Questions on Preferred Stock

FINRA
1

I’m finishing chapter 2 on preferred dividends and had a couple questions on them.

  1. If the stock is cumulative, and the company suspends the dividend, are you required to hold the preferred stock until they start paying again in order to receive the back-dated dividends?

  2. When a company with cumulative preferred stock suspends the dividend, how likely is it, in practice, that the shareholder will be eventually reimbursed? I put a link below that takes to a list of available preferred stock. I sorted by yield %, and there are a handful that have really high yield % due to a dramatic fall in stock price. In my mind, if the shareholders will eventually be reimbursed for the missed dividends, I wouldn’t think it would be trading at such low prices.

Thanks!

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Hi @Andrew3 - thanks for using our forum! Also, great questions!

  1. Quick answer - there is no requirement to hold preferred shares. They may be sold in the market at any time.

  2. This is a tough question to answer. I tried to do some research myself to find some numbers for you, but couldn’t come up with much. Regardless, it’s no surprise preferred stock prices decline significantly in the event of skipped dividends. Let’s make sure we understand what cumulative means. Issuers of cumulative preferred stock are only under one obligation - to make up skipped dividends if they plan on paying dividends again in the future. This is why some of the practice questions you’ll encounter on this topic will sound something like:

Two years ago, an issuer of 5% preferred stock suspended their dividend. The following year, they skipped the dividend again. This year, they intend to pay a dividend to common stockholders. What must the issuer pay preferred shareholders this year?

Answer = 15% dividend

The only reason the issuer was required to make up the skipped dividends was because they intended to pay a dividend to common stockholders. In this circumstance, the issuer is obligated to make the preferred shareholders “whole” prior to paying the common dividend. Technically, the issuer wouldn’t be required to make up the skipped dividends if they never intended on paying dividends again.

This is the risk of preferred stock, and likely the reason for the high yields on those preferred shares you found. Another reason relates to the underlying cause of the skipped dividends. Companies know how bad a skipped or suspended dividend can look to investors, and therefore only entertain the idea if they’re in true financial distress. Preferred stock is still company ownership - the less valuable the company, the less desirable the shares.

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Gotcha, makes sense. Thanks!

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