91Ó°ÊÓ

Preferred stock is a unique type of equity often sought after by investors looking for stable and predictable dividends. Unlike common stock, preferred shares usually come with a fixed dividend rate, in this case, 2% based on a $20 par value. This means every share gets a $0.40 dividend per year as long as the company decides to distribute dividends.

These shares are called "preferred" because in the event of dividend distribution, the holders receive their share before any distribution is made to holders of common stock. Additionally, in situations such as company liquidation, preferred shareholders are paid out before common shareholders, offering an added layer of investment security.

Common stock represents ownership in a company and a claim on part of its profits. Generally more volatile than preferred stock, it does not come with a guaranteed dividend. However, common stock often has the potential for higher returns over the long term through capital appreciation, unlike the more predictable returns from preferred stocks.

Common shareholders typically have voting rights, which allow them to have a say in important company decisions. In dividend distribution, common stockholders receive their dividends only after the preferred shareholders have received their due share. The dividends to common shareholders can vary widely, depending on the company’s performance and profitability, as we see in the varying dividends per share in different years in the exercise.

A cumulative dividend is a crucial feature of some preferred stocks that benefits the shareholder. If a company is unable to pay its dividend for any reason, the dividend does not simply vanish. Instead, it accumulates, meaning the missed payments are carried forward into the future. Consequently, before any dividends can be paid to common shareholders, the company must first pay all accumulated dividends to preferred shareholders.

In our example, the company skipped paying dividends in its first year, which resulted in a $40,000 cumulative dividend obligation. This unpaid dividend burden then needed to be addressed in subsequent years, as seen in the dividends distributed in the following years.

Dividends per share is a valuable metric used to measure the dividend income an investor might expect from their shares. It is calculated by dividing the total dividends paid out by the number of shares outstanding.

This measure provides insight into the income-generating capability of an investment and helps assess whether a stock is a suitable investment based on income needs. In our example, we saw different dividends per share for common stock over five years: from no dividend in the first year to $2.80 per share in the fifth year. For preferred shareholders, the rate remained steady at $0.40, showing the stability of preferred stock dividends.