Preferred stocks can be valued using the dividend discount model, as they usually pay a fixed dividend. Since preferred stocks have indefinite maturity, the DDM can be represented as:
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Let’s say that a company has issued $100 par preferred stock, and pays an annual dividend of $6. The required return is 9%. The value of the preferred stock will be:
V = $6/0.09 = $66.67
The above calculation assumes that the preferred stock has indefinite maturity.
Let’s say that stock has a maturity of 2 years. The value will now be calculated as follows:
V = $6/(1.09) + $6/(1.09)^2 + $100/(1.09)^2 = $94.72
The above calculations are for a plain vanilla preferred stock. Some preferred stocks have features such as convertible, callable, etc. With those features, the valuation will need to be adjusted according to the price of these features.
