The terms "cumulative" and "noncumulative" describe different rules corporations use to pay dividends on preferred stock. Corporations issue preferred stock to raise money for operations and growth. Dividends are cash or stock payments to stockholders. The high dividends available from preferred shares encourage income-oriented investors to buy these stocks.
Preferred stock is part of the ownership structure (i.e. stockholders' equity) of a corporation. Unlike common stock, preferred shares always pay a dividend but do not necessarily give you voting rights at annual meetings.
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The major selling point for preferred stock is its high dividend yield, usually in the 4 percent to 8 percent range. Dividend yield is the annual dividend amount divided by the share price. If a company goes belly-up and is liquidated, the proceeds go to holders of bonds, preferred shares and common shares, in that order. This means that shareholders may wind up with little or no money after the bondholders get theirs.
Preferred share dividends are normally fixed, so the shares don't benefit from the growth of the issuing corporation. While dividends might be an attractive feature of common stock, they are virtually the only reason to purchase preferred stock.
Read More: The Disadvantages of Preferred Shares
Preferred Stock Dividends Formula
To calculate your preferred stock dividends, you need to know three items:
- Par value of shares: The issuing corporation assigns a value to new shares, called the par value. It does not necessarily bear any relationship to the trading value of the shares.
- Dividend rate: The percentage of a preferred share's par value that will be paid out annually as dividends.
- Position: Your position in a preferred stock is the number of shares you own.
Your annual dividend from your preferred shares is given by:
Annual dividend = par value x dividend rate x position.
Stock dividends are usually paid in quarterly installments, so your next dividend payment will be:
Quarterly dividend payment = annual dividend / 4.
For example, suppose you own 1,000 shares of Company X cumulative preferred stock. Each share has a par value of $100 and a dividend rate of 8 percent. Your annual dividend will be $100 x 0.08 x 1,000, or $8,000. Your next quarterly dividend will be $8,000 / 4, or $2,000.
Although it's easy enough to calculate your dividends by hand, you might prefer to use an online cumulative dividend calculator or construct a spreadsheet to handle the task for you.
Sometimes, a corporation skips one or more quarterly dividends. A cash shortage, extraordinary losses or managerial chaos might be to blame. The attraction of cumulative preferred shares is that the corporation must pay all current and skipped dividends before resuming payment of common stock dividends. This extra measure of safety comes at a price – cumulative preferred shares cost more than identical shares without the cumulative feature.
To calculate cumulative dividends per share, you must add the missed dividends to the current dividend from the preferred stock dividends formula.
To update the example, suppose Company X has delayed two dividend payments on its cumulative preferred stock. You receive word that dividend payments will resume on the next payment date, including skipped dividends. You should expect to receive the following:
Cumulative dividend = Next quarterly dividend payment plus postponed dividend payments
= $2,000 + (2 x $2,000) = $6,000.
Read More: What Is a Good Dividend Yield?
Like cumulative preferred stock, noncumulative shares require that the corporation pay all current preferred dividends before the corporation can distribute any dividends on common stock. However, owners of noncumulative preferred do not have any right to skipped dividends. Unless otherwise specified, you can assume that preferred shares are noncumulative.
Comparison With Bonds
Both bonds and preferred shares make periodic cash payments. However, unlike stock dividends, corporations must guarantee all bond interest payments and the return of the bond's face value at maturity. Most preferred shares don't mature (i.e. they are perpetual), but a type called "retractable" has a maturity date on which the corporation redeems the preferred shares for a preset price.
If a bond issuer defaults on an interest payment, bondholders can sue the company, take it over and sell off its parts for cash. Preferred shareholders have no such remedy for missed dividends. If a corporation is liquidated, bondholders are paid ahead of preferred shareholders.
Read More: Preferred Stock Vs. Bonds