Definition
The term convertible preferred stock is used to describe one of several classes of preferred stock that can be issued by a company. To add to the marketability of this investment, convertible preferred stock provides the holder with the right to exchange this investment for shares of common stock.
Calculation
The number of shares of common stock received for each share of convertible preferred is known as the conversion ratio. Therefore, the conversion price is calculated as:
Conversion Price = Price of Preferred Shares / Conversion Ratio
Explanation
The ability to convert preferred stock to shares of common stock is typically granted on a certain date or after a predetermine timespan elapses. The price of convertible shares tends to move in step with the price of the company's common stock. If a company demonstrates through earnings, or other means, that it will prosper in the future, and its common stock rises, this is to the benefit of the preferred stockholder.
The convertible preferred stock has the additional advantage of preference with respect to dividends, as do all holders of preferred stock.
Example
Company Z's preferred shares of convertible stock were sold at a market price of $70 and a conversion ratio of 7. The break even conversion price is:
= $70 / 7, or $10 per share
When the price of Company Z's stock rises above $10 per share, then the conversion will be profitable for this investor.
Related Terms
- The financial accounting term preferred stock refers to a class of equities issued by corporations that contains special preferences, or features, that are not present in common stock. Preferred stock dividends are typically paid before those of common stocks; however, they usually don't have the voting rights common shareholders enjoy.
Moneyzine EditorSeptember 21st, 2023 - The financial accounting term par value is used to describe the stated, or printed, value of a security. Par values can be assigned to bonds as well as common and preferred stocks.Moneyzine EditorSeptember 20th, 2023
- The financial accounting term treasury stock refers to those shares of stock that have been issued by a company, and purchased, or reacquired, by that same company. Treasury stock appears in the owner's equity section of the company's balance sheet.Moneyzine EditorSeptember 21st, 2023
- The times preferred dividends earned measures a company's ability to meet its preferred dividend payments to shareholders. This financial ratio only requires two inputs, net income and the company's annual preferred dividends paid, both of which can be found on the company's income statement.Moneyzine EditorSeptember 21st, 2023
The term dilutive securities refers to financial instruments that are not in the form of common stock but can be converted to common stock. Examples of dilutive securities include convertible bonds and preferred stock, warrants and stock options.Moneyzine EditorJanuary 16th, 2024
The term cumulative preferred stock refers to securities containing a feature that requires the payment of passed dividends to preferred shareholders before providing common shareholders with a dividend payment. While it's possible for a company to issue noncumulative preferred stock, these securities would be considered unattractive to investors.Moneyzine EditorJanuary 12th, 2024- The term participating preferred stock refers to securities containing a feature that allows shareholders to receive an additional dividend if certain conditions are met. This additional dividend is typically linked to the payment of common stock dividends. When preferred stock contains this feature, the securities can be fully-participating or partially participating.Moneyzine EditorSeptember 20th, 2023
The term callable preferred stock refers to securities containing a feature that allows the issuer to redeem or call in the shares at its option. Callable preferred stock will specify the redemption price as well as a date after which the securities can be redeemed.Moneyzine EditorJanuary 10th, 2024
