Why do some preferred stocks have a higher yield than common stocks?

By Matt Lee AAA
A:

Before we answer this question, let's just take a quick review of what a stock's yield is actually measuring.

The yield is calculated by taking the stock's annual expected dividend and then dividing that number by the stock's current market price, which results in a coefficient that is usually expressed in percentage terms. A yield can be calculated for any class of stock that pays a dividend. For example, assume the common stock of XYZ Inc. pays an annual dividend of $0.50 per share, and the current stock price is $15 per share. The yield on this stock is currently 3.33% ($0.50/$15), and represents the amount of dividends a shareholder will receive for every dollar invested. In this case, an investor will receive about $0.033 (3.33%) for every $1 used to purchase XYZ Inc common stock at the current market price.

Now that we know what a yield is, we can now answer the question: why do some preferred stocks have a higher yield than common stocks?

The reason as to why this is lies in the numerator of the equation: dividends. Traditionally, preferred shares offer a higher annual dividend per share over common stock, but there are some draw backs to this privilege. By purchasing preferred shares (which is usually done by large investors and insiders), the purchaser gives up the right to vote on matters affecting the shareholders and there is less of a chance for price appreciation when holding preferred shares. In other words, the incentive to owning preferred shares is the dividend. If this is the only incentive, or most prominent one, then the dividend must compensate the investor for the lack of price appreciation in shares, which is one of the major incentives for holding common stock. The higher the dividend is for a given price per share, then the higher the stock's yield will be.

To learn more about preferred shares, please read A Primer On Preferred Shares.

RELATED FAQS

  1. What are the components of shareholders' equity?

    Understanding company valuation figures, such as shareholders' equity, can be a powerful tool in assessing the financial ...
  2. How do I calculate the dividend payout ratio from an income statement?

    Understand the dividend payout ratio, how it differs from the dividend yield and how it can be calculated from a company's ...
  3. What are the pros and cons of owning preferred stock instead of common stock?

    Understand and explore the advantages and disadvantages of owning preferred stock as opposed to owning common stock shares ...
  4. What is the difference between dividend yield and dividend payout ratio?

    Understand the difference between the dividend yield and the dividend payout ratio, two basic investment valuation measures ...
RELATED TERMS
  1. Policyholder Dividend Ratio

    The policyholder dividend ratio is a measurement of the profitability ...
  2. Paid-Up Additional Insurance

    Additional whole life insurance that a policyholder purchases ...
  3. Accelerated Dividend

    Special dividends paid by a company ahead of an imminent change ...
  4. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  5. Return On Equity - ROE

    The amount of net income returned as a percentage of shareholders ...
  6. Payout Ratio

    The proportion of earnings paid out as dividends to shareholders, ...

You May Also Like

Related Articles
  1. Trading Strategies

    Risk Management Techniques For Shorting ...

  2. Mutual Funds & ETFs

    Why Monthly Dividend ETFs are Good for ...

  3. Trading Strategies

    General Electric: Good News/Bad News

  4. Trading Strategies

    American Express: Headwinds and Tailwinds

  5. Trading Strategies

    Is 'Big Blue' Now Black And Blue?

Trading Center