Types of Preferred Stock

• If a preferred stock is cumulative it means that when the company decides not to pay dividends to their preferred shareholders, the unpaid dividends accumulate. When the company decides to pay dividends again, they must pay the cumulative preferred dividends before dividends are paid on common stock. Noncumulative preferred stock does not accumulate unpaid dividends. A shareholder who owns noncumulative preferred stock is entitled only to the dividends declared in the current year.
  
  

Similarities

• Both cumulative and noncumulative preferred shareholders have the right to receive dividends before common stock holders receive their dividend payments. Since cumulative and noncumulative preferred shares are types of preferred shares, they do not give shareholders the right to vote on company policies.
  
  

Differences

• When a company does not pay dividends for several years on cumulative preferred stock, each year’s dividend accumulates as a liability to the company and the dividends are said to be in arrears. When a company decides to issue dividends again, they must pay the dividends in arrears first. Noncumulative preferred shares do not build up dividends in arrears, and shareholders of noncumulative preferred shares do not have the right to missed dividend payments.
  
  

Considerations

• Investors should note that not all preferred stocks have a cumulative feature. As a result, investors should research the stock issue first. For preferred shares that do not contain the cumulative feature, investors need to consider if the extra risk provided by these shares is worth the potential gain.
  
  

Market Effects

• When a company decides not to pay dividends, the price of preferred stock will decline both because dividends are not being paid and also because this nonpayment of dividends signals decreased earnings. This effect is seen on both cumulative and noncumulative preferred stock prices.