Dividends in Arrears

Dividends in Arrears are missed dividend payments that a company owes to its shareholders. However, this isn't just any missed dividend; this concept applies specifically to a special type of stock called cumulative preferred stock. Think of these shareholders as being at the front of the line for payouts. If a company hits a rough patch and can't afford to pay its promised dividends, these unpaid amounts don't just disappear. Instead, they pile up as a debt—the “arrears.” The company is legally obligated to pay back every last cent of these accumulated dividends to its preferred shareholders before the holders of common stock can receive any dividends at all. This protective feature is what makes cumulative preferred stock a unique and often safer, income-focused investment compared to its common counterpart.

Imagine you own a share of “SafeCo” cumulative preferred stock, which promises to pay you a $10 dividend every year. This year, however, SafeCo has a terrible year and decides to suspend all dividend payments to conserve cash. You don't receive your $10. This missed payment is now considered a dividend in arrears. The company owes you $10. Next year, SafeCo makes a brilliant comeback. The business is booming, and the board of directors wants to reward shareholders. But before they can even think about paying a dividend to the common stockholders, they have to settle their tab with you. They must pay you:

• The $10 dividend from last year (the arrears).
• The $10 dividend for the current year.

So, you receive a $20 payment per share before anyone else in the common stock pool sees a penny. This “cumulative” feature acts as a strong protection for preferred shareholders.

For the savvy investor, the appearance of dividends in arrears is a major signal—one that can be interpreted in a couple of different ways. It’s a classic case of seeing either a warning sign or a hidden gem.

First and foremost, dividends in arrears are a bright red flag. Companies do not like to miss preferred dividend payments. It damages their reputation in the financial markets and can make it much more difficult and expensive to raise money in the future. A company that is forced to skip these payments is likely experiencing significant financial distress. For a conservative value investing practitioner, this might be a clear signal to stay away, as it points to fundamental problems within the business that could lead to further decline or even bankruptcy.

On the other hand, for a more enterprising or contrarian value investor, dividends in arrears can spell opportunity. If you do your homework and determine that the company's problems are temporary and solvable, you might have found a “special situation.” The market often overreacts to bad news, pushing the price of the cumulative preferred stock down. An investor who believes in the company's long-term recovery could potentially:

• Buy the preferred stock at a deep discount.
• Wait for the company to turn its operations around.
• Collect a lump-sum payment of all the accumulated back-dividends once the company restores its financial health.

This is a high-risk, high-reward strategy. It requires a deep dive into the company’s financials, including its balance sheet and income statement, to be confident that a recovery is not just possible, but probable.

• What are they? Unpaid dividends on cumulative preferred stock that the company must eventually pay out.
• Who gets paid first? Holders of cumulative preferred stock must receive all dividends in arrears before common stockholders can be paid any dividends.
• What do they signal? Often a sign of serious financial trouble, but for the discerning value investor, they can sometimes highlight a high-potential turnaround investment.
• Is it a guarantee? No. If the company goes bankrupt, preferred shareholders might still lose their investment and never see the arrears paid. Due diligence is essential.