Securities. Categories of common stock

There is a lot to be said about securities. Security is an instrument that signifies (1) an ownership position in a corporation (a stock), (2) a creditor relationship with a corporation or governmental body (a bond), or (3) rights to ownership such as those represented by an option, subsription right, and subsription warrant. People who own stocks and bonds are referred to as investors or, respectively, stockholders (shareholders) and bondholders. In other words a share of stock is a share of a business. When you hold a stock in a corporation you are part owner of the corporation. As a proof of ownership you may ask for a certificate with your name and the number of shares you hold. By law, no one under 21 can buy or sell stock. But minors can own stock if kept in trust for them by an adult. A bond represents a promise by the company or government to pay back a loan plus a certain amount of interest over a definite period of time.

We have said that common stocks are shares of ownerships in corporations. A corporation is a separate legal entity that is respon­sible for its own debts and obligations. The individual owners of the corporation are not liable for the corporation’s obligations. This concept, known as limited liability, has made possible the growth of giant corporations. It has allowed millions of stockholders to feel secure in their position as corporate owners. All that they have risked is what they paid for their shares.

A stockholder (owner) of a corporation has certain basic rights in proportion to the number of shares he or she owns. A stockholder has the right to vote for the election of directors, who control the company and appoint management. If the company makes profits and the directors decide to pay part of these profits to shareholders as dividends, a stockholder has a right to receive his proportionate share. And if the corporation is sold or liquidates, he has a right to his proportionate share of the proceeds.

What type of stocks can be found on stock exchanges? The question can be answered in different ways. One way is by industry groupings. There are companies in every industry, from aerospace to wholesale distributors. The oil and gas companies, telephone com­panies, computer companies, auto companies and electric utilities are among the biggest groupings in terms of total earnings and market value. Perhaps a more useful way to distinguish stocks is according to the qualities and values investors want.

Growth Stocks. The phrase “growth stock” is widely used as a term to describe what many investors are looking for. People who are willing to take greater-than-average risks often invest in what is often called “high-growth” stocks—stocks of companies that are clearly growing much faster than average and where the stock com­mands a premium price in the market. The rationale is that the company’s earnings will continue to grow rapidly for at least a few more years to a level that justifies the premium price. An investor should keep in mind that only a small minority of companies really succeed in making earnings grow rapidly and consistently over any long period. The potential rewards are high, but the stocks can drop in price at incredible rates when earnings don’t grow as expected. For example, the companies in the video game industry boomed in the early 1980s, when it appeared that the whole world was about to turn into one vast video arcade. But when public interest shifted to personal computers, the companies found themselves stuck with hundreds of millions of dollars in video game inventories, and the stock collapsed.

There is less glamour, but also less risk, in what we will call—for lack of a better phrase—“moderate-growth” stocks. Typically, these might be stocks that do not sell at premium, but where it appears that the company’s earnings will grow at a faster-than-average rate for its industry. The trick, of course, is in forecasting which companies really will show better-than-average growth; but even if the forecast is wrong, the risk should not be great, assuming that the price was fair to begin with.

There’s a broad category of stocks that has no particular name but that is attractive to many investors, especially those who prefer to stay on the conservative side. These are stocks of companies that are not glamorous, but that grow in line with the economy. Some examples are food companies, beverage companies, paper and packaging manu­facturers, retail stores, and many companies in assorted consumer fields. As long as the economy is healthy and growing, these companies are perfectly reasonable investments; and at certain times when everyone is interested in “glamour” stocks, these “non-glamour” issues may be neglected and available at bargain prices. Their growth may not be rapid, but it usually is reasonably consistent. Also, since these companies generally do not need to plow all their earnings back into the business, they tend to pay sizable dividends to their stock­holders.

PREFERRED STOCKS

A preferred stock is a stock which bears some resemblances to a bond (see below). A preferred stockholder is entitled to dividends at a specified rate, and these dividends must be paid before any dividends can be paid on the company's common stock. In most cases the preferred dividend is cumulative, which means that if it isn't paid in a given year, it is owed by the company to the preferred stockholder; If the corporation is sold or liquidates, the preferred stock­holders have a claim on a certain portion of the assets ahead of the common stockholders. But while a bond is scheduled to be redeemed by the corporation on a certain "maturity" date, a preferred stock is ordinarily a permanent part of the corporation's capital structure. In exchange for receiving an assured dividend, the preferred stockholder generally does not share in the progress of the company; the preferred stock is only entitled to the fixed dividend and no more (except in a small minority of cases where the preferred stock is "participating" and receives higher dividends on some basis as the company's earnings grow).

Many preferred stocks are listed for trading on the NYSE and other exchanges, but they are usually not priced very attractively for individual buyers. The reason is that for corporations desiring to invest for fixed income, preferred stocks carry a tax advantage over bonds. As a result, such corporations generally bid the prices preferred stocks up above the price that would have to be paid I' a bond providing the same income. For the individual buyer, a bond may often be a better buy.