# Understanding Preferred Dividends: Benefits and Calculations

## What Are Preferred Dividends?

Preferred dividends are made to shareholders of a company's [preferred stock](https://www.investopedia.com/terms/p/preferredstock.asp). Unlike common [dividends](https://www.investopedia.com/terms/d/dividend.asp), they are usually fixed and must be paid before [common shareholders](https://www.investopedia.com/terms/c/commonstock.asp). This gives preferred shareholders stability, but the fixed rate can be a downside because it doesn’t adjust for inflation. In this article, we explain how preferred dividends work, how they’re calculated, and show you key factors you should consider as an investor.

### Key Takeaways

*   Preferred dividends are paid on preferred shares and take priority over common stock dividends.  
    
*   Preferred dividends often offer higher rates than common stock, attracting investors seeking stable income.  
    
*   Dividends are determined by multiplying the dividend rate by the par value of the preferred stock.  
    
*   Preferred dividends must be paid before any profits are distributed to common shareholders.  
    
*   In times of financial strain, any missed preferred dividends accumulate and are paid before common stock dividends.

## The Mechanism of Preferred Dividends

The board of directors decides if and how much dividend to pay to common stockholders. The dividend is a reward to stockholders. It represents their share of the company’s profits and is an incentive for them to hold onto the stock for the long term. The [board](https://www.investopedia.com/articles/analyst/03/111903.asp) may raise, reduce, or eliminate its dividend based on the recent success of the business and depending on what other priorities it sees for the money.

Preferred dividends are based on the stock's [par value](https://www.investopedia.com/terms/p/parvalue.asp) and dividend rate. They are issued at a fixed rate, which may be disadvantageous during high inflation since the payment isn't adjusted for changing interest rates.  

The [dividends](https://www.investopedia.com/articles/02/010902.asp) for preferred stocks are, by definition, determined in advance and paid out before any dividend for the company’s common stock is determined. The dividend may be a set percentage or may be tied to a particular benchmark interest rate. The dividend is generally paid on a quarterly or annual basis.

## Calculating Preferred Dividends

All issuances of preferred stock contain the [equity](https://www.investopedia.com/terms/e/equity.asp)’s dividend rate and par value in the preferred-stock [prospectus](https://www.investopedia.com/terms/p/prospectus.asp). The dividend rate multiplied by the par value equates to the total annual preferred dividend. If the total dividend to be received is paid out in installments, such as in quarters, the [issuer](https://www.investopedia.com/terms/i/issuer.asp) divides the total preferred dividend by the number of periods to get an approximate installment payment.

The [preferred dividend coverage ratio](https://www.investopedia.com/terms/p/preferreddividendcoverageratio.asp) is a measure of a company’s ability to pay the required amount that will be due to the owners of its preferred stock shares. Preferred stock shares come with a dividend that is set in advance and cannot be changed. A healthy company will have a high preferred dividend coverage ratio, indicating that it will have little difficulty in paying the preferred dividends it owes.

## Exploring Dividends in Arrears: Implications for Investors

A [business](https://www.investopedia.com/ask/answers/090415/are-dividends-considered-expense.asp) can choose not to pay dividends, but skipped preferred dividends build up and must be paid before common stockholders receive anything. All previously omitted dividends must be paid before any current-year dividends may be paid.

Preferred dividends accumulate and must be reported in a company’s financial statement. [Noncumulative](https://www.investopedia.com/terms/n/noncumulative.asp) preferred stock does not have this feature, and all preferred dividends in arrears may be disregarded.

## Additional Features of Preferred Dividends and Their Impact

Preferred stockholders typically get preferential treatment for dividends but may not share in excess earnings. Some have participation rights allowing higher dividends beyond the fixed rate, but most preferred stocks are nonparticipating.

[Callable preferred stock](https://www.investopedia.com/terms/c/callablepreferredstock.asp) results in higher preferred dividends, as investors are sacrificing long-term security. If the preferred stock is retired at the [call price](https://www.investopedia.com/terms/c/callprice.asp), future preferred dividends may be included in the repurchase. [Convertible preferred stock](https://www.investopedia.com/terms/c/convertiblepreferredstock.asp) has lower preferred dividends, as the investor receives the additional of converting the preferred stock to common stock.

## What Is a Benefit of Preferred Dividends?

One benefit of preferred stock is that it typically pays higher dividend rates than common stock of the same company. A company declares all future preferred dividend obligations in advance, so it must allocate funds for that purpose where they accumulate in arrears.  

## What Are Preferred Dividends Based on?

Preferred dividends are issued based on the par value and dividend rate of the preferred stock. While they are issued at a fixed rate based on their par value, this may be unfavorable in high inflation periods. This is because the fixed payment is based on a real rate of interest and is typically unadjusted for inflation.

## How Is Preferred Dividend Determined?

The dividend rate multiplied by the par value equals the total annual preferred dividend. If it is paid out in installments, such as in quarters, the issuer divides the total preferred dividend by the number of periods to get an approximate installment payment.

## The Bottom Line

Preferred dividends are paid before common dividends, giving preferred shareholders an added layer of protection. They are usually higher than common stock dividends and must also cover any unpaid amounts (dividends in arrears) before common shareholders are paid. These dividends are set in advance based on the share’s par value and dividend rate, which makes them less flexible during inflation. Investors may like preferred dividends because they offer steady income, but they do come with limited growth potential compared to common stock dividends.