Preferred Stock to Stockholder’s Equity
The term preferred stock to stockholder’s equity refers to a measure that allows the investor-analyst to understand if a company is favors preferred stockholders to holders of common stock. The preferred stock to stockholder’s equity ratio is may indicate control of earnings and dividends resides with preferred shareholders.
Preferred Stock to Stockholder’s Equity = Preferred Stock / Total Stockholder’s Equity
* The values for both preferred stock and stockholder’s equity can be found on the company’s balance sheet.
Capital structure and solvency measures allow the investor-analyst to understand the company’s ability to remain in business in the long term. This is usually assessed by examining the relationship between debt, equity and the proportions of different types of stock. Solvency is the ability to continue operating, which oftentimes depends on cash flow. One of the ways to understand the capital structure of a company is by calculating their retained earnings to stockholder’s equity ratio.
The preferred stock to stockholder’s equity ratio allows the investor-analyst to understand if a company’s stock issuing policy favors the holders of preferred shares. As the name implies, holders of preferred stock oftentimes have “preference” with respect to the payment of dividends as well as the payment of their original investment in the event of liquidation. For this reason, a relatively high ratio of preferred stock to total stockholder’s equity may be unpalatable to investors considering the purchase of common stock. When this ratio is high, the investor should carefully examine the exact rights bestowed upon holders of preferred stock since they can vary by company.
The manager of a large mutual fund would like to better understand Company ABC’s capital structure and whether or not the holders of preferred stock have a tight grip on the company. He’s already examined the rights granted holders of preferred shares and has a concern that they not only have preference with respect to the payment of dividends, but they are also offered protections in the event of liquidation. He asked his team to review the balance sheet of Company ABC’s most recent annual report and compare the company’s preferred stock to stockholder’s equity ratio to that of its peers. The team found the following: total stockholder’s equity $37,500,000 and preferred stock of $21,000,000. The preferred stock to stockholder’s equity ratio would then be:
= $16,125,000 / $37,500,000, or 43.0%
The analysts compared this value to an industry average, which they found was 18.7%. Given this finding, the mutual fund manager asked his team to evaluate a number of solvency metrics so they could make a more informed decision before purchasing the company’s common stock.