The preferred Dividend Coverage ratio is used to calculate the ability of the company to pay the dividend to its preferred shareholders based on the net income of the company.
In other words, this ratio is used by the investors to find the efficiency of the company by comparing profit to the preferred dividend. For the payment of a dividend if the company has sufficient profit then the company has good performance.
Definition: What is the preferred dividend coverage ratio?
Are you looking for a Preferred dividend coverage ratio meaning? This ratio is also the name of times preferred dividend earned ratio. It looks at the net income of the company to analyze that this income is sufficient to meet the fixed dividend payable amount on its outstanding preferred shares or not. For the evaluation of the financial health of the company this ratio is useful for current and potential shareholders and also for debt holders.
This ratio is mostly used by the creditors and banks to find how much additional debt the company can handle. This ratio could affect the common stock dividend that’s why common stock shareholders need to be aware of this.
In the ideal condition, the company has more profit to cover the dividend payment of the company. But in the practical, they’re maybe not in the same condition as in ideal. When the coverage of the company is 1 then the company have more profit to meet its preferred dividend obligation. If the coverage ratio is less than 1 then the company has not enough profit to meet its preferred dividend obligation.
The formula of preferred dividend coverage ratio
The preferred dividend coverage (PDC) ratio formula can be calculated by dividing the total profit or net income by the annual preferred dividend amount.
Preferred dividend coverage ratio = net income/annual preferred dividend
The above result for PDC is on the annual basis. PDC ratio can be calculated quarterly. For the quarter bases calculation of PDC, we need to divide the result of PDC by 4.
Examples of PDC ratio Formula
Now we take the preferred dividend coverage ratio example of Lee’s company A. The net income of his company is 20M dollars. Preferred issued for the total par value of 10,000,000 dollars at 5%. The preferred dividend coverage ratio for this company calculated as
40 times = $20,000,000/($10,000,000 x 0.05)
From the above result, it is clear that the financial health of the company of Lee is very good. Because with his profit he can cover 40 times their annual preferred dividend obligations.
Analysis and Interpretation of Preferred dividend coverage ratio
The number shows if the company make a sufficient amount of income to cover its obligations. If we take the example of the owner of the home. Net income of the homeowner supporting his mortgage payment every month. To meet his mortgage obligation if he spent most of his money, then a small change in the net income can’t make the mortgage payment for the homeowner.
Just like the homeowner it same for the company. The company which issued preferred stock and make enough to cover its preferred dividend payment, can not pay a dividend to the common shareholder.