Security Analysis by Benjamin Graham and David Dodd was first published in 1934. It is a fundamental book for serious students of value investing.
Given a large portion of the American corporation financing was done through low-grade bonds and preferred stocks, Mr. Graham and Mr. Dodd thought it is worth discussing them despite the unpopularity of such issues.
The authors start with a rather non-negative view that capped upside potential is not a real problem for such issues because the possible return in low-grade issues is of the order of returns achievable from common stock. However, low-grade issues should be evaluated similarly to the thorough analysis that goes into common stock investments. Nonetheless, there are specific differences between common stock and low-grade issues. The presence of the latter signifies business weakness which could be short-term in nature, and the price could come back. Plus, there is a possibility of income continuation from such issues versus nonpaying common stock.
The authors emphasize working capital considerations for junk bonds and speculative preferred stock. Large working capital could be beneficial. Specifically, working capital in multiples of par and market value could make such issues attractive from a security standpoint given asymmetric payoff. However, such investments should be done on a group basis because there is still a possibility of loss.
The authors specifically tackle various stages of speculation in speculative low-grade preferred stocks as they are more subject to beliefs than low-grade bonds. One of the areas of extreme speculation was seen when preferreds accumulated dividends. Thus writers suggest a principle as a preventive measure.
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