CHAPTER 15

Preferred Securities, Dividends, and Returns to Berkshire Hathaway

Let’s now discuss preferred securities and properly model out the preferred dividends so we can calculate returns to Berkshire Hathaway.

PREFERRED SECURITIES

Preferred securities (also known as “preferreds” or “preferred stock”) are financing instruments that are senior to common stock but subordinate to bonds in terms of claim.

The following features are usually associated with preferred stock:

  • Preference in dividends. Preferreds generally issue a dividend paid out before dividends to common stockholders.
  • Preference in assets. In the event of liquidation, preferreds are senior to common stock but subordinate to bonds.
  • Convertibility to common stock. Preferred securities may come with an equity component.
  • Callability at the option of the corporation. Preferreds may come with the rights to call on the securities.
  • Nonvoting. Quite often these securities do not have voting rights.

The precise details of the structure of preferred stock can differ from security to security. However, the best way to think of preferred stock is as a hybrid between debt and equity. The dividends associated with the security can be considered equivalent to the benefits of interest (debt), and the ability to convert the security to equity can give the upside potential of an equity security.

For the most part, preferred securities do not come with a tax advantage for corporations. Preferreds pay fixed dividends with after-tax ...

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