What is Cumulative Preferred Stock?
Cumulative preferred stock is a type of preferred stock that requires that if you fail to pay dividends in the past, you must first pay dividends to your cumulative preferred shareholders. This is before other classes of preferred and common shareholders receive dividends. Cumulative preferred stock is also known as cumulative preferred stock.
Cumulative preferred stock
- Cumulative preferred stock is a type of preferred stock that requires the company to pay cumulative preferred stock all dividends, including those previously missed.
- Shareholders in this class are to be paid before other classes of preferred and common stock shareholders.
- Cumulative preferred stock is in contrast to non-cumulative preferred stock for which no omitted or unpaid dividends are issued. If there are no dividends in a particular quarter or year, shareholders simply miss.
Understand cumulative preferred stock
Cumulative preferred stock is a type of preferred stock. Preferred stock typically has a fixed dividend yield based on the par value of the stock. This dividend is paid to preferred holders at regular intervals, usually quarterly. Preferred stock is valued in the same way as bonds. Bond income is considered a liability and preferred stock income is counted as an asset. Bondholders also claim priority over the company’s assets.
Cumulative preferred stock is a type of preferred stock. Others include non-cumulative preferred stock, participating preferred stock and convertible preferred stock.
Unpaid and cumulative preferred stock
If a company faces financial problems and fails to meet all its obligations, it may stop paying dividends and focus on paying business-specific costs and debt. If the company overcomes the trouble and begins to pay dividends again, the standard preferred stock shareholders are not entitled to receive the missed dividends. These standard preferred stocks are sometimes referred to as non-cumulative preferred stocks.
In contrast, holders of cumulative preferred stock receive all dividends in arrears before the preferred shareholders receive payment. Basically, ordinary shareholders have to wait until all cumulative preferred dividends have been paid before receiving the dividend again. For this reason, cumulative preferred stock often pays less than non-cumulative preferred stock, which is slightly more risky.
Example of cumulative preferred stock structure
For example, a company issues cumulative preferred stock with a par value of $ 10,000 and an annual payment rate of 6%. The economy will slow down. The company can only afford to pay half of its dividend, and cumulative preferred stockholders have a debt of $ 300 per share. The following year, the economy worsens and the company can no longer pay dividends at all. Shareholders will then have to pay $ 900 per share.
In the third year, the economy is booming and the company can resume dividends. Cumulative preferred stock shareholders are required to pay a $ 900 delinquency charge in addition to the current $ 600 dividend. When all cumulative shareholders receive a payment of $ 1,500 per share, the company may consider paying dividends to other classes of shareholders.
Risk Factors for Cumulative Preferred Stock
Cumulative preferred stock can typically be offered at a lower payment rate than required for non-cumulative preferred stock because the cumulative function reduces the risk of dividends to investors. Due to this low cost of capital, the preferred stock of most companies is issued in a cumulative function. In general, only good companies with a strong dividend history can issue non-cumulative preferred stock without increasing the cost of capital.