Cumulative Preference Shares Meaning, Advantages, and Missed Payments

Investing in the stock market can be a bit confusing, especially when it comes to understanding different types of shares. One such type of share is the cumulative preference share. These shares are special because they offer fixed dividends to the shareholders, and in case the company misses out on paying these dividends, the unpaid dividends are carried forward. This ensures that the shareholders receive their full payments in the future, even if the company faces difficulties. In this blog, we will discuss what cumulative preference shares are, their types, their benefits and disadvantages, and how missed payments are handled.

What Are Cumulative Preference Shares?

Cumulative preference shares are a type of preference share where the company promises to pay dividends to shareholders first, before paying dividends to ordinary shareholders. If the company does not have enough money to pay dividends in any particular year, these dividends do not disappear. Instead, they are carried forward to the next year. This means the company has to pay any missed dividends before paying dividends to regular shareholders. This feature provides extra security for investors, ensuring they don't miss out on their due payments, even if the company faces financial problems.

For example, if you own cumulative preference shares in a company and they miss paying you dividends in one year, they will owe you those dividends the next year, in addition to the current year’s dividends. This is unlike regular preference shares, where missed payments are usually not carried forward.

Get instant access to markets—Open Demat account

Types of Cumulative Preference Shares

There are different types of cumulative preference shares, and each type has its own characteristics. Here are the main types:

1. Cumulative Convertible Preference Shares (CCPS)

These shares give investors the option to convert their preference shares into common stock after a certain period. It allows them to benefit from the rise in the company’s stock price if it happens in the future. For example, if the company grows and its share price increases, investors can convert their preference shares into common shares and sell them for a higher price.

2. Cumulative Redeemable Preference Shares (CRPS)

These shares are redeemable, meaning the company has to buy back the shares at a certain time, usually after a fixed number of years. The company will also have to pay all accumulated dividends before redeeming the shares. For example, if you hold CRPS for 5 years, you will get all missed dividends plus the redemption price when the company buys back the shares.

3. Cumulative Participating Preference Shares

These shares allow investors to receive both the fixed dividends as well as a share in the company's profit. This type of preference share is rare and is usually issued by larger companies. For example, if the company is doing well and has extra profits, the investor will get additional dividends on top of the fixed ones.

Benefits of Cumulative Preference Shares

Cumulative preference shares offer several benefits that make them an attractive investment option:

1. Fixed and Guaranteed Income

Investors who hold cumulative preference shares can count on fixed, regular payments. This provides a reliable source of income. For example, if a company offers a 5% dividend on its cumulative preference shares, you can expect to receive 5% of your investment every year.

2. Priority Over Ordinary Shares

Cumulative preference shareholders are given priority over common shareholders when it comes to dividend payments. This reduces the risk for investors. If a company faces financial troubles and can't pay dividends to ordinary shareholders, it still has to pay cumulative preference shareholders.

3. Dividend Payment Protection

If a company misses payments one year, it doesn't mean you lose out. The missed dividends are carried forward and paid to you in the future. This ensures you don't miss out on earnings. For example, if the company misses your dividends for two years, you will receive the total missed amount in addition to the current year’s dividends.

4. Safety During Financial Difficulties

For investors who want more safety than common stocks, cumulative preference shares offer better protection. In times of financial hardship, the company has to settle dues to preference shareholders before paying dividends to common shareholders.

Disadvantages of Cumulative Preference Shares

While there are many advantages, cumulative preference shares come with some disadvantages too:

1. No Voting Rights

Unlike common stockholders, holders of cumulative preference shares don’t have voting rights. This means they can’t influence important company decisions, such as electing board members. For example, if the company is going in a direction you disagree with, you won't have a say in the matter.

2. Limited Profit Sharing

Though cumulative preference shares provide fixed dividends, they do not participate in the company’s profit beyond that fixed amount. If the company makes huge profits, the preferred shareholders won’t benefit beyond the guaranteed dividend.

3. Interest Rate Risk

Cumulative preference shares usually offer fixed dividends, so if interest rates in the market go up, your fixed dividend may lose some of its appeal. For instance, if interest rates rise to 7% while you’re earning 5%, your investment becomes less attractive.

4. No Ownership in the Company

Cumulative preference shares do not offer ownership rights, unlike common stocks. This means even though you may receive dividends, you do not have a say in the company’s growth strategies or major decisions.

Missed Payments with Cumulative Preference Shares

One of the most significant features of cumulative preference shares is how missed payments are handled. If a company doesn’t have enough profits to pay dividends one year, those missed payments don’t disappear. Instead, they accumulate and must be paid in the future. This is a major advantage because it ensures you won't lose out on your dividends.

For example, let’s say you hold cumulative preference shares worth ₹1,00,000, with an annual dividend of 6%. If the company misses paying you dividends for two years, they will owe you ₹12,000 (₹6,000 per year). Next year, the company will pay you ₹18,000 (₹6,000 for the current year and ₹12,000 for the missed payments).

Difference Between Cumulative Preference Shares and Regular Preference Shares

While both types of preference shares offer dividends before common stockholders, the main difference is how missed payments are handled:

• Cumulative Preference Shares: If dividends are missed, they accumulate and are paid in the future. For example, if you don't receive dividends for two years, they will be paid to you later.
• Regular Preference Shares: If dividends are missed, they are not carried forward. This means if the company skips a dividend payment, you lose out on that year's dividend.

Conclusion

Cumulative preference shares are an attractive investment option for those who want guaranteed income and some protection during tough financial times. While they have certain disadvantages, such as the lack of voting rights and limited profit-sharing, the security they offer with guaranteed dividends makes them appealing, especially for conservative investors. It's important to understand the workings and features of cumulative preference shares to make an informed investment decision.