Definition
A non-cumulative preference share is a type of preference share that does not carry the right to claim dividends missed in previous years. This means if the company decides not to pay dividends in a given year, shareholders of non-cumulative preference shares lose the right to these dividends entirely and cannot claim them in the future.
Comparison with Cumulative Preference Shares
Unlike their non-cumulative cousins, cumulative preference shares assure shareholders that, should dividends be omitted in any year, they are ‘accumulated’ to be paid out in subsequent profitable years before any dividends can be paid to common shareholders. This stark difference highlights a pivotal choice for investors between potentially higher risk (non-cumulative) and greater security (cumulative).
Example
Imagine two wells—Cumulonimbus (cumulative) and Nonstop (non-cumulative). During a drought year (read: no profit), Cumulonimbus manages to retain rainwater (dividends) for future years, whereas Nonstop, quite unfortunately, doesn’t keep any rainwater at all. In investor’s layman terms: In good years, both quench your thirst, but in dry years, only Cumulonimbus has a backup plan.
Financial Implications
Investing in non-cumulative preference shares often appeals to those who speculate on a company’s consistent performance, where the risk of not receiving dividends in a lean year is overshadowed by the share’s usually higher yield during profitable phases. However, the lack of a safety net makes it a more daring venture.
Strategic Choice
Selecting non-cumulative preference shares might suit the bold who dance with risk, but those who prefer a slow waltz with stability tend to lean towards cumulative shares, especially in industries prone to fluctuations.
Related Terms
- Preference Share: A class of ownership in a corporation that has a higher claim on assets and earnings than common shares, usually with fixed dividends.
- Dividend: A portion of a company’s earnings decided by the board to be distributed among shareholders.
- Equity Investment: The act of investing in company shares providing ownership and a potential share in the profit.
Recommended Reading
- “The Intelligent Investor” by Benjamin Graham. A staple for understanding investment philosophies including different types of shares.
- “Corporate Finance” by Richard A. Brealey. Delve deeper into the mechanics of how companies manage their equity, including the complex choices between issuing different types of preference shares.
With a sprinkle of economic wisdom and a dash of daring, may your equity adventures be as fruitful as a well-stocked orchard—even if some of the trees (non-cumulative shares, of course) don’t always bear fruit.
