What is Cumulative Preferred Stock?
Cumulative preferred stock are those class of shares wherein any unpaid or undeclared dividends for the current year must be accumulated and paid for in the future. However, such stocks are costlier, do not have voting rights and cannot demand the interim dividends.
Cumulative Preferred stockholders get a fixed dividend rate irrespective of the profit margin; this means they are not participating in the profits of the company. The benefit of these stocks is that in case of the financial crisis if the company will not be able to declare the dividend then also the dividend amount will get accumulated and will get paid in the future whenever the company declares the dividend.
The company has not declared dividends in the last 4 years due to the financial crisis. For the last 4 years, the dividends for the cumulative preferred stockholders were $20 each year that was unpaid.
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The business in the 5th year was great, and therefore, the management declares a dividend to its shareholders. However, the company will have to pay $80 to the cumulative preferred stockholders first and then they are allowed to distribute the dividends to the common shareholders.
- The cumulative preferred stocks are safe and secure when it comes to financial safety among all other stocks available in the market. The reason behind the same is that they will always get their dividend irrespective of the bad performance of the company.
- These stockholders are privileged to get the dividends before any other stockholder of the company.
- In an unpleasant situation of liquidation of the company, the cumulative preferred stockholders get the settlement at the earliest in comparison to other stockholders.
- The company has an obligation to give the cumulative preferred stockholder the right to demand the dividend in case of any financial failure. If at that time, the dividends are not paid, then the dividends are accumulated in accounts and are paid afterwards to the cumulative preferred stockholders when things are normal for the company.
- Such stockholders may get a higher rate of return in case the company gets a profitable year.
- The biggest disadvantage is that they don’t enjoy voting rights compared to other stockholders.
- Such shareholders will always get the fixed dividend irrespective of the profit earned during the year. In contrast, other stockholders will get the dividend payment as per the profits earned by the company.
- It is costly than any other stocks available in the market since the cumulative preferred stock carries some extra privileges.
- They may get partial or delayed dividend payments from the company.
- The dividends are fixed, but in case of any other stocks like debts the management will have to pay the debt interest to the holder as well, and there cannot be any delay in the payment of the same.
- These stockholders cannot claim dividend in the middle of the year. They are not allowed interim dividends they are only paid yearly.
This has been a guide to what is cumulative preferred stock. Here we discuss how it works along with examples, advantages and disadvantages. You can learn more about financing from the following articles –