Cumulative Preferred Stock is a type of preferred stock where any unpaid dividends accumulate until they are paid out to the shareholders. This stock takes precedence over common stock dividends, meaning companies must pay any outstanding cumulative dividends before any common stock dividends.
Key Features of Cumulative Preferred Stock
- Dividend Accumulation: Unpaid dividends on cumulative preferred stocks carry over to future periods.
- Precedence over Common Stock: Holders of cumulative preferred stock receive dividends before common shareholders get any dividends.
- Fixed Dividend Rates: Cumulative preferred stocks typically have fixed dividend rates.
- Priority in Liquidation: In the event of liquidation, cumulative preferred shareholders have priority over common shareholders regarding asset claims.
Types of Preferred Stock
- Cumulative Preferred Stock:
- Ensures that missed dividend payments are accumulated.
- Beneficial for risk-averse investors seeking consistent returns.
- Non-Cumulative Preferred Stock:
- Unpaid dividends do not accumulate.
- Riskier since missed dividends are not compensated.
- Convertible Preferred Stock:
- Can be converted into a specified number of common shares.
- Offers the potential for capital appreciation.
- Participating Preferred Stock:
- Holders can receive extra dividends along with common shareholders if company profits allow.
Special Considerations
- Risk Mitigation: Cumulative preferred stocks provide a safety net for investors against missing out on dividends due to poor company performance.
- Callable Feature: Many cumulative preferred stocks can be called (redeemed) by the issuer at a predetermined price.
- Tax Treatment: Dividends received from preferred stocks might be eligible for preferential tax rates, depending on the jurisdiction.
Examples
- Company A has cumulative preferred stock with a $5 annual dividend. If Company A fails to pay dividends in Year 1, it owes $10 in Year 2 before paying any dividends to common shareholders.
- Company B issues cumulative preferred stock callable at $110, where dividends accumulate until the company redeems the stock at the call price.
Historical Context
The concept of cumulative preferred stock surfaced to attract conservative investors looking for steady income from their investments. These stocks became prevalent amongst shareholders who prioritize dividend reliability over potential capital gains.
Applicability of Cumulative Preferred Stock
Cumulative preferred stock is often utilized by:
- Companies requiring capital infusion: These companies offer attractive dividend terms to lure investors.
- Institutional Investors: Including pension funds and insurance companies, seeking predictable cash flows.
Comparisons
- Cumulative vs. Non-Cumulative Stock:
- Cumulative stock ensures accumulated dividend payments, while non-cumulative does not.
- Preferred Stock vs. Common Stock:
- Preferred stock, especially cumulative, provides more predictable income and higher claim in liquidation compared to common stock.
- Convertible vs. Non-Convertible Stock:
- Convertible stocks provide an option to convert to common stock benefiting from the company’s growth.
Related Terms
- Callable Preferred Stock: Preferred stock that can be redeemed by the issuer at a predetermined price and time.
- Dividend Yield: The dividend expressed as a percentage of the stock price.
- Par Value: The nominal value of the stock on which dividends are based.
FAQs about Cumulative Preferred Stock
Q: What happens if a company cannot pay dividends to cumulative preferred stockholders? A: The unpaid dividends accumulate and must be paid out before any dividends can be issued to common shareholders.
Q: Are cumulative preferred stock dividends guaranteed? A: The dividends accumulate but are not guaranteed to be paid within a specific timeframe if the company lacks the funds.
Q: Can cumulative preferred stock be converted to common stock? A: Not typically; however, some preferred stocks are convertible based on specific terms set by the issuing company.
Q: Are cumulative preferred stocks callable? A: Many cumulative preferred stocks come with a callable feature, allowing the issuer to redeem them at a specified price.
References
- Ross, S. A., Westerfield, R. W., & Jaffe, J. (2016). Corporate Finance. McGraw-Hill Education.
- “Preferred Stock.” Investopedia. Retrieved from Investopedia Website.
- “Cumulative Preferred Stock Defined.” Nasdaq. Retrieved from Nasdaq Website.
Summary
Cumulative Preferred Stock is a favored investment option for income-oriented investors seeking added security through accumulated dividend payments. These stocks not only assure dividends before common stocks but also present a relatively lower risk, making them an essential aspect of diversified investment portfolios. The halted accumulation of unpaid dividends and precedence in liquidation reinforce their attractiveness among conservative investors aiming for steady returns.
