In other words, cumulative preferred shares allow the issuer (the company) to retain and defer the payment of dividends to its preferred shareholders. The objective of this type of action is that the company is not forced to distribute dividends in a bad economic situation or for any other reason.
Companies, when expanding, launch new projects, or even, to overcome a bad economic situation, they may need liquidity. To solve this problem, they can issue shares or bonds that allow them to attract financing from investors.
These issues are made through what are known as financial assets. Among all the financial assets that a company can issue, there is a type of preferred stock that we are going to explain to you in this article, cumulative preferred shares.
The main characteristic of cumulative preferred shares is the following: Although the dividends are not distributed in the corresponding year, they are accumulated to be distributed in the future. In this way, the investor does not lose those dividends, but delays their payment.
What is a preferred stock?
A preferred stock, as its name suggests, gives preference to its owner over ordinary shareholders. This preference is most often of an economic nature, but it can also be of any other aspect.
The most common privilege that preferred shares usually entail for their owners is a higher payment of dividends compared to ordinary shareholders, when the distribution takes place.
It is also true that these types of shares do not usually include in their characteristics the right to vote at the shareholders’ meeting. Therefore, the shareholder cannot participate in the decisions made by the company.
In the event that the company declares bankruptcy and is unable to resolve this situation, the preferred shareholder has priority at the time of the liquidation of the company’s assets.
Advantages of Cumulative Preferred Stock
Cumulative preferred shares have three types of advantages. The first of them, as we have mentioned before, is that it grants greater hierarchy in the process of liquidation of the company to the shareholder.
The second one is that, when the company distributes dividends, the preferred shareholder will receive a higher number of income than the ordinary shareholder.
Thirdly, this type of preferred stock allows dividends to be accumulated for the future in case the company decides that they will not be distributed in a certain year.
The main downside to cumulative preferred stock is the risk involved. With this type of financial asset, the capital is not guaranteed and can be lost by the shareholder.
Second, these shares are not listed on the stock market. Therefore, if the shareholder wants to get rid of them, it will not be so easy to find a buyer.
In conclusion, cumulative preferred shares offer the investor the opportunity not to lose the dividends of one year, since they are accumulated for the following ones.