How to Calculate a Required Return of a Preferred Stock

Preferred stockholders get dibs on dividend payments before common stockholders.

Preferred stockholders get dibs on dividend payments before common stockholders.

Required returns play a big role in driving securities prices in financial markets. This return represents the minimum annual percentage profit an investor will accept to own a particular security. While required returns differ among investors, you can calculate the market’s required return of a preferred stock to see how it views the stock. A preferred stock’s required return equals its annual dividend as a percentage of its price. Riskier preferred stocks typically have higher required returns than those with lower risk. In general, a preferred stock’s price falls when its required return rises and increases when its required return declines.

Download a company’s most recent Form 10-K annual report from the investor relations section of its website or from the U.S. Securities and Exchange Commission’s online EDGAR database.

Find its preferred stock’s annual dividend rate and par value per share on the balance sheet or in the financial statement footnotes in the annual report. For example, assume a company’s preferred stock has a par value per share of $60 and pays a 10 percent annual dividend.

Look up the price per share of the preferred stock on any financial website that provides stock quotes. In this example, assume the preferred stock trades for $65 per share.

Multiply the annual dividend rate by the par value per share to calculate the annual dividend. In this example, multiply 10 percent, or 0.1, by $60 to get a $6 annual dividend.

Divide the annual dividend by the price per share. Multiply your result by 100 to calculate the required return as a percentage. Concluding the example, divide $6 by $65 to get 0.092. Multiply 0.092 by 100 to get a 9.2 percent required rate of return on the preferred stock.

Tips

  • Compare the market’s required return for a preferred stock with your own required return. If your required return exceeds the market’s, the current price is too high for your investment needs.
  • Compare required returns among preferred stocks and among different investments to see which ones the market perceives as having higher risk.

Warning

  • A preferred stock’s required return and the actual return you would earn from it might differ. Although preferred dividends are typically fixed, a company can choose not to pay them, which would reduce your actual return.

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