Preferred Stockholders and Cumulative Preferred Stock (Explained)

Introduction

Preferred Stockholders which is also known as preferred shares are defined as the shares within a company’s stock. These stocks have respective dividends that are meant to be paid to the shareholders prior to the issuing of the stock dividends.

If in the future the company becomes bankrupt, the stockholders have the right to get paid from the company assets prior to the common stockholders.

Usually, the preferred stock has a specific dividend. However, common stocks do not. Moreover, shareholders from the preferred stock do not have voting rights, unlike the common shareholders.

Cumulative Preferred Stock in Detail:

Preferred Stock usually has four categories. These categories are:

  • Non-cumulative preferred stock
  • Cumulative Preferred Stock
  • Convertible Preferred Stock
  • Participating preferred stock They are explained in detail below.

1. Cumulative Preferred Stock

This stock consists of a provision that demands the company to pay the shareholders all the dividends. These dividends also include the ones which were removed in the past.

Most of the time, these dividend payments are not paid on time even though they are guaranteed. These become unpaid dividends which are legally directed to the current owner when the date of payment is due.

Sometimes, interest is presented to the shareholder of the cumulative preferred stock.

2. Non-cumulative Preferred Stock

This category of Preferred Stock does not demand an unpaid or removed dividend. If the respective company decides to not pay dividends in a specific year, the non-cumulative Preferred Stock shareholders do not have the authority or power of claiming the past dividends in the immediate future.

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3. Participating preferred stock

This stock provides the shareholders with the right to get paid the dividends in a similar sum to the usually given rate of the dividends. Moreover, an extra dividend depending on the predetermined case is also presented.

This extra dividend should only be given if the total sum of the dividends submitted to the shareholders is bigger compared to per-share sum.

In this case, if the company closes down, the shareholders from the participating preferred stock can succeed the legal right to get paid for the buying cost from the stock along with the share of the left out proceeds given from the common shareholders.

4. Convertible Preferred Stock

This consists of a choice for the shareholders to turn the Preferred shares into a specific number of common shares. This can be given anytime subsequent to a set date. In a normal case scenario, the convertible Preferred Stock is exchanged as per the request of the shareholders.

Nevertheless, a company can achieve a provision on the shares which permits the issuer shareholders to coerce the issues. Depending on the performance of the specific common stock, the base of the convertible common stock is judged.

Example of the Working of Cumulative Preferred Stock

A company issues a Cumulative Preferred Stock having a par value of $10,000 along with a yearly payment percentage of 6%. The economy starts to slow down due to which the company is unable to complete its financial obligations. It can only afford to pay half of the dividend.

Now it owes the shareholder $300 per share. The economy gets even worse in the subsequent year due to which it can not pay any dividend. The company now owes the shareholder $900 per share.

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The following year, the economy rises up which allows the company to pay all dividends. The shareholders of the cumulative Preferred Stock will be paid $900 in arrears along with the present dividend of $600.

When all the shareholders get submitted with $1,500 due per share, the company has to decide whether to pay dividends to the other classes of the shareholders.

Is there any risk involved in the cumulative Preferred Stock?

As opposed to the non-cumulative Preferred Stock, the cumulative Preferred Stock can be offered with a low payment rate. This is because the cumulative factor decreases the risk of dividends to the investors.

Because of this affordable cost of capital, a lot of companies issue the preferred stock offerings with the cumulative factor. Usually, only the blue-chip companies with clear dividend

history can ask for non-cumulative Preferred Stock without the increase of the cost capital.

Conclusion:

In the case of a missed payment, the holders from the cumulative Preferred Stock receive all the payments of dividends in the arrears prior to the shareholders getting a payment.

Normally the common stockholders have to be patient until all the dividends are paid before they get any dividend. This is why the cumulative Preferred shares have a lower payment rate.

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