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Preferred Stock

Investing Lesson 4 - Analyzing an Income Statement

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preferred stock dividends

Unlike common stock dividends, which are not shown on the income statement, GAAP rules require preferred dividends to be deducted from net income to calculate net income applicable to common because they are like interest payments on debt.

Net Income
By this time, you should run into the net income figure on the income statement. This is the total after-tax profit the business made for the period before required dividend payments on the company's preferred stock.

Why can't we just stop here? It has to do with the nature of preferred stock. Regular cash dividends on common stock are not deducted from the income statement. In other words, if a company made $10 million in profit and paid $9 million in dividends, the income statement would show $10 million, the balance sheet $1 million, and the cash flow statement $9 million in dividends distributed. Preferred stock dividends, on the other hand, are more like debt. That's why many companies include them on the income statement and then report another net income figure known as "net income applicable to common", which you'll learn about on the next page.

Preferred Stock and Other Adjustments
Preferred stock is a mix between regular common stock and a bond. I explained everything a new investor should want to know in The Many Flavors of Preferred Stock.

Each share of preferred stock is normally paid a guaranteed, relatively high dividend and has first dibs over common stock at the company's assets in the event of bankruptcy. In exchange for the higher income and safety, preferred shareholders miss out on large potential capital gains (or losses). Owners of preferred stock generally do not have voting privileges.

The terms of preferred shares can vary widely, even when issued by the same company. Some of the many different kinds of preferred stock available are: adjustable rate preferred stock, convertible preferred stock, first preferred stock, participating preferred stock, participating convertible preferred stock, prior preferred stock, and second preferred stock.

The dividends paid to preferred shares are deducted from net income because they are required payments, unlike the common stock dividend which is just a divvying-up part of the profits.

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This page is part of Investing Lesson 4 - How to Read an Income Statement. To go back to the beginning, see the Table of Contents.

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