What is Noncumulative Preferred Stock? Definition Meaning Example

by devteam | Apr 5, 2022 | Bookkeeping

The primary difference between non-cumulative and cumulative preferred stock is in their dividend payments. The primary disadvantage of non-cumulative preferred stock is the potential loss of missed dividends. You can see how the difference between cumulative and noncumulative preferred stock can have a big impact on value. The more troubled a company is financially, the greater value a cumulative preferred has over noncumulative preferred.

• Some types of preferred stock have a fixed end date in which, much like a bond, the original capital contributed is returned to shareholders.
• While the cumulative preferred stock has some advantages, there are a few things to keep in mind before you invest.
• Preferred shareholders have priority over common stockholders when it comes to dividends, which generally yield more than common stock and can be paid monthly or quarterly.
• (3) Ownership is held in the form of depositary shares each representing a 1/1000th interest in a share of preferred stock paying a quarterly cash dividend, if and when declared.
• Preferred stockholders have a higher claim to dividends or asset distribution than common stockholders.
• Noncumulative preferred shareholders offer a company a greater opportunity to manage its cash flow.
• Keep in mind that if the issuing company skips paying noncumulative preferred stockholders dividends, the common stock shareholders will not get either.

The holder of the preferred share gets only the $10 dividend, but the common stockholder will receive the higher dividend. Perpetual preferred stock does not have an expiration date and pays the investor a fixed dividend for as long as the issuing noncumulative preferred stock company is in existence. The company does, however, hold the right to buy back the stock at any time under specific terms defined in the prospectus. This buyback period is basically a call feature that is commonplace in the bond market.

Cumulative Preferred Stock Vs. Non-Cumulative

By not accumulating unpaid dividends, the company has the option to skip dividend payments during periods of financial strain without incurring a significant future financial obligation. As with convertible bonds, preferreds can often be converted into the common stock of the issuing company. This feature gives investors flexibility, allowing them to lock in the fixed return from the preferred dividends and, potentially, to participate in the capital appreciation of the common stock. Cumulative vs. noncumulative The question that comes up when a company chooses not to pay a preferred stock dividend is what happens in the future. That’s where the difference between cumulative and noncumulative preferred stock comes in.

Whether this is advantageous to the investor depends on the market price of the common stock. Unlike bondholders, failing to pay a dividend to preferred shareholders does not mean a company is in default. Because preferred shareholders do not enjoy the same guarantees as creditors, the ratings on preferred shares are generally lower than the same issuer’s bonds, with the yields being accordingly higher. In addition, there are considerations to make regarding the order of rights should a company be liquidated.