In a previous post, we discussed the qualitative aspects of preferred stocks. we have understood what it is and how it is deferred from Common Stocks along with explaining different kinds of preferred stock there in the market. It includes the advantages, disadvantages, and risks of investing in preferred stocks. But now we are going to go to the Practical aspect. Through this post, you will understand the essentialities of investing in preferred stocks and how it differs from Common Stocks, in a practical manner by citing proper examples.
PREFERRED VS COMMON STOCK: QUALITATIVE COMPARISON YOU SHOULD KNOW
We are going to discuss the preferred stock investment based on the assumption that we have invested in the preferred stock and common stock of a company simultaneously at a time earlier. And thereby we will calculate how much profit we got after a specific time interval on both the common and preferred stocks. This makes us easier to analyze, compare, and understand the deeper sense which is enough to take decisions on investing wisely.
Pay attention: We have no affiliate or anything to do with the companies we are taking as examples. we are choosing companies randomly and studying them only for educational purposes. We are not forcing or giving false information about the company to the readers that will harm the company or related persons.
In the previous post, we compared, at the last session, Wells Fargo & Co‘s common stocks WFC and preferred stock WFC-PR value change and dividend payout history on a 1-year and 10-year basis respectively.
Now, let us assume that we had 200000 USD in hand in the year 2014 for investing in the stock market. We chose WFC (common stock) and WFC-PR (preferred stock) to invest in. So we split our entire 200K dollars into two and put each 100K dollars for buying WFC stock at $45.340 per share and WFC-PR at $26.310 per share (the closing price on 1st January 2014 of both the stocks).
So as per calculation,
Number of WFC stocks bought = 100000/45.340 = 2205 stocks
This means the total investment here in WFC is $99974.7 (ie 2205*45.340)
number of WFC-PR stocks bought = 100000/26.310 = 3800 stocks
This means the total investment here in WFC-PR is $99978 (ie 3800×26.310)
Time went by and we found 1st January 2023 the time to sell all the stocks. For almost 9 years we took possession of our WFC and WFC-PR stocks and this is the time to account for the capital appreciation.
WFC is now (1 Jan 2023) at a value of $46.870
capital appreciation of a share = $46.870 – $45.340 = $1.530
So in the form of Capital appreciation, WFC gave you a profit of 1.530 * 2205 = $3373.65
Always remember this fact: dividend stocks will not show dramatic growth (capital appreciation) to your money as other stocks. the companies that have covered their growth phase generally pay dividends as they need not use all their profit for further research and other activities like the growing companies do. This is why we say dividend investors are those people whose aim is to create frequent income from the stock market rather than good returns. we have created a dedicated post on the topic “Is dividend investing a good strategy“. click here to go quickly to the article.
Now let’s consider the dividends of WFC stock.
Here’s the table showing the dividend payout history of WFC from the time we are eligible for getting dividends to the time we got the last dividend.
We can see here that the common stock’s dividend is not the same year. It fluctuates according to corporate conditions. As we bought the stock on 01/01/2014, we are eligible to get the first dividend on 03/01/2014 (because the ex-dividend date, as you can see, is after when we bought the stock).
The following table will give you the data on the total amount we could able to acquire collectively from all the dividend payouts.
Oh great, we got an overall amount of $27253.8 from dividends only. this is way more than the capital appreciation we got.
So as a sum total (from dividend and return), we got a profit of $27253.8 + $3373.65 = $30627.45
It’s time to pay attention to WFC-PR stock (the preferred stock). We know that the price value of preferred stocks is based on the par value and it doesn’t show as many dramatic fluctuations in the graph as the common stocks do. from the chart I’ve given early, it’s crystally clear. look
On 1 Jan 2023, the day we sell the common stock / called up the preferred stock, WFC-PR is at a value of $25.260
Then the capital appreciation per share becomes 25.260 – 26.310 = – $1.050
This is a loss. This would cause us to feel the pain of the overall loss of 1.050 * 3800 = $3990. The loss seems to be greater than the profit we booked from the common stock.
Time for the dividend analysis(the true power of preferred stocks). Here’s the table which shows the WFC-PR dividend payout data:
The table shows the dividend history of the WFC-PR stock on our eligible time interval. The dividend amount is the same (fixed) all over the time (except the first time) even at the time when the company is forced to reduce the dividend amount of the common stockholders, they hooked with the fixed dividend for preferred shareholders.
On calculating the average dividend paid by the common stock, we get it to be lesser than the fixed amount of 0.4141 USD given by the preferred stock.
Let us now calculate the overall income we got through dividends.
Whoa! It’s an incredible profit when compared to the common stock’s (WFC) overall dividend income.
From the common stock’s dividends, it was just only $27253.8. Here from the preferred stock, we got $56596.44 which is $29342.64 more (more than double!).
So the overall profit on investing in the preferred stock (WFC-PR) is $56596.44 – $3990 = $52606.44
|NO. OF YEARS
|NUMBER OF STOCKS
|– $3990 (LOSS)
What we got from this entire example is that the overall profit we got from the preferred stock is way greater than the common stock though we faced a loss in the return (capital appreciation). This is just the case of the American financial company Wells Fargo & Co. We can’t assume the same on all the stocks but most generally yeah. There may be companies there that show a profit in return on preferreds and likewise gives almost constant dividends for common stockholders too.
But what made this large difference in the overall profit is not mostly because of dividends or capital growth. But it’s the very fact that we can buy more preferred stocks than common stocks with the same amount as preferred stocks are based upon the company’s par value. Not the higher market value.
When the company’s board of directors thinks to give let’s say 0.5 dollars per share for both the common and preferred holders, our preferred stock gives us more income as there are more stocks.
Let me illustrate the fact: we have an overall 2205 stocks and 3800 stocks respectively as common and preferred. We needed to spend almost the same money to buy these stocks. As the company gives $0.5 per share to both the categories, we get 2205×0.5 = $1102.5 from common stock and 3800×0.5 = $1900 from preferred stock. This accounts mostly for our greater profit in preferred stock investing.
Now you most probably may be asking what if the growth of the common stock was so great that the capital appreciation was too greater than the overall dividend amount?
Wonderful question. We all know that the preferred stock will not show a greater return (capital appreciation) than the common stock. It is evident from the chart itself that the fluctuations are really low in the preferreds’ chart on comparison. But you are forgetting the reality that Dividend stocks(dividend-providing stocks) will not show greater returns as the other stocks do. Still confused? Go check this post out
Also, small fluctuations can give us good returns in preferred stocks because we have more shares than we could have been able to buy at common stock with the same money.
As a conclusion, I would like to say that if you want to go with low-risk and frequent, stable income from the market, preferred stocks can help you a lot (maybe greater than common stocks). It’s all about your need and perspectives along with your strategies. This post did give you nothing new knowledge but we have exposed the unseen reality. Something kept unnoticed by most people. Anyway, diversification of investment is referred to as a good trait of an intelligent investor. Be smart and rock your life with financial intelligence. All the best from Marketnasium.com
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