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Physician Investing Basics
By Julia O’Neal; MA, CPA
Preferred stock is designed to resemble bonds and usually has a par value of $100. Dividends are stated as a percentage of par—6% preferred would pay $6 annually. The stated dividend is the minimum that the company will pay out. If there are not enough earnings to pay the dividend, the company will pay out whatever is available for dividends.
Preferred Stock Differences
There are different types of preferred stock, which are based on the method of dividend payment.
Cumulative preferred carries a provision that all prior dividends due on preferred stock must be paid before dividends can be paid on common stock.
Participating preferred may earn dividends in excess of the stated percentage if they are available after dividends are paid on common.
Convertible preferred is also issued at $100 par. The stock may be converted into (exchanged for) a designated number of common shares. The conversion ratio and conversion price are determined at the time the stock is issued.
Conversion ratio = Par value / Conversion price
When the stock reaches its conversion price, the cumulative preferred stock is said to be “at parity” with the common stock.
Cumulative preferred stock usually sells “at a premium to” (above) its par value because of the added value attached to the conversion feature. Most of the time, cumulative preferred stock is callable, which means the corporation has the right to “call” or buy back the preferred stock at a specified price, sometimes after a set date.
Cumulative convertible preferred stock is popular. Investors appreciate the ability to combine the attributes of both stock and bond ownership in one vehicle and, because they are so popular, corporations can market these securities easily, often with a lower coupon than a straight bond would require.
MORE: C v P
Assessment: Is preferred stock best for personal or corporate portfolios?
Conclusion: Your thoughts are appreciated.
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