Chapter 8: Classification of Securities
Graham warns that the
basis for
classification is not the title of the issue, but the practical
significance of
its specific terms and status to the owner.
The following
classification is
suggested:
- Investment bonds
and preferred stocks: Includes all issues, whatever the title, in which
prospective change of value may fairly be said to hold minor
importance. The owner’s dominant interest lies in the safety of
his principal and his sole purpose in making the commitment is to
obtain a steady income.
- Speculative bonds
and preferred stocks: Prospective changes in the value of the principal
assume real significance.
- Convertibles,
etc.: The investor hopes to obtain the safety of a straight investment,
with an added possibility of profit by reason of a conversion right or
some similar privilege.
- Low grade senior
issues: A definite risk of loss is recognized, which is presumably
offset by a corresponding chance of profit. These differ from Group
iii, in two respects – they enjoy an effective priority over some
other junior issue, thus giving them a degree of protection and their
profit possibilities, however substantial, have a fairly definite
limit, in contrast with the unlimited percentage of possible gain
associated with common stock investment.
- Common stocks
A bond of investment
grade which
happens to sell at any unduly low price would belong in the second
group, since
the purchaser have a reason to expect in an appreciation of its market
price. A
preferred stock selling at 10 cents on the dollar should be viewed not
as a preferred
stock at all but as a common stock.
The primary emphasis
is not
placed on what the owner is legally entitled to demand but on what he
is likely
to get or justified in expecting, under conditions which appear
probable at the
time of purchase.
Part II deals with
Group (i),
Part III deals with Group (ii) and Parts IV, V, VI deal with Group
(iii).