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 is common stock and preferred stock?

    Learn about the differences between common and preferred shares. Explore situations where preferred shares have more favorable ... Read Answer >>
  2. What is the difference between yield and dividend?

    Learn how to differentiate between dividend yield and dividend return, and see why dividend yield is the more popular rate ... Read Answer >>
  3. What metrics should I evaluate when looking for high-yielding dividend stocks?

    Evaluate high-yield dividend stocks to determine if they are a good investment to produce steady income. Learn what questions ... Read Answer >>
  4. What is the difference between preference and ordinary shares?

    Learn about the main differences between preference and ordinary shares including how dividends are paid for both types of ... Read Answer >>
  5. Why should a company buy back shares it feels are undervalued instead of redeeming ...

    Discover the difference between common stock and preferred stock. When is repurchase preferable to redemption, and what factors ... Read Answer >>
Related Articles
  1. Managing Wealth

    The Advantages of Preferred Dividends

    Preferred dividends are cash distributions a company pays on its preferred shares.
  2. Investing

    Dividend Yield For The Downturn

    High-dividend stocks make excellent bear market investments, but the payouts aren't a sure thing.
  3. Investing

    Valuation Of A Preferred Stock

    Determining the value of a preferred stock is important for your portfolio. Learn how it's done.
  4. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    To find the best dividend stocks, focus on total return, not yield.
  5. Investing

    Looking for Yield? Check Out This Preferred Stock ETF (PFF)

    Take a look at a review of the performance of the most popular preferred stock ETF, the iShares U.S. Preferred Stock ETF from BlackRock.
  6. Investing

    Due Diligence On Dividends

    Understanding dividends and how they work will help you become a more informed and successful investor.
  7. Financial Advisor

    4 Dividend ETFs to Help Fund Your Retirement

    Investing in stocks that pay out dividends can be a smart way to establish a reliable income stream in retirement. Here are four low-fee dividend ETFs.
  8. Investing

    Top 6 Preferred Stock ETFs

    A list of top ETFs which invest in preferred stocks and pay regular dividend income
  9. Investing

    How Dividends Affect Stock Prices

    Find out how dividends affect the price of the underlying stock, the role of market psychology and how to predict price changes after dividend declaration.
  10. Investing

    These 7 companies have increased their dividends 1,000%

    It's one of the most overlooked aspects of income investing. In fact, I'm willing to bet that the majority of income investors don't even consider it when they're buying a dividend stock. That's ...
RELATED TERMS
  1. Preferred Stock

    A class of ownership in a corporation that has a higher claim ...
  2. Preference Shares

    Company stock with dividends that are paid to shareholders before ...
  3. Preferred Dividend

    A dividend that is accrued and paid on a company's preferred ...
  4. Forward Dividend Yield

    An estimation of a year's dividend expressed as a percentage ...
  5. Yield On Cost - YOC

    The annual dividend rate of a security divided by the average ...
  6. Current Dividend Preference

    A safety feature of preferred shares, whereby holders of such ...
Hot Definitions
  1. Trumponomics

    Trumponomics is a term for the economic policies of President Donald Trump.
  2. Universal Health Care Coverage

    An organized healthcare system that provides healthcare benefits to all persons in a specified region. Many countries, such ...
  3. Davos World Economic Forum

    The annual meeting of the World Economic Forum hosted at Davos—a small ski town in Switzerland—in January each year is among ...
  4. Smart Home

    A convenient home setup where appliances and devices can be automatically controlled remotely from anywhere in the world ...
  5. Efficient Frontier

    A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center