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Question:

Ian Goode, CFA, is analyzing the price of the preferred stock of MegaGym. Goode estimates that MegaGym's earnings growth rate over the next five years will be 20%, and that MegaGym's earnings will then grow at a sustainable rate of 5%. The most appropriate method for Goode to value MegaGym's preferred stock is to:

A divide the preferred dividend by the required rate of return on MegaGym’s preferred stock.
Explaination

The value of preferred stock is the preferred dividend divided by the required rate of return on the preferred. Earnings growth rates do not factor into the valuation of preferred stock since the dividend is typically fixed. Therefore, neither a historical price-to-earnings model nor a multistage dividend discount model is appropriate.