Question

discuss how stock prices depend on future dividends and dividend growth. Also, discuss the difference between common and preferred stocks.

Answer 1

As per the dividend discount model, present value of a stock is sum of present value of its future dividends.

Fort a constant growth rate to perpetuity, price of a stock = D₀*(1+g)/(r-g), where r is discount rate and g is growth rate

So we can say that the price of a stock is directly proportional to future dividends and growth of dividends. i.e. Price of a stock increases with increase in future dividends and dividend growth.

Preferred stock has many similarity as well as many differences from stocks. Preferred stock is like ans ownership of a company similar to common stock whereas, preferred stock does not have any voting right but common stock has. Also, dividend is fixed in preferred stock but in common stock it is not, and preferred stock has a priority in company's earnings that is they are given dividends before the common stock. Also, in case of default preferred stock holders are given priority over the common stockholders i.e. common stockholders are paid after preferred stockholders who are paid after debt holder in case of liquidation of company's assets.