Various factors affect the market price of preferred stock of a corporation. Here, we are going to discuss four major factors. These are:
- dividend rates,
- payment or nonpayment of dividends,
- level of interest rates, and
- conversion into common stock
(1) Dividend rate:
The dividend on preferred stock is usually paid at fixed rate. This rate has a direct impact on the market price of preferred stock because most of the investors buy preferred stock to receive dividends on continuous basis. The higher dividend rate is a signal of higher return on investment (ROI) and investors would be willing to pay more to acquire preferred stock.
(2) Payment or nonpayment of dividends:
The payment of dividends depends on the profitability of the company. If investors expect a good profitability position of the company in future, they will expect a regular dividend income and the market price of the preferred stock will rise. On the other hand, if future profitability position of the company is estimated to be weak, the market price of its preferred stock will fall.
(3) The level of interest rates:
There is an inverse relation between interest rates and the market price of preferred stock. A rise in interest rates lowers the market price of preferred stock and vice versa. For example, if the dividend on $100 par value preferred stock of a company is 6% whereas the interest rate on debt securities prevailing in the market is %10, the investors looking for a continuous stream of passive income will certainly go for buying the debt securities.
(4) Conversion into common stock:
If a preferred stock has the conversion feature attached, its holders would be able to convert their preferred stock into common stock. This feature can increase the value of the preferred stock in the eyes of both actual and potential investors because they will have the opportunity to become the real owners of the company in future.
A wise investor do not use a single but a combination of factors to decide whether or not to buy the preferred stock of a particular company.
The rate of return and the level of risk:
Do investors only compare the rate of return on one investment with another? No they also compare the level of risk involved in one investment with another.