What Is Noncumulative?
Let me tell you directly: the term 'noncumulative' refers to a kind of preferred stock where you, as a stockholder, won't get any unpaid or omitted dividends. These preferred shares come with set dividend rates, either as a fixed dollar amount or a percentage of the par value. If the company decides to skip dividends in a year, you lose the right to claim those payments later on.
Understanding Noncumulative
Noncumulative preferred stock means you don't get to collect any dividends that the company missed paying. On the other hand, cumulative preferred stock does let you claim those missed dividends. That's a key difference you should note if you're looking at these investments.
The Differences Between Common and Preferred Stock
Companies issue common stock, preferred stock, or both. Preferred stock has priority over common shares when it comes to recovering value if the company goes bankrupt and sells assets. More crucially, preferred stocks have predefined dividend rates, so if the company profits, you as a preferred shareholder get dividends before common stockholders do.
However, preferred stocks behave more like bonds and don't gain much from the company's big growth spurts—common shareholders capture those upsides. Common shareholders also get voting rights, which preferred shareholders usually don't have.
Convertible Bonds and Preferred Stock
Some corporate bonds include a conversion feature, allowing you to turn them into a set number of common or preferred stock shares. This gives bondholders a way to shift from debt to equity. For instance, suppose you hold a $1,000 par value bond convertible into 20 shares of preferred stock.
If the bond's market value is $1,050 and the stock trades at $60 per share, converting would give you stock worth $1,200 versus the $1,050 bond. If your aim is income, you might stick with the bond and skip conversion. But if you're after growth, converting to stock could make sense—just compare the rates on the bond and the preferred stock first.
Important Note on Noncumulative Stocks
Most companies avoid issuing noncumulative stocks because smart investors won't buy them unless they're heavily discounted.
Example of How a Noncumulative Preferred Stock Works
With cumulative preferred shares, you get any missed or omitted dividends later. Say ABC Company skips the $1.10 annual dividend for its cumulative preferred stockholders; you can collect that later. This means cumulative holders get all missed dividends before common stockholders see any, if dividends resume.
But if the shares are noncumulative, you never get that missed $1.10. That's why cumulative preferred shares hold more value than noncumulative ones.
Key Takeaways
- Noncumulative stock skips paying any unpaid or omitted dividends.
- Cumulative stock gives you rights to those missed dividends.
- Investors find cumulative preferred stock more appealing than noncumulative.
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