Key Takeaways
- Preferred dividends are calculated as Par Value x Stated Dividend Rate
- Preferred shareholders receive fixed dividends before any common dividends are paid
- Cumulative preferred stock accumulates unpaid dividends as "dividends in arrears"
- Understanding preferred dividends is critical for calculating EPS available to common shareholders
To calculate preferred dividends, multiply the preferred stock's par value by its stated dividend rate. For example, if a company issues preferred stock with a $100 par value and a 6% dividend rate, the annual preferred dividend is $100 x 0.06 = $6.00 per share. This fixed calculation makes preferred dividends straightforward compared to common dividends, which are set at the board's discretion.
Preferred dividends matter to common stock investors because they represent a senior claim on earnings. When you see earnings per share (EPS) reported for a company like JPMorgan Chase (JPM), preferred dividends have already been subtracted from net income before the per-share figure is calculated. Understanding how preferred dividends work helps you assess how much of a company's earnings are actually available for common shareholders.
The Basic Formula
Annual Preferred Dividend = Par Value x Dividend Rate
The par value (also called face value or stated value) is printed on the preferred stock certificate and set at issuance. Common par values are $25, $50, and $100. The dividend rate is a fixed percentage, also set at issuance. Unlike common stock dividends, preferred dividend rates do not change over the life of the security (for fixed-rate preferreds).
Example 1: A company has 10,000 shares of 7% preferred stock with a $50 par value outstanding.
- Per-share annual dividend: $50 x 0.07 = $3.50
- Total annual preferred dividends: 10,000 x $3.50 = $35,000
- Quarterly payment: $35,000 / 4 = $8,750
Example 2: A company has 50,000 shares of 5.5% preferred stock with a $100 par value.
- Per-share annual dividend: $100 x 0.055 = $5.50
- Total annual preferred dividends: 50,000 x $5.50 = $275,000
Cumulative vs. Non-Cumulative Preferred Stock
The distinction between cumulative and non-cumulative preferred stock significantly affects how dividends are calculated over time, especially when a company misses payments.
Cumulative preferred stock accumulates any unpaid dividends as dividends in arrears. These must be paid in full before any common dividends can be declared. Most preferred stock is cumulative.
Example: A company has 5,000 shares of cumulative 8% preferred stock, $100 par value. The annual preferred dividend obligation is 5,000 x $8.00 = $40,000. If the company skips dividends for two years, it accumulates $80,000 in arrears. In year three, before paying any common dividends, the company must pay $120,000 to preferred holders: $80,000 in arrears plus the current year's $40,000.
Non-cumulative preferred stock does not accumulate missed payments. If the company skips a year, those dividends are permanently forfeited. Non-cumulative preferred is less common because investors demand higher rates to compensate for this risk.
Impact on Earnings Per Share (EPS)
Preferred dividends directly affect how EPS is calculated for common shareholders. The formula for basic EPS subtracts preferred dividends from net income.
Basic EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares
Example: A company reports net income of $10 million, has $500,000 in annual preferred dividends, and 5 million weighted average common shares outstanding. Basic EPS = ($10,000,000 - $500,000) / 5,000,000 = $1.90 per share. Without the preferred dividend adjustment, EPS would be overstated at $2.00.
For cumulative preferred stock, you subtract the current year's preferred dividends from net income regardless of whether they were actually paid. This is because the obligation exists even if payment is deferred. For non-cumulative preferred stock, you only subtract dividends that were actually declared.
Preferred Dividends and the Dividend Coverage Ratio
When evaluating a company that has both preferred and common stock outstanding, the dividend coverage ratio should account for the preferred obligation first.
Common Dividend Coverage = (Net Income - Preferred Dividends) / Common Dividends
This adjusted ratio shows how many times the company can cover its common dividend after satisfying preferred obligations. If a company earns $20 million, owes $2 million in preferred dividends, and pays $6 million in common dividends, the coverage ratio is ($20M - $2M) / $6M = 3.0x. The preferred dividends are essentially a fixed charge that reduces the earnings available for common payouts.
Accounting Journal Entry for Preferred Dividends
The journal entries for preferred dividends mirror those for common dividends. When the board declares a preferred dividend:
Declaration Date:
Debit: Retained Earnings $35,000
Credit: Preferred Dividends Payable $35,000
Payment Date:
Debit: Preferred Dividends Payable $35,000
Credit: Cash $35,000
Between the declaration date and the payment date, Preferred Dividends Payable appears on the balance sheet as a current liability. Just like common dividends, preferred dividends reduce retained earnings and do not appear on the income statement.
Frequently Asked Questions
How do I find a company's preferred dividend obligation?
Check the equity section of the balance sheet for preferred stock details, including par value and dividend rate. The notes to financial statements typically provide the full terms. You can also find this in the company's 10-K filing under the stockholders' equity footnote.
Can preferred dividend rates change?
Fixed-rate preferred stock has a permanent dividend rate. However, adjustable-rate preferred stock exists where the rate resets periodically based on a benchmark like the Treasury rate. There are also fixed-to-floating preferreds that pay a fixed rate for an initial period then switch to a floating rate.
Are preferred dividends taxed differently than common dividends?
Most preferred dividends from U.S. corporations qualify for the same favorable qualified dividend tax rates as common dividends (0%, 15%, or 20% depending on your tax bracket). However, preferred dividends from REITs, banks paying trust preferred dividends, and certain foreign issuers may be taxed as ordinary income. Always check the tax treatment before investing.