it generally must do so.
Amount of Dividend
Dividends on common shares typically depend on variables, such as the company's earnings and cash flow, the number of shares outstanding and the board's strategy. Preferred dividends, on the other hand, are fixed, typically as a percentage of the issue price, which is the price at which the company originally sold the shares. You can usually find the details in the stock's prospectus. For example, the stock might pay an annual dividend of 6 percent of the issue price. If the issue price is $25 a share, then each share would produce $1.50 a year in dividends. Dividends might be paid annually, as in one $1.50 payment, or quarterly, in four payments totally $1.50.
Preferred shareholders always get their dividends before common shareholders do. A company cannot pay common shareholders until it has paid the preferred shareholders. A company also can't reduce the preferred dividend to ensure that there's something left over for investors owning common shares.
There may be times when a company runs short on cash and doesn't have enough to pay the preferred dividend. In such cases, the board of directors can vote to suspend payment of preferred dividends. But that doesn't mean the company gets out of paying them entirely. Instead, the dividends accrue in arrears, which means the company still owes the money. When the company is able to pay dividends again, the preferred shareholders must get all their unpaid dividends before the company can pay common shareholders.
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