Differences Between Cumulative & Non-Cumulative Preference Shares

Cumulative preferred stock is sometimes considered appropriate for retirement portfolios because it generates income.

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"Preference share" is just another name for preferred stock. It is neither a common stock nor a bond, but a hybrid of both. Like common stock, it brings capital into the company that issues it, instead of more debt. Like a bond, it pays a fixed income that is normally competitive with corporate bond interest when it is first issued. After that, the stock trades in the marketplace and will fluctuate in price and yield according to the direction of interest rates and the premium granted by the market to dividend yield.

Definition

Preference, or preferred, stock is called that because it carries a legal claim that is superior to common stock on the underlying earnings and assets of its issuer company if that company is liquidated as a result of bankruptcy. Preferred stock dividends are set when the issue is first priced and are fixed for the life of the security unless there is a provision to the contrary. The payment of preferred stock dividends takes place prior to the payment of dividends to common stockholders because preferred stock legally sits ahead of common stock in rights to the company's assets. However, preferred stock normally does not have voting rights.

Cumulative Preferred Stock

If financial problems beset a company, causing it to lose money, it can't pay its dividend obligations to its preferred and common stockholders. For holders of cumulative preferred stock, the dividends owed continue to accumulate until they are paid. All dividends owed to holders of cumulative preferred shares must be paid before holders of straight, or noncumulative, preferred and common stock can receive dividends. Straight, noncumulative preferred does not accumulate unpaid dividends, but its dividends are paid ahead of common stock, after any accumulated dividend obligations have been paid to holders of the cumulative preferred. Common stock dividends get paid last. Cumulative preferred also ranks higher than noncumulative preferred in the event of liquidation of company assets.

Other Types of Preferred Stock

Cumulative preferred stock always takes precedence over noncumulative preferred and common dividends, but there may be different levels of cumulative rights, such as first or senior cumulative preferred, which has preference over the regular cumulative preferred. There can also be a subordinated cumulative preferred, which is paid after the regular cumulative preferred dividends or asset liquidation is satisfied.

Pros & Cons

Cumulative preferred ranks above noncumulative preferred in terms of investment security, so it trades rich to the market for noncumulative preferred. This means its dividend rate of return is lower and it may have a higher credit rating assigned to the issue compared with that of the noncumulative preferred of the same issuer. A company issues a cumulative preferred so it can price its dividend lower than the market rate for noncumulative preferred. Investors seeking low-risk investments will accept a lower dividend rate in return for the promise of assured dividend payments and first call on company assets in the event of liquidation.

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