Is Valuation of Preferred Stock Similar to Bonds?

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The pricing of bonds and preferred stock involves relative value measurement techniques for each type of security. Preferred stocks have many variations, including convertible preferred, participating preferred and cumulative preferred stock issues. Preferred stock is often issued as equity with characteristics of debt. Bonds share few of these characteristics and thus employ different means of valuation. The similarities of preferred debt and bonds is limited to some yield calculations.

Current Yield

Bond prices trade in points, where 100 represents maturity value, or par. The current yield is the interest rate paid on the bond, also called the coupon rate. Dividing the bond price by the coupon rate yields the current yield, an approximation of the yield to maturity. Preferred stocks do not have a stated maturity, otherwise they would be considered a bond. A preferred stock's current yield is the sum of the stated annual dividend divided by the current value of the preferred stock. Preferred stock trades in dollars. Maturity values of \$25, \$50, and \$100 are common prices for publicly traded preferred stock.

Yield to Maturity

Bonds have a stated maturity denoting when principal must be repaid. Valuation of a bond is usually defined by the yield to maturity, which equates, through a mathematical formula, the time to maturity to the amount of cash received. Valuation of preferred stock must be based on the current yield, because there is not a stated maturity. Instead, preferred stocks are redeemed by use of a call -- an extraordinary redemption. Since notice can usually be given on just 30 days' notice, valuation of preferred stock by a maturity calculation is impossible.

Missed Coupon Payment

A bond that fails to make an interest payment when due can be considered in default. Some bond agreements allow for an additional period of time, usually no more than 10 days, for the deficiency to be cured and the investor made whole. Valuation of such bonds quickly reduces the creditworthiness of a bond, and the accrued interest is added to the principal due. Preferred stock may be issued as cumulative preferred, meaning it is not a default when interest payments are not made on time. They accrue interest like a bond, and missed interest must be paid before any stock dividends can be paid.

General Pricing Considerations

Bonds and preferred stock follow general interest rate trends. When interest rates rise, valuations of both securities fall. This reduced price increases the effective yield of the existing bond or preferred stock, putting it at a competitive yield with newly issued securities. Credit quality differences tend to treat valuations based on the circumstances of the credit. While the valuation process is generally similar for bonds and most preferred stock, the particular circumstances are not the same.

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