DEFINITION of 'Current Dividend Preference'

A safety feature of preferred shares, whereby holders of such shares are entitled to receive dividends before common shareholders. Current dividend preference means that preferred shareholders have priority or preference over common shareholders when it comes to dividend distributions. This feature implies that under no circumstances can dividends be paid to common shareholders before preferred shareholders.

BREAKING DOWN 'Current Dividend Preference'

Dividend distributions depend on a number of factors such as the company's operating performance, level of retained earnings and payout ratio. While dividend payments on common shares are largely at the company's discretion, preferred dividends generally have a greater degree of stability. For example, consider a company called The World’s Best Widget Co., that has four million preferred shares with a face value of $25 outstanding; these shares have a stipulated dividend of 5%. The World’s Best Widget Co. also has 100 million common shares outstanding, on which it has been paying dividends of 20 cents. This means that the company pays out $5 million in preferred dividends and $20 million in common share dividends. If the company has a healthy financial position and is consistently profitable, paying these dividends should not cause it any problems. However, if it has a couple of unprofitable or marginally profitable years, then it may consider trimming dividends on its common stock, or even suspending them altogether. But even in this scenario, it must pay out preferred shares dividends, either in this period or at a later date.

Dividend rate and preferred stock

The dividend rate for a preferred stock is a fixed amount, unlike common share dividends, which might fluctuate, depending on a company’s profits, and how much of those profits the company's board of directors decides to issue in the form of dividend payments. Generally speaking, preferred share dividends are viewed as more stable than common stock dividends, and have a higher probability of being paid, given that preferred stockholders are paid their full fixed dividend rate each period as long as the company is in operation.

One feature that often accompanies the Current Dividend Preference is a Cumulative Preferred Shares function, where all missed dividends on the cumulative preferred shares must be paid out in arrears, before any dividend can be paid to common stock shareholders. Another perk enjoyed by preferred shareholders manifests if the company becomes insolvent and subsequently files for bankruptcy, in which case the preferred stock shareholders stand stand ahead of common stock shareholders, if ever a bankruptcy court divides up a company’s remaining assets.

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