F1 CAPITAL - PREFERRED STOCKS

What is Preferred Stock?

A type of ownership in a company Combines features of common stock and bonds Called “preferred” because shareholders get special privileges

Characteristics of Preferred Stock

1.Fixed Dividends
2. Priority in Dividends
3. Preference in Assets
4. No Voting Rights
5. Convertible Feature
6. Callable Feature
7. Cumulative Dividends

it refers to the process of determining the present value of the future dividends that a preferred stock is expected to pay, assuming those dividends are fixed and continue indefinitely. It is calculated by dividing the Annual Dvidend over the Required Rate of Return.

VALUATION OF PREFERRED STOCKS

Types of Preferred Stock Valuation

• DIVIDEND DISCOUNT MODEL

• YIELD-TO-CALL

the dividend discount model is a method of valuing the price of a company's capital stock or business value based on the assertion that intrinsic value is determined by the sum of future cash flows from dividend payments to shareholders, discounted back to their present value

DIVIDEND DISCOUNT MODEL

a calculation of the potential return on a callable bond if it is redeemed by the issuer before its maturity date.

YIELD-TO-CALL

ANALYSIS OF PREFERRED STOCKS

The goal of analyzing preferred stocks is to determine whether a particular issue is a good investment based on:

Income stability (dividends), Financial strength of the issuer, Risk exposure, and Market sensitivity to economic factors such as interest rate changes

Key Factors in the Analysis of Preferred Stocks

• Dividend Yield and Rate of Return

• Credit Quality and Risk

• Call and Conversion Features

• Interest Rate Sensitivity

Indicates how much income an investor receives relative to the market price.

Dividend Yield and Rate of Return

Evaluates the company’s ability to sustain dividend payments and meet obligations.

Credit Quality and Risk

Callable preferreds: The company can buy back shares at a fixed price, limiting investors’ potential long-term gains.

Convertible preferreds: Can be converted into common shares, allowing investors to benefit from stock price appreciation.

Call and Conversion Features

Preferred stock prices generally decline when interest rates rise, and increase when rates fall.

Interest Rate Sensitivity

How to Interpret the Analysis

High Yield → Higher Risk (less stable issuers) Stable Yield → Stronger Financial Position (creditworthy issuers)

Compare performance to market rates and bond yields for insight.

ADVANTAGES

Higher claims on assets

Stable dividend payments

Convertible shares

Preferred shareholders have priority over common shareholders in claims on company assets during bankruptcy and liquidation, making preferred shares appealing to conservative investors seeking downside risk protection.

Higher claims on assets

Preferred stocks typically pay fixed dividends, providing a predictable income stream. This stability is especially valuable for institutions keen on consistent returns, which provide a stable stream of income for investors.

Stable dividend payments

Convertible preference shares can be exchanged for common shares, offering potential gains if common shares rise, while participating shares allow investors to earn extra dividends beyond the fixed rate if the company hits set profit goals.

Convertible shares

DISADVANTAGES

No voting rights

Limited upside potential

Preferred shareholders lack voting rights and may see the value of their fixed dividends decline if interest rates rise, potentially making other fixed-income investments more attractive. This could cause buyer’s remorse with preference shareholder investors, who may realize that they would have fared better with higher interest fixed-income securities.

No voting rights

Since there is a fixed dividend payment on preferred shares, it may not keep up with the pace of inflation and the price of preferred shares may not appreciate as much as the price of common shares if a company’s business grows.

Limited upside potential

Profit when stock price rises and investor sells at a higher price.

Capital Appreciation