Preferred Dividend Coverage Ratio

The preferred dividend coverage ratio is a coverage ratio that measures a company's ability to pay off its required preferred dividend payments. Preferred dividend payments are the scheduled dividend payments that are required to be paid on the company's preferred stock shares. Unlike common stock shares, the dividend payments for preferred stock are set in advance and cannot be changed from quarter to quarter. The company is required to pay them. A healthy company will have a high coverage ratio, indicating that it has little difficulty in paying off its preferred dividend requirements. A company with less financial health will have a lower coverage ratio, indicating they have fewer funds on hand to make the required dividend payments. Since preferred stock dividends are paid out before common stock dividends are determined, a falling preferred dividend payout ratio may indicate a company could be inclined to reduce its common stock dividend in the future.

The formula for the preferred dividend coverage ratio is:

The preferred dividend coverage ratio not only gives investors an idea of a company's ability to pay off its preferred dividend requirements, but it also gives common shareholders an idea of how likely they are to be paid dividends. Preferred dividends are paid out of net income before money is allocated for common share dividends. If the company has a hard time covering its preferred dividend requirements, common shareholders are less likely to receive a dividend payment on their holdings. The preferred dividend coverage ratio can be reduced if the company issues more shares of preferred stock or if the company's net income falls. Net income is computed by subtracting total expenses from total revenues and can be reduced if revenues fall or if expenses increase.