Definition
A Cumulative Preference Share is a type of preference share that bestows upon its holder the right to accrue unpaid dividends from prior years. Unlike ordinary shares, these shares come with a financial safety net: if a company skips dividend payments due to inadequate earnings in a particular year, cumulative preference shares ensure that these dividends are paid out in subsequent profitable years before any dividends are distributed to ordinary shareholders. In the United States, these shares are often referred to as cumulative preferred stocks.
Key Characteristics
Guaranteed Dividends
The primary allure of cumulative preference shares lies in their dividend guarantee. If a company faces financial hurdles and misses dividend payments, holders of these shares are first in line for payment once the company regains financial stability.
Priority Over Ordinary Shares
In the pecking order of profit distribution, cumulative preference shareholders outrank ordinary shareholders, securing their investment against corporate fluctuations.
Potential Drawbacks
While the promise of deferred dividends sounds appealing, it’s essential to recognize that these dividends will only be paid if the company does not just survive the downturn but becomes profitable again.
Financial Implications
For investors, cumulative preference shares are a reassuring bulwark against dividend volatility, turning potential corporate upheavals into mere pauses in their income stream. However, the security of these shares often comes at the cost of lower dividend yields compared to riskier stocks, and they generally offer less capital appreciation potential.
Related Terms
- Ordinary Shares: Shares that entitle the holder to dividends and other rights but do not include protections for missed payments.
- Non-Cumulative Preference Shares: Preference shares that do not accumulate unpaid dividends. Missed payments are forfeited if not declared.
- Dividend: The portion of profits distributed to shareholders from a company’s earnings.
Further Reading
For those looking to delve deeper into the mechanics and strategies behind cumulative preference shares and other investment options, consider these books:
- “The Intelligent Investor” by Benjamin Graham - A comprehensive guide that covers various aspects of investing, including the role of preference shares.
- “Security Analysis” by Benjamin Graham and David Dodd - This book provides detailed insights into analyzing and valuing different types of securities, including preference shares.
In the realm of investments, cumulative preference shares stand as a testament to the principle of patience paying dividends, quite literally. They remind us that in the corporate world, sometimes the race does not go to the swift but to the steadfast.
