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.

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