The Yin And Yang Of Preferred Stocks

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Investment in preferred stocks may have a number of merits. Chief among them is a reasonable regularity of income coupled with a reasonable safety of principal, since the preferred stockholder is assured of certain rights with respect to the latter. The rate of return on preferred stocks is often slightly higher than that which may be obtained on good-quality bonds.

In addition, the high-grade preferred have always shown considerable resistance to market fluctuations. It is to be noted that the better quality preferred stocks are now eagerly sought by insurance companies, trustees, endowment funds, and the like. We hasten to add, however, that all preferred stocks are not alike in quality, so that careful investigation should be made and investment confined only to upper-grade issues.

Those who argue against investment in preferred stocks point out the following features: there is limited return although considerable risks of ownership are borne; there is no enforceable right to dividends, since these must be declared by the board of directors and they may pass one or more dividends at their discretion; the owner of a preferred stock is in a position midway between that of a bondholder (creditor) and that of a common stockholder (partner), so that his stock is "neither fish nor fowl" and his position may eventually prove to be an uncomfortable one.

From the viewpoint of our typical investor of modest means we may say that there are a number of good-grade, low-par-value preferred stocks in which he may safely invest; among these are the stocks of certain very successful public utilities. The return, at least under present market conditions, is in the range between 4 and 5 percent; these yields lie somewhere between those of good-grade bonds and the better common stocks. Since all fixed charges have been covered over two and one-half times and since these utilities resist successfully the various ups and downs in the general business cycle, these preferred stocks represent good value and may well be included in the investment portfolio of the investor of modest means.

As is the case with all securities, we must emphasize that there is no such thing as a "cheap" preferred stock, nor does the word "preferred" necessarily operate as some sort of magic wand. Those that are of poorer grade will reflect just that appraisal in their prices, sometimes fluctuating within wide limits because of the varying fortunes of their respective companies. Perhaps the best rule to follow would be to insist on good quality; in this way there is at least some insurance of safety of principal, not to mention regularity of income.

It must be remembered that the chief risk in all high-grade securities (bonds and preferred stocks) is not related to the general course of business activity. It is most commonly related to the current rates of interest; in other words, whether money is plentiful or is "tight." This has already been mentioned in our discussion of bonds; it also applies to the market price and the yield of preferred stocks.

Should a choice be required between investment in bonds and preferred stocks, there would seem to be a number of good reasons to prefer the former. Bond interest must be paid and is a first claim on earnings, but directors may pass a preferred dividend when earnings do not permit payment and force the preferred into arrears. In the end, it is up to the individual investor and the advice of his broker to decide which way to roll the dice.

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