What Is Noncumulative?

The term "noncumulative" describes a type of preferred stock that does not pay stockholders any unpaid or omitted dividends. Preferred stock shares are issued with pre-established dividend rates, which may either be stated as a dollar amount or as a percentage of the par value. If the corporation chooses not to pay dividends in a given year, investors forfeit the right to claim any of the unpaid dividends in the future.

Key Takeaways

  • Noncumulative stock does not pay unpaid or omitted dividends.
  • Cumulative stock does entitle investors to missed dividents.
  • Preferred stock is often more attractive to investors than common stock.

Understanding Noncumulative

Noncumulative describes a type of preferred stock that does not entitle investors to reap any missed dividends. By contrast, "cumulative" indicates a class of preferred stock that indeed entitles an investor to dividends that were missed. When investors purchase stocks, they enjoy certain perks as shareholders, including the right to dividends (if the company claims sufficient earnings), as well as voting rights, in certain situations.

The Differences Between Common and Preferred Stock

Companies either issue common or preferred stock, the latter of which is generally more attractive to investors because preferred stockholders stand first in line to liquidate their holdings if the company declares bankruptcy and sells off its assets. More importantly, preferred stocks are issued with stated dividend rates. If a company is profitable, preferred shareholders collect dividends before common stockholders.

How Noncumulative Preferred Stock Works

Investors who own cumulative preferred shares are entitled to any missed or omitted dividends. For example, if ABC Company fails to pay the $1.10 annual dividend to its cumulative preferred stockholders, those investors have the right to collect that income at some future date. This essentially means cumulative preferred stockholders will receive all of their missed dividends before holders of common stock receive any dividends, should the company begin paying dividends again.

If the preferred shares are noncumulative, the shareholders never receive the missed dividend of $1.10. This is why cumulative preferred shares are more valuable than noncumulative preferred shares.

Most companies are reluctant to issue noncumulative stocks because shrew investors are unlikely to buy this class of shares—unless they're offered at significant discounts.

Factoring in Convertible Bonds

Corporate bonds may be issued with a conversion feature, enabling those bonds to be converted into a specific number of shares of either common stock or preferred stock. This conversion option lets bondholders convert a debt investment into equity security. For example, let's assume an investor owns a $1,000 par amount corporate bond that can be converted into 20 shares of preferred stock.

Let's further assume that the bond's market value is $1,050, while the stock is selling at $60 per share. If the investor converted his holding into preferred stock, he would own securities with a total market value of $1,200, compared with a $1,050 bond. If the investor's goal is to earn income, he may keep the bond and elect not to convert. By contrast, an investor who is interested in some growth may opt to convert his bond holdings into equities.