Okay, you know what a dividend is. Companies generally commit to paying it when they have soooo much extra cash profit that they really don’t know what to do with the dough.
Yeah, nice place to be.
In the case of preferred stock, the dividends aren’t just…optional-ish. They operate more like bond interest. only with a catch. Dividends on preferred stock can, in fact, be halted without the company being repossessed by the debt holders. Like...in the case where the company falls on hard times. Or it wants to preserve its cash to buy a competitor. Or it just wants another jet-with-waterslide-thing.
So there are two types of preferred stock in this realm...the ones that pay cumulate dividends, and ones that don’t… cleverly named non-cumulative. Say a company has halted dividends from its preferred for 3 ½ years… and it was paying five dollars a quarter in dividends from those cumulative preferreds. Well, if it was to resume paying dividends on them, it would first have to pay all 14 quarters’ worth of dividends before it began to issue more dividends. That is, it owed 3 years times 4 quarters, or 12 quarters, plus a half year, or 2 quarters, for a total of 14, at 5 bucks a quarter a share. That's 5 times 14, or 70 bucks. Big obligation. But it has to pay that amount before it can resume dividend payments.
Why would a company have a cumulative feature in its preferred dividend obligation? Because investors forced it to do so, worried that the preferred dividends might be just summarily stopped, and then the investors would have little or no return on their investment in the preferreds. And this can be a problem for companies that have fallen on hard times. They are essentially made illiquid, in that they can’t afford to pay the back dividends on the preferreds, and they can’t raise more capital with this blight on their record of having stopped paying a divvy. Most preferred stocks are non-cumulative, and if companies decide to just stop paying them, they can…but if they do, it’s like they have kind of reneged on a handshake. And, uh…investors…talk.
So like…good luck to the company ever trying to raise capital again from the cold, cruel outside world.
Related or Semi-related Video
Finance: What is the Dividend Discount M...2 Views
Finance allah shmoop what is the dividend discount model Well
it's a technique used to value companies or at least
it wass in the stone age And yet in the
nineteen fifties maybe which basically says that a company's value
is fully contained in the cash dividends it distributes back
to invest doors This model is only useful really for
its historical relevance We we just don't use that much
these days Yeah back in the old timey cave man
days when there was essentially no research of real merit
being done on the performance of investments of whatever flavor
the dividend discount model was the best thing investors had
to value an investment in a company And remember in
those days companies paid rial dividends that were a meaningful
percentage of the total value of the company Unless so
a company pays a dollar a share this year in
dividends Historically it's raised dividends at about three percent a
year like paid a dollar last you'd expect two dollars
three next year in dollars six and change the next
so well The dividend discount model discounts backto present value
And yes we have an opus on what president value
Means but here's the logline definition present value of all
future cash flows discounted for risk in time Back to
cars Yeah that thing well a few odd things are
worth noting in this horse and buggy era formula The
dividend discount model ignores the terminal or end value of
the company Like say twenty years from now the company
is sold for cash The dividends are all that are
really focused on though in our model that seem strange
to you Well maybe But let's say the discount rate
is ten percent in the risk free rate is four
percent for a total of fourteen percent a year discounted
back to the present So doing the math just looking
at the terminal value of say a hundred million bucks
in a sale to be made twenty years from now
Let's figure out what that's worth today Well you take
the one point one four Put it to the twentieth
power to reflect twenty years of discounted valuation compounding And
you say one point one four forty twenty powers about
thirteen point seven So to get the present value of
one hundred million bucks twenty years from now using this
discount rate Will you divide the hundred million by thirteen
point seven and that means that the one hundred million
dollars twenty years from now today is worth only seven
point three million bucks And yeah that's ah big haircut
kind of like this guy Well the formula focuses ah
lot on near term dividend distribution and it's Really more
interesting is a relic of original financial research in theory
than anything directly useful today And if you find this
interesting while then we may have a gig for you
here at shmoop finance central Yeah come on down We 00:02:39.715 --> [endTime] need writers good ones not like me
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