What is a 'Cumulative Preferred Stock'
Cumulative preferred stock is a type of preferred stock with a provision that stipulates that if any dividend payments have been missed in the past, the dividends owed must be paid out to cumulative preferred shareholders first. This is before other classes of preferred stock shareholders and common shareholders can receive dividend payments.
Presented as a percentage, the cumulative return is the raw mathematical return of the following calculation:
BREAKING DOWN 'Cumulative Preferred Stock'A preferred stock typically has a fixed dividend yield based on the par value of the stock. This dividend is paid out at set intervals, usually quarterly, to preferred holders. Preferred stocks are valued similarly to bonds. Bond proceeds are considered to be a liability, while preferred stock proceeds are counted as an asset. Also, bondholders have a priority claim on company assets.
When a company runs into financial problems and cannot meet all of its obligations, it may suspend its dividend payments and focus on paying business-specific expenses and debt payments. When the company gets through the trouble and starts paying out dividends again, standard preferred stock shareholders possess no rights to receive any missed dividends. Holders of cumulative preferred stock shares must receive all dividend payments in arrears before preferred stockholders may receive a payment. Common stockholders must wait until all cumulative preferred dividends are current and the quarterly preferred stock payment is made before they may receive any payment.
For example, a company issues cumulative preferred stock with a par value of $10,000 and an annual payment rate of 6%. The economy slows down; the company can only afford to pay half the dividend and owes the cumulative preferred shareholder $300 per share. The next year, the economy is even worse and the company can pay no dividend at all; it then owes the shareholder $900 per share. In year three, the economy booms, allowing the company to resume dividends. The shareholder must be paid the $900 in arrears in addition to the current dividend of $600. Once all cumulative shareholders receive the $1,500 due per share, the company may consider paying dividends to other classes of shareholders.
Basic Risk Factor
As the cumulative feature reduces the dividend risk to investors, cumulative preferred stock can usually be offered with a lower payment rate than required for a noncumulative preferred stock. Due to this lower cost of capital, most companies' preferred stock offerings are issued with the cumulative feature. Generally, only blue-chip companies with strong dividend histories can issue noncumulative preferred stock without increasing the cost of capital.