Cumulative preferred stock is an option that is structured to accrue dividends rather than paying them out at the time they are earned. As with other forms of preferred stock, any dividends that are accrued must be paid out to shareholders before the investors with shares of common stock issued by the company receive dividend payments. This type of structure is often attractive to shareholders who prefer to receive larger dividend payments rather than a series of smaller payments over time. Companies generally issue this type of stock as a means of safeguarding against periods where insufficient earnings are generated, or the occurrence of any other type of event that would seriously hamper the operation if the dividend payments could not be deferred for a period of time.
With stock options of this type, there is usually a fixed dividend yield that allows the investor to keep track of how much return is accruing in his or her account. This is helpful because it makes it easier to arrange finances in anticipation of when the accrued dividend payment is received. Doing so helps to ease the tax burden of receiving the lump sum payment of the cumulative dividend in one tax period, rather than over several periods. At the same time, this approach also allows the investor to plan in advance of what to do with the dividend payment, possibly choosing to use the proceeds to purchase more shares of the cumulative preferred stock, or use the funds for acquiring other types of investments.
As with any type of preferred stock option, investors who hold shares of cumulative preferred stock are among the first to receive some type of compensation in the event that the business chooses to liquidate or is acquired by another company. Like other forms of preferred stock, investors with shares of cumulative preferred stock are not likely to have voting rights similar to those of shareholders who own common shares, although this is not always the case. The exact structure of the stock issue will have some impact on how the dividends are calculated, and often include at least some information related to how the dividends will accrue over time.
The main advantages of cumulative preferred stock are the larger dividend payments that occur less frequently, and the relatively strong position of the shareholders in the event that the company is liquidated or acquired. With a position of priority in this payment process, holders of the cumulative preferred stock stand to recover a larger amount of the investment ahead of other investors, even if the business has gone into a bankruptcy situation. These features tend to make the stock option appealing to investors who are willing to assume some risk, but still wish to earn the best possible returns on their investments.