What is Perpetual Preferred Stock?
Perpetual preferred stock is a type of preferred stock that pays a fixed dividend to investors for as long as the company remains in business. It does not have a maturity, nor a specific buyback date but does typically have redemption features.
Unless redeemed, issued perpetual preferred stock will thus pay dividends indefinitely, provided the issuer is still extant. These shares often trade on stock exchanges similar to common stock.
- A perpetual preferred stock is a type of preferred stock that pays a fixed dividend to the investor for as long as the company is in business.
- Perpetual preferred stock doesn't have a maturity, or specific buyback date but does have redemption features.
- Perpetual preferred stock has characteristics that are similar to a bond with an extremely long maturity date.
What Are Stocks?
Understanding Perpetual Preferred Stock
There are two types of preferred stocks—perpetual and nonperpetual. Perpetual preferred stock does not have an expiration date and pays the investor a fixed dividend for as long as the issuing company is in existence. The company does, however, hold the right to buy back the stock at any time under specific terms defined in the prospectus. This buyback period is basically a call feature that is commonplace in the bond market.
Companies buy back perpetual preferred shares for several reasons, most notably changes in interest rates and tax laws. Investors must bear this in mind because losing their shares to a redemption means they will suddenly lose an income stream. If interest rates fall below the yield paid to stockholders, for example, the company would, most likely, buy back the outstanding perpetual preferred stock. As a result, the investors would not be able to reinvest their money and receive the same dividend rate that had been instrumental in their receiving a steady income stream. Though not exactly identical, a perpetual preferred stock has characteristics that are similar to a bond with an extremely long maturity date.
Pricing Perpetual Preferred Shares
Since, in theory, perpetual preferred stock can exist indefinitely, so too must the dividend payments. Hence, to price these, one would calculate the present value (PV) of a perpetuity, which is the fixed dividend amount divided by the dividend yield:
Perpetual Preferred Stock Price = Fixed Dividend ÷ Dividend Yield
A nonperpetual preferred stock will have a stated buyback price and buyback date, usually 30 or more years from the date of issue. It also has a defined maturity date and therefore has more certainty regarding cash flows.
Preferred Stock vs. Bonds
Investors put their money in a preferred stock because it combines the ease and trading benefits of stocks with the fixed income benefits of bonds. Holders of all types of preferred stock receive priority over common stockholders. This preference is significant when it comes to the payment of dividends and voluntary liquidation of assets, but is essential in bankruptcies. During a bankruptcy, preferred stockholders receive first shot at the company's asset liquidation. Preferred stocks offer greater protection than common stocks in this situation.
However, unlike common stock, investors in preferred shares do not get a direct benefit from increases in the company’s earnings. They are only entitled to the dividend in force when they purchased their shares. As an example, an investor buys a preferred stock when the dividend payment is $10 per year. The company later raises that payment to $15 per year. The holder of the preferred share gets only the $10 dividend, but the common stockholder will receive the higher dividend.
Companies can issue bonds or preferred stock for many reasons. It is important to consider whether the company's balance sheet is already loaded with debt before buying either one. Adding more debt might risk a credit downgrade or a problem with regulators. Unlike corporations, individuals get no tax benefit from owning preferred stock. But preferred shares likely offer higher yields than an equivalent bond.
There are certain risks to consider before buying preferred shares. Indeed, a good deal of preferred stock is issued by companies with lower credit ratings. Also, the board of directors can vote to suspend the dividend payments, and the preferred stockholders cannot sue them.