Cumulative Preferred Stock Versus Non-Cumulative
Preferred stocks have priority over common stocks to receive dividends. When a corporation decides to pay dividends to shareholders, it must first pay dividends on preferred stock before it can pay dividends on common stock. There are also several classes of preferred stock based on how and when preferred dividends are paid.
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Cumulative Preferred Stock
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When a company is having financial difficulties, its board of directors may vote to reduce, omit, suspend or eliminate the dividend. Common stockholders have no recourse. But cumulative preferred shareholders will have their dividends accumulated on the company's books until the corporation can resume the dividends, at which point they will receive the current dividend plus any accumulated dividends in arrears.
Example
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A shareholder of 100 shares of $25 par 6 percent cumulative preferred stock in XYZ is entitled to receive $1.50 in dividends annually. XYZ, experiencing financial difficulties, suspends the dividend for two years. The dividend accrues at the rate of $1.50 per year. In year three the dividend is resumed and the shareholder receives the current dividend of $1.50 plus the $3.00 in arrears.
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Non-Cumulative Preferred Stock
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Shareholders of non-cumulative preferred stock clearly lack this advantage. They don't have the right to any dividends in arrears. But they still have priority over common stockholders. When dividends are resumed, they, too, must first be paid on preferred stock.
Non-Cumulative Preferred Stock Dividend vs. Common Stock Dividend
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Corporations are under no obligation to pay dividends on their common stock. It's usually a nice bonus to the shareholders that is entirely up to the board of directors. Preferred stocks, on the other hand, are issued with a stated dividend because investors buy them for dividend income. When (or if) a common stock dividend is resumed, it can be in any amount, but the non-cumulative preferred stock dividend is likely to be resumed in full.
Which Is Better?
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All other things being equal, cumulative preferreds are clearly better than non-cumulative preferreds, but securities are rarely issued with a clear set of advantages of one type over the other. Look for potential trade-offs elsewhere in the fine print before buying.
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References
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