Understanding Preferred Securities | PIMCO (2024)

FAQs

How to value preferred securities? ›

The value of preferred stock is equal to the present value (PV) of its periodic dividends (i.e. the cash flows to preferred shareholders), with a discount rate applied to factor in the risk of the preferred stock and the opportunity cost of capital.

Definition: Preferred stock is a special class of stock issued by a company that pays dividends. Preferred stock is more like a bond than true stock because the main appeal is dividend income. Most preferred stocks are limited in the total profit they can earn.

Consider a company is issuing a 7% preferred stock at a $1,000 par value. In turn, the investor would receive a $70 annual dividend, or $17.50 quarterly.

Preferred securities usually have long maturities or are perpetual with no maturity at all. There are two types of preferreds stock: cumulative and noncumulative. Noncumulative preferred stock does not repay unpaid or omitted dividends while cumulative preferred stock entitles investors to missed dividends.

They calculate the cost of preferred stock by dividing the annual preferred dividend by the market price per share.

Most securities are valued using some variation of the Discounted Cash Flow (DCF) method. The DCF method approach states that the price of a security is equal to the present discounted value of all cash flows generated by the security in the future.

Preferred stock is equity. Just like common stock, its shares represent an ownership stake in a company. However, preferred stock normally has a fixed dividend payout as well. That's why some call preferred stock a stock that acts like a bond.

Common stock tends to outperform bonds and preferred shares. It is also the type of stock that provides the biggest potential for long-term gains. If a company does well, the value of a common stock can go up.

Among the downsides of preferred shares, unlike common stockholders, preferred stockholders typically have no voting rights. And although preferred stocks offer greater price stability – a bond-like feature – they don't have a claim on residual profits.

What are the best preferred stocks to buy? ›

Preferreds are issued with a fixed par value and pay dividends based on a percentage of that par, usually at a fixed rate. Just like bonds, which also make fixed payments, the market value of preferred shares is sensitive to changes in interest rates. If interest rates rise, the value of the preferred shares falls.

If preferred stocks have a fixed dividend, then we can calculate the value by discounting each of these payments to the present day. This fixed dividend is not guaranteed in common shares. If you take these payments and calculate the sum of the present values into perpetuity, you will find the value of the stock.

Like common stocks, a preferred stock gives you a piece of ownership of a company. And like bonds, you get a steady stream of income in the form of dividend payments (also known as preferred dividends). In terms of risk, preferred stocks are riskier than bonds, but a little less risky than common stocks.

Earnings Multiple - This method involves calculating the earnings per share of the company and multiplying it by a price-to-earnings (P/E) ratio. The value of preference shares is then calculated based on their proportionate share of the earnings.

First, find the equity by subtracting liabilities from assets. Next, find the preferred equity by dividing total liabilities by total shares outstanding. Finally, divide the equity by the preferred equity to find the book value per share.

The different variables to be considered in calculating the cost of preferred stock include: Par Value is the value at which the stock is issued. Dividend is the percentage of par value paid out as dividends. Market value is the current trading price of the preferred stock.