What it means
Preferred shares rank ahead of ordinary shares for dividends and, if the company fails, for repayment of capital, but behind creditors. Most pay a fixed dividend set as a percentage of the par value, which is the nominal amount printed on the share, often $25 or $100.
A perpetual issue simply has no end date. Because there is no maturity, the investor's return comes only from the dividends and from selling the shares to someone else.
The price in the market moves in the opposite direction to interest rates. If market rates rise, the fixed dividend looks less attractive and the price falls, and if rates fall the price rises.
Many perpetual issues are callable, meaning the company may redeem them at par after a set number of years. A company will usually exercise that right when it can replace the preferred shares with cheaper funding, which limits the investor's upside.
Others may be cumulative, meaning unpaid dividends build up and must be paid before ordinary shareholders receive anything. For the issuing company, perpetual preferred stock is a way to raise long-term capital without diluting the voting power of ordinary shareholders and without a repayment date to plan around.
Banks and insurers use it because regulators may count part of it as capital. The dividends are normally paid from after-tax profit, so unlike interest they do not reduce taxable income in many countries.
The nuance is that perpetual does not mean risk free. The dividend can be suspended if the company is in trouble, and the claim ranks below all debt.
A holder who needs to sell during a period of rising rates or credit worries may receive far less than they paid.
In practice
Real-world examples.
Example
A utility company needs long-term capital but does not want to issue more ordinary shares. It sells $200,000,000 of perpetual preferred stock at a fixed 5.5% dividend, which gives it permanent funding and keeps control with existing shareholders. Each year the company pays $11,000,000 in dividends, calculated as 200,000,000 x 0.055.
Example
A retired investor buys preferred shares of a regional bank at $25 each with a $1.50 annual dividend, a yield of 6%. She likes the steady income and accepts that the price will move with interest rates. She plans to hold the shares for the income rather than sell them.
Example
A bank treasurer issues perpetual preferred stock because her regulator allows part of it to count towards the bank's capital requirements. The bank pays a dividend instead of interest and has no maturity to refinance. This reduces the pressure on the bank's funding plan in a difficult market.
Formula
Calculation
Value of perpetual preferred stock = annual dividend / required yield
Suppose a share has a par value of $100 and pays a fixed dividend of 6%, which is 100 x 0.06 = $6 a year. If investors in the market now require a yield of 8%, the share is worth 6 / 0.08 = $75. If the required yield falls to 5%, the share is worth 6 / 0.05 = $120. The same $6 dividend is worth more or less depending on market rates.Case study
Seen in the real world.
Granite Insurance is an illustrative, fictional company that issued $50,000,000 of perpetual preferred stock, with a $25 par value and a 6% dividend. The dividend cost was 50,000,000 x 0.06 = $3,000,000 a year.
Three years later market yields on similar shares had risen to 8%, so the market value of a $25 share with a $1.50 dividend fell to 1.50 / 0.08 = $18.75. Investors who bought at $25 and sold then lost $6.25 per share, or 25%.
The shares were callable, but Granite did not call them because replacing the funding would have cost more. The illustrative lesson is that a fixed dividend with no end date makes the price sensitive to interest rates.
Watch out
Common mistakes.
- Assuming perpetual means the investor will get the original amount back, when the only return is the dividend stream or a sale price.
- Treating preferred dividends as a guaranteed obligation like interest, when the board can suspend them.
- Ignoring the call feature, which allows the company to redeem the shares when it suits the company.
Questions
People also ask.
How is perpetual preferred stock different from a bond?
A bond has a maturity date and is a debt owed to the holder, while perpetual preferred stock has no maturity and ranks below debt.
How is it different from ordinary shares?
Preferred shareholders receive a fixed dividend and are paid before ordinary shareholders, but they usually have no voting rights and limited upside.
What happens to the price when interest rates rise?
The price usually falls because the fixed dividend becomes less attractive compared with new investments offering a higher yield.
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