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 predetermined dividend rates, either 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 those unpaid dividends in the future.
Key Takeaways
- Noncumulative stock does not pay unpaid or omitted dividends.
- Cumulative stock entitles investors to missed dividends.
- Cumulative preferred stock is more attractive to investors than noncumulative preferred stock due to guaranteed payout of missed dividends.
Understanding Noncumulative
Noncumulative stock is a type of preferred stock that does not entitle investors to reap any missed dividends. In contrast, “cumulative” preferred stock entitles an investor to dividends that were missed.
The Differences Between Common and Preferred Stock
Companies issue either common stock, preferred stock, or both. Preferred stock ranks ahead of common shares in receiving payout if the company declares bankruptcy and sells off its assets. More importantly, preferred stocks come with stated dividend rates. If a company is profitable, preferred shareholders receive dividends before common stockholders.
On the other hand, preferred stocks trade more like bonds and don’t benefit much if the company experiences significant growth. Common shareholders reap those benefits. Additionally, common shareholders have voting rights, while preferred shareholders typically do not.
Convertible Bonds and Preferred Stock
Corporate bonds may be issued with a conversion feature, enabling those bonds to be converted into a pre-specified number of shares of either common or preferred stock. This option allows bondholders to convert a debt investment into stock. 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.
Now, let’s assume the bond’s market value is $1,050 while the stock is selling at $60 per share. If the investor converts their bond into preferred stock, they would own securities with a total market value of $1,200, compared to the $1,050 bond value. If the investor aims for income, they may keep the bond and not convert it. Conversely, an investor interested in growth may opt to convert the bond holdings into equity by comparing offered rates on the bond and the preferred stock. Most companies are hesitant to issue noncumulative stocks, as savvy investors are unlikely to purchase this class of shares unless they are offered at significant discounts.
Example of How a Noncumulative Preferred Stock Works
Investors who own cumulative preferred shares are entitled to any missed or omitted dividends. For instance, 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 a future date. This means cumulative preferred stockholders will receive all of their missed dividends before holders of common stock receive any dividends, should the company start paying dividends again.
If the preferred shares are noncumulative, shareholders never receive the missed dividend of $1.10. This is why cumulative preferred shares tend to be more valuable than noncumulative preferred shares.
Related Terms: preferred stock, dividends, investors, common stock, bonds, convertible bonds, stock market.
