Investing in dividend-paying stocks is a great way to add a steady...
by Ashley GrasseWhat is a Cumulative Dividend? Understand What They Are and How They Work
A cumulative dividend guarantees that you’ll get your dividend payment in the future, even if the company can’t pay them out on its typical schedule. They are usually attached to preferred shares, meaning not all shareholders are afforded this security blanket.
It sounds like a great option, but as with all things, some strings are attached. If you want to know more, you’ve come to the right place. We will dive into all the ins and outs of cumulative dividends.
How Do Cumulative Dividends Work?
Standard dividends are payments you get for simply buying and holding company shares. They are incentives the company gives investors to buy and hold but are not always guaranteed.
Cumulative dividends, which are a feature of preferred shares, work similarly to standard dividends but with a couple of added perks. It gives you first dibs on payments and a rollover in periods when the company can’t pay them out.
Let’s look at an example.
When everything is profitable and running smoothly, a company can comfortably pay its shareholders dividends as expected on a regular schedule.
However, during financial hardships or slower economic periods, the company may have to announce that it won’t have the money to pay out all its dividends.
That’s where the cumulative dividends feature comes into play.
If only some shareholders get paid this time around, as a preferred share owner, you have priority and will get your money before common shareholders.
In the event that you don’t get paid, your dividends accumulate and carry over to the next cycle.
When profits return, or the economy bounces back, cumulative dividend shareholders will get all skipped and current payments that the company owes them up to that point.
Common shareholders without the cumulative feature will not always have that same luxury.
So how do you get cumulative dividends? While most companies issue common shares, some offer preferred shares.
These preferred shares usually come with extra benefits like voting power, higher claims to assets, or even cumulative dividends. Not all preferred shares have every perk, so you’ll need to do your research to find companies offering what you’re looking for.
Formula to Calculate Cumulative Dividend
Cumulative dividends at face value are just like standard dividends. There’s a rate, usually a percentage, that you’ll get paid for each of your shares based on its par value. The par value, unlike the market value, is determined by the company.
The formula to calculate the cumulative dividend amount is the rate multiplied by the par value. Both of these values are in the stock’s prospectus.
Cumulative Dividend Amount Per Share = Preferred Stock Share Dividend Rate x Preferred Share Par Value
Advantages of Cumulative Dividends
- Despite a company’s performance or an economic downturn, you will eventually get your dividend payment.
- You get priority when it comes to dividend payments over other stockholders at a time when the company can only pay some dividends.
- If a company liquidates, you get a settlement sooner than other stockholders.
Disadvantages of Cumulative Dividends
- As a cumulative dividend shareholder, you won’t have voting privileges in company meetings.
- They are more expensive since they have more benefits.
- Cumulative dividends get paid on a yearly basis, so you can’t claim multiple during the year.
Example of Cumulative Dividend
Let’s take a look at an example of what you’ll make with cumulative dividends and what happens when they start to roll over.
If the rate is 2% and the par value is $50, then you’ll get $1 per share you hold on the ex-dividend date. 5% (0.05) x $50 = $1 / share. So, if you hold 100 shares, you get $100.
The cumulative part comes into play if the company can’t give you that $100 this time around. They take note of it and ensure you get the payout on the next cycle.
Continuing the example, let’s say the company hits hard times and doesn’t have the money to pay everyone for three cycles. Each cycle, they are still stacking your $100 IOU and noting that they are in debt to you.
On the 4th cycle, they are back to business as usual and are ready to pay everyone dividends again. You will get your previously missed three $100 payments and the current cycle’s payment, for a total of $400.
Differences Between Cumulative and Non-cumulative Dividends
| Cumulative | Non-Cumulative |
|---|---|
| If dividends aren’t paid out, they accumulate and get distributed the following year to preferred shareholders. | If dividends aren’t paid out, shareholders lose their right to dividends that year. |
| Cumulative preferred stocks don’t come with voting rights. | Non-cumulative common stocks give the owner voting rights at stockholder meetings. |
| They are less volatile since payments are guaranteed regardless of company performance. | They are considered volatile since the basis of the dividend rides on the company’s performance. |
Ease Your Mind with Cumulative Dividends
Cumulative dividends give investors the peace of mind that no matter how a company’s year goes, they will ultimately get the payments they were promised.
On the flip side, a preferred stock with a cumulative dividend won’t give you a vote in shareholder meetings.
Only you can determine what type of investment is right for you. As always, be sure to do your research when making decisions about your finances.
