How do you value preferred stock using the perpetuity model, and what drives preferred stock yields?

Preferred stock is a hybrid security — it has features of both equity and fixed income. For CFA Level I, the perpetuity model is the primary valuation approach.

The Perpetuity Model: Since preferred stock pays a fixed dividend indefinitely (no maturity date):

V_preferred = D_preferred / r

Where D_preferred is the annual preferred dividend and r is the required rate of return.

Example: Sterling Industries issues preferred stock with a $100 par value paying a 6% annual dividend. Investors require an 8% return.

V = $6.00 / 0.08 = **$75.00**

The preferred stock trades at a discount ($75 <$100 par) because the coupon rate (6%) is below the market's required return (8%).

What Drives Preferred Stock Prices?

Factor	Impact on Price	Explanation
Market interest rates rise	Price falls	Higher discount rate
Credit quality deteriorates	Price falls	Higher required return
Rates fall below coupon	Price rises (but may be called)	Lower discount rate
Call feature	Limits upside	Issuer redeems at par when rates fall

Callable Preferred Stock: If Sterling's preferred is callable at $102, and market rates drop to 4%:

• Theoretical value: $6 / 0.04 =$150
• But Sterling will call it at $102
• Market price will approach $102, not$150

Callable preferred stock has a price ceiling near the call price, which creates negative convexity — a concept you'll explore more deeply in CFA Level II fixed income.

Adjustable-Rate Preferred Stock (ARPS): The dividend rate resets periodically (e.g., quarterly) based on a benchmark rate. Because the dividend adjusts to market conditions, ARPS trades closer to par value and has lower price volatility than fixed-rate preferred.

Preferred vs. Common Stock:

• Preferred dividends are fixed and take priority over common dividends
• Preferred holders generally have no voting rights
• In liquidation, preferred claims come before common but after all debt
• Preferred dividends may be cumulative (missed dividends accumulate) or non-cumulative

Exam tip: The CFA Level I exam frequently presents a preferred stock with a par value, stated dividend rate, and required return, then asks for the intrinsic value. Remember: this is simply D/r. Watch for questions that test whether the preferred trades at a premium (coupon rate > required return) or discount (coupon rate < required return).

For more equity valuation practice, check our CFA Level I question bank on AcadiFi.