WHAT IS CUMULATIVE PREFERRED STOCK?
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Simply stated, cumulative preferred stock accumulates dividends
if they are not paid out when scheduled. No funds are actually saved, but a book
entry is recorded for shareholders of record. If a company does not pay any
dividends to preferred stockholders in one or more periods, it must first pay
preferred stockholders the missed dividends, as well as any current dividend
due, before paying any dividends on common stock.
For example, if Company ZYX failed to pay the set dividend to
preferred stockholders for the first two quarters of the year and then decided
to pay dividends for the third quarter, it would need to pay the preferred
stockholders the accumulated dividends from quarters one and two as well as the
dividend now due in quarter three before paying any dividends to the common
In contrast, if a company decides not to pay out a dividend to
the owners of common stock for a particular period, the common stockholders will
never be reimbursed for the "missed" dividend. This is because common stock does
not guarantee a dividend?fixed or otherwise. Instead, it allows the stockholders
to share in the overall fortunes of the company. Common shareholders may receive
much larger earnings than preferred shareholders, but they also incur a greater
risk of receiving no earnings at all.
stock is cumulative, although noncumulative preferred stock does exist.
Income investors, those for whom regular dividends are important, choose
cumulative preferred stock over non-cumulative.
Besides selecting cumulative preferred stocks, many
investors sometimes also choose convertible preferred stock when
available. Next, we will look at the option to convert.