BAJAJ BROKING
July 09, 2025
4 mins read
Cumulative preference shares are a special kind of share that gives investors a steadier, more secure income. Unlike ordinary preference shares, if a company can’t pay dividends in a particular year, those unpaid amounts don’t disappear; rather, they pile up.
The company must clear these outstanding dividends before giving any payouts to common shareholders. In other words, even if the business isn’t making money, holders of cumulative preference shares build up a claim on those dividends, and they’ll receive all back payments once the company returns to profitability.
When a company loses money in a year, dividends owed to these shareholders are recorded as arrears. As soon as the company earns enough to cover them, it pays off the accumulated amounts in full. Read on as we discuss cumulative preferred shares in detail.
Cumulative preference shares, also called cumulative preferred shares, guarantee their owners priority in dividend payments. Since companies don’t always turn a profit, common shareholders might miss out on dividends during loss-making years. However, for cumulative preference shareholders, there is a set dividend rate approved annually. If the company can’t pay in a downturn, that dividend amount carries forward as arrears.
These arrears must be settled before any dividends flow to ordinary shareholders. This setup ensures that preference shareholders have a higher claim on the company’s earnings and enjoy a more stable income stream, even when profits dip.
To understand more about what is cumulative preferred stock, let us take a look at its features:
They are the ones who get the dividend first. When the dividend is declared, it is paid before common equity investors receive their payment.
If the company doesn't pay dividends in a given year, the amount due doesn't just go away. They accumulate and are owed because of the preference by the preference shareholders. Only after the company pays these accumulated dividends is it permitted to distribute them to common shareholders.
The preference share dividend is typically a fixed percentage of the face value of the share. This fixed-rate issue gives a certain income, unlike common shares, where dividends can vary based on profitability.
Generally, holders of cumulative preferred shares are not entitled to vote at shareholder meetings. They don’t participate in electing the board or deciding on major corporate moves.
In the event that the company is wound up, cumulative preference shareholders take precedence over common shareholders when assets are to be distributed. They are still below creditors (like bondholders), but above ordinary equity in claim.
These shares may be converted into common shares under specific circumstances or after a predetermined timeframe. This gives owners the chance for extra gain in case the common stock of the company performs well, apart from their predetermined dividend payments.
Cumulative preference shares come in several variants, each tailored to meet different investment goals and risk levels. Each of these types serves a unique purpose, helping investors align their investment choices with their financial goals, risk appetite, and time horizon. Here's a simplified look at the main types:
These shares come with an option for the company to buy them back after a fixed period. This provides the company with flexibility in managing its capital, and investors have a clearer idea of their investment timeline.
These shares don’t have a set maturity date, meaning they remain active indefinitely unless the company decides to repurchase them. While they offer the potential for long-term income, investors may have their money tied up for an uncertain duration.
These shares offer something extra. Along with fixed dividends, if the company performs exceptionally well, shareholders may also receive additional dividends from the surplus profits. This type allows investors to benefit from both stable income and company growth.
This is a more conservative option. Investors receive only the fixed annual dividends, with no share in any additional profits the company may earn. It's a lower-risk, lower-reward choice.
These shares can be converted into common equity shares at a later date, subject to specific terms and conditions. This feature enables investors to transition from fixed income to equity participation, potentially benefiting from future share price appreciation.
As the name suggests, these shares cannot be converted into common stock or equity. They are meant strictly for those seeking regular, fixed income without the intention of switching to common stock.
Suppose a company issues cumulative preferred shares that pay a 5% dividend each year. If during a year the company isn’t profitable and can’t pay dividends, your 5% simply rolls over. The following year, assuming profits return and dividends are declared, you’d receive the unpaid 5% from the previous year plus that year’s 5%. In total, you’d get 10% before any dividends go to common shareholders.
Cumulative preference shares offer numerous advantages, which is why they attract investors and businesses alike. However, as with any investment, there are a couple of downsides as well. Here's the balanced view on both sides:
Assured Dividend Accumulation
One of the significant benefits is that if a company cannot pay dividends in a particular year, the unpaid portion is carried forward to the next year. Once the company returns to profitability, these pending dividends are distributed, providing investors with a sense of financial security.
Priority Over Common Shareholders
Cumulative preferred shareholders are settled first, not only for dividends but also in the event of liquidation. This added layer of protection can be valuable during economic downturns or company insolvency.
Stable and Predictable Income
Such shares have a fixed dividend rate, and therefore, they represent a more stable source of income than common shares, whose dividends can fluctuate or disappear in bad years.
Higher Returns Than Common Equity (In Some Cases)
Compared to equity shareholders, preference shareholders often receive a higher dividend rate, especially when the company is not performing well.
No Ownership Dilution for Companies
Issuing cumulative preference shares from a company's perspective raises funds without diluting voting control or ownership, in contrast to issuing additional equity shares.
Limited Growth Potential
The fixed dividend is a disadvantage when the company does extremely well. Even though equity shareholders might get larger payments in prosperous times, cumulative preferred shareholders are left with their fixed rate, missing out on additional profits.
No or Minimal Voting Rights
Cumulative preference shareholders typically do not have a voice in company matters. Their right to vote is limited to issues directly impacting their shares, such as liquidation or changes to the capital structure, thereby excluding them from many of the corporate decisions.
Lower Return Compared to Equity in Boom Periods
As the return is predetermined, cumulative preference shares can underperform relative to equity shares when the business is expanding rapidly and generating high profits.
Limited Market Appeal Without Strong Backing
Typically, only financially robust (blue-chip) corporations are capable of issuing non-cumulative preference shares successfully. Generally, cumulative preferred stock is typically issued to maintain capital expenses at a lower level; however, this implies that the investors' return is normally conservative.
While cumulative preferred shares offer stability and priority over common stock, they are not without risks. Here are some key concerns investors should be aware of:
Even though unpaid dividends are supposed to accumulate, there's no guarantee of when they’ll be paid, especially if the company struggles financially for an extended period. In such cases, dividends may be deferred for years.
The Impact:
For investors who count on regular dividend income, this delay can disrupt cash flow and create financial uncertainty.
In the unfortunate event of liquidation, cumulative preference shareholders are behind bondholders and other debt holders in the line for repayment. If the company’s assets aren’t enough to cover all obligations, preference shareholders may receive little to nothing.
The Impact:
This makes cumulative preferred shares riskier than debt instruments when it comes to recovering invested capital in the event of bankruptcy.
Many cumulative preference shares come with a callable feature, which means the company can repurchase them at a set price after a specified period. While this benefits the issuer, it can work against investors, especially if the shares are called when interest rates are low and better alternatives aren't available.
The Impact:
This can reduce long-term income potential for investors and force them to reinvest their money at lower returns.
Cumulative preferred shares can be a good option for investors seeking stable returns. They ensure that even if a company can't pay dividends during tough times, those unpaid amounts will be carried forward. Once the company is profitable again, these accumulated dividends are paid out before any are distributed to regular shareholders. This can give cumulative shareholders an added layer of security and priority.
It may be a smart option for those who prefer consistent income, especially in uncertain market conditions. Overall, these shares offer a blend of reliability and preference, making them attractive for cautious, income-focused investors.
Disclaimer: This article is for informational purposes only and does not constitute investment advice. Bajaj Broking Financial Services Ltd. (BFSL) makes no recommendations to buy or sell securities.
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Cumulative preference shares are an investment where unpaid dividends are accumulated and paid out later, providing investors with greater protection even if the business is experiencing a poor year.
The key difference is that cumulative shares accrue unpaid dividends to be paid afterwards, whereas non-cumulative shares do not—if a dividend is not paid, it is lost.
They provide a stable income, greater priority for dividends, and improved safeguarding in bad times compared to ordinary shares.
Not necessarily. They're ideal for those who desire steady returns, but may not be suitable for high growth or greater control over the business.
Dividends are paid at a specific rate, and in case the company misses a payment, it accumulates and is paid back later when the company is prosperous once again.
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