Understanding Cumulative Dividends: A Guide for Investors

A cumulative dividend is a required fixed distribution of earnings made to shareholders. Preferred sharesPreferred SharesPreferred shares (preferred stock, preference shares) are the class of stock ownership in a corporation that has a priority claim on the company’s assets over common stock shares. The shares are more senior than common stock but are more junior relative to debt, such as bonds. are the most common type of share class that provides the right to receive cumulative dividends. If a company is unable to distribute dividends to shareholders in the period owed, the dividends owed are carried forward until they are paid. In addition, the dividends must be paid before common shareholders receive a dividend.

Formula for Cumulative Dividend

To calculate the dollar amount of a cumulative dividend, use the following formula:

Where:

• Dividend Rate is the expected dividend payment expressed as a percentage on an annualized basis.
• Par Value is the face value for a share.

Note: The dividend rate and par value can be found on a preferred stock prospectus.

Key Features of a Cumulative Dividend

As opposed to non-cumulative (regular) dividends, a cumulative dividend comes with the following key features:

1. Fixed dividend payment

A cumulative dividend pays a fixed dividend amount depending on the dividend rate and par valuePar ValuePar Value is the nominal or face value of a bond, or stock, or coupon as indicated on a bond or stock certificate. It is a static value of the stock. In other words, the dividend must be paid regardless of company profitability.

2. Seniority in dividend payments

Preferred shareholders with a cumulative dividend feature must be paid first before any dividends can be paid to common shareholders.

3. Accumulation of dividend payments

If a company is unable to pay a cumulative dividend in the year outstanding, the dividend amount accumulates until the company settles the amount outstanding.

Preferred Stocks and Cumulative Dividends

Preferred stock is a higher class of share ownership in that the owner of a preferred stock exercises a higher claim on assets of the company. Although not always, preferred shares commonly include a cumulative dividend feature. In addition, dividends attributed to preferred shares must be paid out first before any dividends are paid to common shares.

It is important to note that preferred stock is commonly called a hybrid securityHybrid SecuritiesHybrid securities are investment instruments that combine the features of pure equities and pure bonds. The securities tend to offer a higher return than pure fixed income securities such as bonds but a lower return than pure variable income securities such as equities., because of its inherent “equity” and “debt” features.

1. Equity feature

Preferred shares are similar to common shares in that they represent an ownership interest and the share price value can appreciate.

2. Debt feature

Preferred stock is similar to debt in that a preferred stockholder is paid a fixed dividend periodically (i.e., a cumulative dividend).

Examples of a Cumulative Dividend

1. New preferred share issue

Colin is looking to invest in the new preferred share issue of ABC Company. He would like to determine the dividends to be received per share of preferred stock owned. On the preferred stock prospectusProspectusA prospectus is a legal disclosure document that companies are required to file with the Securities and Exchange Commission (SEC). The document provides information about the company, its management team, recent financial performance, and other related information that investors would like to know., he notices that the dividend rate is 5% with a par value of $100.

If Colin were to purchase 1,000 preferred shares of ABC Company, assuming that the preferred shares come with a cumulative dividend feature payable once a year, how much in dividends is he entitled to annually?

Cumulative Dividend = 5% x $100 = $5 (Dividend per preferred share)

Since Colin is looking to purchase 1,000 preferred shares, he would be entitled to $5,000 annually.

2. Preferred shares during an economic downturn

Colin recently purchased 1,000 preferred shares of ABC Company. Unfortunately, Colin bought the preferred shares during an economic downturn. The company later issued a warning to shareholders that its company would not be able to pay dividends to all shareholders during this year’s operation and, accordingly, decided to carry forward dividend payments on preferred shares. What would happen to Colin’s dividend payment in the current year?

If ABC Company is unable to pay dividends in the current year to preferred shareholders, the dividend amount is carried forward to later years. If the company is unable to pay dividends in Year 1 and then declares a dividend payment to preferred shares in Year 2, Colin would be receiving $10,000 in dividends ($5,000 owed from Year 1 and $5,000 entitled in Year 2).

Additional Resources

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• Dividend Payout RatioDividend Payout RatioDividend Payout Ratio is the amount of dividends paid to shareholders in relation to the total amount of net income generated by a company. Formula, example
• Dividend PolicyDividend PolicyA company’s dividend policy dictates the amount of dividends paid out by the company to its shareholders and the frequency with which the dividends are paid
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