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Preferred shares have qualities of both stocks and bonds, which makes their valuation different than that for a common share.

Preferred shares offer a fixed dividend payment that come at guaranteed intervals, be it quarterly, monthly, yearly or some other period. To find the value of the preferred stock, each future dividend payment needs to be discounted back to the present, and then added together.

If ABC Corporation pays a .25-cent monthly dividend, and the required rate of return is 6%, then the expected value of the preferred stock, using the dividend discount approach, would be $50. That’s 25 cents divided by the monthly discount rate, or 6% divided by 12 months.

Since every dividend is the same, the formula can be reduced to V equals D divided by r. V is the value, D is the dividend and r is the required rate of return.

Other considerations include the chance that dividends from preferred stock will be cut if earnings are too low to accommodate a distribution. The risk increases as the payout ratio – or the dividend payment compared to earnings – grows higher.

Preferred shares have an implied value similar to bonds, and their value will move inversely with interest rates. If the preferred shares are callable, the buyer should pay less because of the added benefit the company enjoys.

Dividend growth must also be accounted for. The calculation is D divided by r minus g, or the value equals the dividend divided by the required rate of return minus the growth number. By subtracting the growth number, cash flows are discounted by a lower number, resulting in a higher value.

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