Because preferred stock does not have a stated maturity date, computing dividends is measured by calculating its current yield, its accrued yield and its taxable yield equivalent. As a result, a given preferred stock may have a yield that is different in every tax situation.
Compute current yield by dividing the amount of the next dividend by the stock price. Multiply the result by the ordinary number of payments in a year.
Accumulate arrears in preferred stocks. This means the preferred stock dividend was skipped at previous due dates. Cumulative preferred stock dividends in arrears accrue until paid. Thus, a $2 annual dividend that has not been paid in two years trading at $16 (its par value is $25 per share) has a current yield in arrears of ( 2 x $2) / $16, or 4/16 or 25 percent.
Compute total return for a preferred stock you expect to be defeased soon. If a bond is being called, its yield to call is the difference from par plus any arrears. In the case above, the total return is $25 -- $16, or $9, plus the $4 dividend divided by the current price of $16. In other words ($9 + $4) = $13; $13 / $16 is 81.25 percent. The time horizon is ignored.
Trade preferred stocks on their current yield and relative attractiveness to corporate bonds. Preferred stocks do not have maturities. Instead, they remain in the secondary market until they are called by the issuer, usually with only 30 days' notice. Use the computation that is most appropriate for your needs.
Tips & Warnings
- Calculate preferred stock dividends differently for companies, tax-exempt institutions and individuals. In most cases, individuals need to treat the income as fully taxable. Tax-exempt institutions pay no tax and thus receive the full yield. Corporations pay an effective tax rate after preferences of 15 percent.
- Preferred stocks should be compared to corporate bond yields as a measure of relative value.
- Do not make assumptions regarding when a preferred stock will be called. Often, the decision to call is based on balance sheet needs, not interest rate savings.
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