Fixed dividends

Definition

Fixed dividends are predetermined payments made to shareholders, typically associated with preferred stock, which do not fluctuate with the company's earnings. These dividends provide a reliable income stream for investors and are paid out before any dividends are distributed to common shareholders. This characteristic underscores the preference of preferred stockholders in receiving their returns, especially during financial downturns when common stock dividends may be suspended.

5 Must Know Facts For Your Next Test

1. Fixed dividends are typically expressed as a percentage of the par value of the preferred stock and are paid out at regular intervals, often quarterly.
2. Preferred stock with fixed dividends often has seniority over common stock in the event of company liquidation, providing additional security to investors.
3. In times of economic distress, companies may choose to suspend common stock dividends while maintaining fixed dividend payments to preferred shareholders.
4. The ability of a company to pay fixed dividends can be impacted by its cash flow situation and overall financial health.
5. Investors often prefer fixed dividend stocks for their predictable income and lower risk compared to common stocks, especially in volatile markets.

Review Questions

• How do fixed dividends influence the investment decisions of potential shareholders?
  • Fixed dividends play a significant role in attracting investors who seek stability and predictable returns. Potential shareholders might prefer preferred stocks with fixed dividends because these payments are guaranteed before any payouts to common shareholders. This reliability becomes particularly appealing during uncertain economic times when income stability is a priority for investors. The assurance of fixed payments can lead to a more attractive risk-reward profile compared to common stocks that may offer more variable returns.
• Discuss the implications of fixed dividends on a company's financial strategy and capital allocation.
  • The obligation to pay fixed dividends can affect a company's financial strategy by requiring careful capital allocation. Companies must ensure they have sufficient cash flow to meet these obligations before distributing any profits to common shareholders or reinvesting in the business. This requirement can limit a company's flexibility during periods of lower earnings, forcing it to prioritize these payments over growth opportunities. Additionally, if a company consistently meets its fixed dividend obligations, it may enhance its reputation and attract more investors looking for stable income.
• Evaluate the risks and benefits associated with investing in fixed dividend preferred stocks compared to common stocks.
  • Investing in fixed dividend preferred stocks comes with both risks and benefits that differ from those associated with common stocks. The primary benefit is the reliability of income through consistent dividend payments, which can offer security in volatile markets. However, risks include the lack of voting rights and potential losses if the company faces bankruptcy, as preferred shareholders may still receive less than what they invested. In contrast, common stocks may provide greater capital appreciation potential but come with higher volatility and uncertainty regarding dividend payouts, particularly in adverse economic conditions.

Related terms

preferred stock:

A class of stock that provides its holders with a fixed dividend before any dividends are paid to common stockholders, often without voting rights.

dividend yield:

A financial ratio that shows how much a company pays out in dividends each year relative to its stock price, expressed as a percentage.

cumulative dividends: Dividends that accumulate on preferred shares if they are not paid in a given year, ensuring that preferred stockholders receive all owed payments before common stockholders receive anything.