With preferreds, the investor is standing closer to the front of the line for payment than common shareholders, although not by much. Non-cumulative preferred stock carries a lower risk for investors compared to cumulative preferred stock. With non-cumulative preferred stock, investors understand that missed dividends are not recoverable, and there is no accumulation of unpaid dividends.

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Noncumulative Preferred Stock

There is a real debate in the comments section of my articles and in some of the other articles that I read here on Seeking Alpha. I never realized that people are so concerned about the cumulative feature of preferred stocks. In fact this debate is really funny, because for the income investor this clause should mean absolutely nothing. I understand that this sounds too strange for a big part of the readers and I will non cumulative preferred stock appreciate the discussion, but let’s look at the facts first. Although noncumulative stocks offer lower security, they tend to be priced at a lower rate than cumulative stocks, and still offer the advantages of preferred stock. Information about a company’s preferred shares is easier to obtain than information about the company’s bonds, making preferreds, in a general sense, perhaps more liquid and easier to trade.

Institutions are usually the most common purchasers of preferred stock, especially during the primary distribution phase. This is due to certain tax advantages that are available to them but which are not available to individual investors. Because these institutions buy in bulk, preferred issues are a relatively simple way to raise large amounts of capital. Cumulative preferred stock can receive the dividend even before the stockholders receive their payment. Similarly, holders of preferred stock may be able to take advantage of lower tax rates on qualified dividends, which may enjoy a 0, 15 or 20 percent rate, though not all preferreds are able to.

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By not accumulating unpaid dividends, the company has the option to skip dividend payments during periods of financial strain without incurring a significant future financial obligation. This can help the company preserve its cash flow and financial stability. On the flip side, preferred stocks trade more like bonds, and thus don’t benefit much if the company experiences massive growth.

Noncumulative stockholders will get paid only after the cumulative stockholders have received their share. While preferreds are interest-rate sensitive, they are not as price-sensitive to interest rate fluctuations as bonds. However, their prices do reflect the general market factors that affect their issuers to a greater degree than the same issuer’s bonds. Investors should review the issuing company’s dividend history and payout ratio to evaluate the reliability and consistency of its dividend payments. Companies with a strong track record of paying dividends and a low payout ratio may be more attractive investments. This feature provides investors with the opportunity to participate in potential capital appreciation if the common stock’s value increases.