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Chapter 14: The Theory of Preferred Stocks

The typical preferred stock represents an unattractive form of investment. On the one hand, its principal value and income return are both limited; on the other hand, the owner has no fixed, enforceable claim to payment on either principal or income. Preferred stocks combine the limitations of creditorship (bonds) with the hazards of partnership (common stocks).

The essential difference between preferred stocks and bonds is that payment of preferred dividends is entirely discretionary with the directors, whereas payment of bond interest is compulsory. The preferred stockholders are subject to the danger of interruption of dividend payments under conditions which would not seriously threaten the payment of bond interest.

Qualification of Grade Preferred Stocks: It must meet all the minimum requirements of a safe bond. It must exceed these requirements by a certain added margin to offset the discretionary feature in payment of dividends. The stipulation of inherent stability in the business itself must be more stringent than in the case of a bond investment.

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