 Personal Finance PowerPoint Presentation, Perpetual Preferred Stock, prepared to get financially fit by practicing personal finance. Most of this information comes from Investopedia Perpetual Preferred Stock, which you can find online. Take a look at the references, resources, continue your research from there. This is by Eklish Ganti, updated June 3rd, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investment, fixed income, typically bonds, equities, typically stocks. We're now looking at the Perpetual Preferred Stock. If we first think about what Preferred Stock is, it falls into the equity side of things technically, but it works functionally as kind of in-between in some ways, the fixed income and the equity side. So quick recap then. What is the fixed income? What is a bond? For example, we could think of a bond in essence as us loaning money to the issuer of the bond, like a corporation or a government entity in return for fixed income in the form of interest payments, typically as well as the maturity payment that we're going to receive at the end, the face amount at maturity at the end. Those then are going to be those fixed interest payments that we can depend on a company or a government that issues the bond cannot not pay those interest payments without getting in trouble because they would have to default on the bond if they were to do so. If we look at the equity, if we think about common stock, not preferred stock, but first common stock, that's going to be an ownership interest in the company. So a company, separate legal entity, breaking out ownership into equal units called stocks. Stocks that we're interested in are often traded because they're publicly traded stocks, or publicly traded company trading on an exchange, giving us easy access to trading those stocks. So that's the stock side of things. If we just take a look at the preferred stock, then it has some benefits to it. We're not looking at the perpetual. We're going to tack on the perpetual, but first the preferred stock generally is on the equity side of things technically, however, and the reason it's preferred is because you could get paid the dividends before the common stocks. And because if you liquidated the company, they went out of business or bankrupt, the preferred stock would get paid generally before the common stock, although they would be paid after the bonds. That's what makes it kind of in the middle in nature. It doesn't make it better than common stock, but it has a different kind of structure to it. Okay, so keeping that in mind, what is perpetual preferred stock? A perpetual preferred stock is a type of preferred stock that pays a fixed dividend to investors for as long as the company remains in business. It does not have a maturity nor a specific payback date, but does typically have redemption features. Now note when you're looking at the dividend payments for the preferred stock, it's usually going to be dependent on the structure of the preferred stock structured more as kind of like a fixed income type of payment that has less capacity for the corporation, for example, to be determining whether or not they're going to be paying it, or there's going to be limitations in terms of whether or not they can decide not to pay, say, a preferred stock, whereas on the common stock side of things, they could decide not to pay the common stocks if they so choose and put the money back into the company to try to basically grow the company. So that dividends represent the payment of the earnings of the company to the owners, those being the equity investors, common stock and preferred stockholders. It's similar to a draw if you were to think about a partnership or a sole proprietorship where we make money in those entities and then we draw it out for our personal use. We don't have the same kind of draw system for companies because one stockholder cannot draw out money different from another stock. The two stocks need to be the same and therefore we got to have the same distributions per stock. Therefore, we have the dividends determined not by the stockholders directly at least, but instead by the company, the board of directors and the management of the company. So the preferred stock's a little bit similar to the bonds because it's more of a fixed kind of payment. However, on the bond side of things, it's definitely fixed and determined because it's going to be on the bond, how much interest you're going to get and if they don't pay you on the bond, it's going to be a stricter type of thing because they will default on the contract of the bond if they were not to pay the interest and that would be very bad. There's a little bit more flexibility on the preferred stock, typically. Now, we also have this concept here that they're going to be paying the dividends for the life of the business. So that's also different to the bonds because the bonds have a maturity date. So the bonds are issued. You're going to get interest payments for some time frame until the bond matures and then you get the maturity and value of the bond. If the preferred stock, you're going to get more fixed payments which are similar to the interest payments on the bond, but you don't have that same maturity date and the maturity value. They could just go on forever. So if you're trying to value how much the bond is worth and how much the preferred stock is worth, one way to do that is to try to take the future cash flows and present value them with the bonds. You could do that by taking the present value of the interest payments and the maturity principle. With the preferred stock, it's a little bit tricky because the payments could go on indefinitely in theory if the company was to stay in business indefinitely. So you got to make some assumptions in that case. Okay, unless redeemed, issued perpetual preferred stock will thus pay dividends indefinitely provided the issuer is still extent, is still existent. So these shares often trade on stock exchanges similar to common stock, understanding perpetual preferred stock. There are two types of preferred stock, perpetual and non-perpetual. Perpetual preferred stock does not have an expiration date and pays the investor a fixed dividend for as long as the issuing company is in existence. The company does, however, hold the right to buy back the stock at any time under specific terms defined in the prospectus. The buyback period is basically a call feature that is commonplace in the bond market. So if they have the capacity to buy it back, that's going to be a benefit to the issuer because then given market conditions they could exercise that on their side. Companies buy back perpetual preferred shares for several reasons. Most notably changes in interest rates and tax laws. Investors must bear this in mind because losing their shares to a redemption means they will suddenly lose an income stream. So they're going to get paid for it, possibly whatever the price is, but they lose that future income stream which is why they invested in it. So if interest rates fall below the yield paid to stockholders, for example, the company would most likely buy back the outstanding perpetual preferred stock. As a result, the investors would not be able to reinvest their money and receive the same dividend rate that had been instrumental in their receiving a steady income stream. In other words, the company is going to obviously exercise the right if they have the capacity to buy it back when they want to basically refinance because there's been rate changes in the market and they think they can finance at better rates. Which means that the money you're going to get, we won't be able to find the same rates that we got before because now that the market rates have changed at that point so we probably won't be able to find an investment at the same rates that we had when we originally invested in the preferred stock. So though not exactly identical, a perpetual preferred stock has characteristics that are similar to a bond with an extremely long maturity date. So you can kind of think of the perpetual preferred stock as a stream of payments that you're going to be getting similar to interest payments on the bond. But they don't have a maturity date, you can kind of imagine them going on forever and that's how you might try to value basically the preferred stock by present valuing those. Obviously, if you go on way out into the future, the payments that you're going to be getting are going to be really small in terms of present value amounts. So you can still kind of present value them at a reasonable price using that kind of method, present value in the current, the future stream of payments. Pricing perpetual preferred shares, since in theory perpetual preferred stock can exist indefinitely, indefinitely, so too must the dividend payments. Hence, to price these, one would calculate the present value, PV, of a perpetual perpetuity which is the fixed dividend amount divided by the dividend yield. So we got the perpetual preferred stock price is equal to the fixed dividend divided by the dividend yield. A non-perpetual preferred stock will have a stated buyback price and buyback date, usually 30 or more years from the date of issue. So it also has a defined maturity date and therefore has more certainty regarding cash flows. Preferred stock versus bonds, the matchup. Investors put their money in preferred stock because it combines the ease and trading benefits of stocks with the fixed income benefits of bonds. Holders of all types of preferred stock receive priority over common stock shareholders, meaning they have to get paid first with regard to the payments of the dividends and if there was liquidation. This preference is significant when it comes to the payment of dividends and voluntary liquidation of assets but is essential in bankruptcy. During a bankruptcy, preferred stockholders receive first shot at the company's asset liquidation so if they go out of business in essence. Preferred stock offer great protection than common stocks in this situation. It doesn't mean common stocks are better or worse, it just means because the common stock has benefits as well they're typically going to be good in good times if things go quite well, your valuation of your common stocks might outpace the preferred stock most likely. However, unlike common stock investors in preferred stocks do not get a direct benefit from increases in the company's earnings. So if things go well, then and they boom, you would rather be on the common stock side of things because you're going to hit more benefit in that case. So they are only entitled to the dividend in force when they purchase their shares. As an example, an investor buys a preferred stock when the dividend payment is $10 per year. The company later raises that payment to $15 per year. The holder of the preferred shares gets only $10 dividends, but the common shareholder will receive the higher dividend. Companies can issue bonds of preferred stock for many reasons. It is important to consider whether the company's balance sheet is already loaded with debt before buying either one. Adding more debt might risk a credit downgrade or a problem with regulators. Unlike corporations, individuals get no tax benefit from owning a preferred stock, but preferred shares likely offer higher yields than an equivalent bond. There are certain risks to consider before buying preferred shares. Indeed, a good deal of preferred stock is issued by companies with lower credit ratings. Also, the board of directors can vote to suspend the dividend payments when the preferred shareholders cannot sue them.