What is Noncumulative
Noncumulative describes a type of preferred stock that does not pay the stockholder any unpaid or omitted dividends. Preferred stock shares are issued with a stated dividend rate, which may be a stated dollar amount or a percentage of the par value. If the corporation chooses not to pay dividends in a given year, the investor does not have the right to claim any of the unpaid dividends in the future.
BREAKING DOWN Noncumulative
Noncumulative is a type of preferred stock that does not entitle an investor to any missed dividends, while cumulative is a type of preferred stock that does entitle an investor to dividends that were missed. When investors purchase stock, they have certain rights as shareholders, including the right to a dividend (if the company has sufficient earnings) and voting rights in certain situations.
The Differences Between Common and Preferred Stock
Companies may issue common and preferred stock. Several features of preferred stock make it more attractive to an investor than common stock. Preferred stock is issued with a stated dividend rate, and preferred shareholders are paid dividends before common stockholders, if the company generates earnings for the year. If the company decides to liquidate and sell its assets, preferred shareholders have a claim on any remaining assets that is superior to common shareholders.
How Noncumulative Preferred Stock Works
If an investor owns cumulative preferred shares, he is entitled to any missed or omitted dividends. If, for example, ABC Company does not pay the $1.10 annual dividend to its cumulative preferred stockholders, they are entitled to collect this dividend at some point in the future. If the preferred shares are noncumulative, the shareholders never receive the missed dividend of $1.10. This is why cumulative preferred shares are more valuable than noncumulative preferred shares.
Factoring in Convertible Bonds
Corporate bonds may be issued with a conversion feature, which means that the bond can be converted into a specific number of shares of either common stock or preferred stock shares. A conversion option gives the bondholder the opportunity to convert a debt investment into an equity security.
Assume, for example, that an investor owns a $1,000 par amount corporate bond that can be converted into 20 shares of preferred stock, and the bond's market value is $1,050, while the stock is selling at $60 per share. If the investor converted into preferred stock, he would own securities with a total market value of $1,200, compared with a $1,050 bond. If the investor's goal is to earn income, he may keep the bond and not convert, but an investor who is interested in some growth may convert into the equity security.