preferred dividends in portfolios

The Role of Preferred Dividends in Portfolios

by Josh Hunter

When buying stock, investing strategies are usually most concerned about factors such as initial cost, stability and potential for growth. But it’s important not to overlook the wealth-building potential of dividends, either as an investor or as a company owner. 

What Are Dividends?

A dividend is a payment made by a company to its shareholders. This payment can take the form of cash or additional shares and is typically paid quarterly, though some companies pay “special,” or unscheduled, dividends as well. Think of stock dividends as a type of profit-sharing program for investors.

Common vs. Preferred Dividends

You’ve likely heard the terms “common” and “preferred” when reading or hearing about stocks. Both types of stocks can provide their owners with dividends, but only preferred stockholders are entitled to dividends if, and when, a company pays them. 

Preferred dividends are paid to holders of a company’s preferred stock. If a company’s profits aren’t enough to pay all shareholders a dividend, the company will pay its preferred shareholders their preferred dividends and the shareholders  of the company’s common stock will miss out on that round of dividends. 

Are Companies Required to Pay Preferred Dividends?

Businesses are not required to pay preferred dividends to their shareholders, or any dividends for that matter. Investors should be aware of this before choosing stocks as the possibility of dividend income or shares ought to be calculated when putting together a portfolio. It is also true, however, that there are many strong stocks that do not pay dividends: Historic performance of a stock, as well as the company’s operations and industry, are just a few of the other issues that investors should take into consideration before purchasing preferred shares.

Advantages of Dividend Stocks to Investors

Investing in companies that pay dividends can offer significant advantages over purchasing shares in businesses that do not. 

Income

Preferred dividends are paid on the par value (face value) of stock each quarter. Unlike the share value, the par value of stock does not fluctuate, and your dividend rate is set out in your stock’s prospectus. You will know when to expect these dividends, which can provide some stability to your investment plan.  

How to Calculate Preferred Dividends: If you want to calculate your annual preferred dividend distribution per share, you can use the following formula: (par value of your stock) x (dividend rate) = (annual dividends).

Additional Shares as Dividends

If the company provides preferred stock dividends, you’ll receive additional shares of the company’s preferred stock without having to invest additional funds. It should be noted, however, that stock dividends can, at least in the short term, dilute a stock’s value. This is because stock dividends increase the number of shares outstanding, which, if all other factors remain the same — such as a company’s market cap — will cause the price of each share to drop. Over time, however, a strong stock might regain its value and you’ll have more shares from which to reap potential earnings and build your wealth.

Dividend Reinvestment Programs (DRIPs)

Some companies offer dividend reinvestment programs, or DRIPs, to their preferred shareholders. These programs allow shareholders to reinvest their dividends into new shares of stock. In some cases, the company may provide a discount for doing so. A DRIP may provide investors with the best of both worlds: The ability to earn dividends and then increase your holdings at a bargain price.

It’s important to note that even if a company doesn’t have a DRIP, investors can arrange to do pretty much the same thing with their broker. The process may vary slightly, but investors can arrange to automatically reinvest dividends into their portfolio.

Should Your Company Provide Preferred Dividends?

If you are a business owner and looking to improve your ability to attract and retain shareholders, offering preferred dividends may be a sound option. Investors are often attracted to the possibility of extra earnings or the ability to increase their shares without having to actually purchase more stock. Shareholders may also feel more connected to your company if they are able to directly share in the profits rather than simply waiting for your stock price to rise.

Just remember that offering preferred dividends has its costs. When your company provides a dividend, it makes those payments out of company profits. This means you won’t have access to those funds for expenses or for further development of your organization or brand so make sure your company is stable before offering preferred stock dividends.

How to Find Preferred Dividends

If you are looking for an opportunity to find preferred dividends for your portfolio, you may benefit from speaking with a wealth advisor at Gratus Capital. Your advisor takes the time to learn about you and your financial goals and tolerance for risk and may help you determine whether preferred shares should be a component of your portfolio. If preferred stocks are a good option for you, your advisor can help guide you toward companies that offer preferred dividends to their shareholders.

Sources:

Dividend Reinvestment

How to Calculate Dividend Distribution of Preferred Stocks

Par For The Course: What Is Par Value?