Question

Preferred stock valuation uses a constant dividend while common stock can receive dividends based on fixed growth or dividends based on earnings. Why is this statement true

Answer 1

Answer:

The statement is true that Preferred stock valuation uses a constant dividend in its valuation while common stock can receive dividends based on fixed growth or dividends based on earnings and not a constant dividend.

The reason is because preferred stock has a guaranteed dividend with a fixed income.  This fixed income can, therefore, be expressed as a fixed percentage, thereby making preferred stock a fixed income investment.

Explanation:

A preferred stock because of its fixed-income is similar to a bond.  A bond earns a fixed percentage of interest.  In the same way, a preferred stock earns a fixed percentage of dividend, though there are many variants under the preferred stock class.  It is also like equity stock in that the stockholders participate in profit distribution but lack voting powers unlike common stockholders.