47. Common Stock

One of the largest tasks that you will face when setting up an overall financial plan is that of attempting to protect your assets from the ravages of inflation and hopefully make some money at the same time.

About the only way inflation can be minimized is through an investment that has a good likelihood of appreciating at a rate in excess of the inflationary rate. Over the years, equity participation has come to be regarded as one of the best inflation fighters available, as well as one of the types of investments that offer good wealth-building opportunities.

When one thinks of equity participation, what usually comes to mind are common stocks; and well they should, for they represent by far the largest single type of equity participation available to the investing public. However, while it is the largest, common stock ownership is not the only type of equity participation available.

Common stock, by and large, is usually represented by a certificate. The use of a stock certificate is evidence of what is basically a huge and extremely complex bookkeeping transaction undertaken to show who has whatshare of what company and how it was acquired. The certificate represents:

A fractional share in the assets of the corporation on liquidation;

A proportional share of current net assets and future assets while
viable; and

A voice in management.

Basically, the various types of common stock one of your clients could use in his or her financial plan are growth stocks, income stocks, blue chip stocks, "glamour" stocks, speculative stocks, hybrid stocks such as convertible preferred (representing elements of both growth and income), cyclical stocks, and in some cases "hot new issues," complete with trading in the underlying options and warrants issued from time to time.

Growth Stocks - Growth stocks are stocks that have good long-term prospects, either because the industry is expanding or because the company itself appears to be more sound than others in the industry. Because of the need for growth, dividends are plowed back into the company operation, with the tacit understanding of the shareholders that the overall aim is long-range rather than short-range profits.

When looking for a growth area to recommend, you must look at the growth factor of industries. For example, consider the electronics boom of the late 1950s or the "baby boom," which led to the rapid rise ineducational-material stock, or the government spending in housing in 1964, and, most recently, the trend towards ecology and antipollution. Considering growth elements for a balanced portfolio involves a continual awareness of new consumer demands, trends, and technological processes. Most brokerage houses have lists of what they consider to be good growth potentials from both industry standards and the point of view of the current leaders within the particular industry and will be only too glad to provide them on request. If you want to do some looking on your own, make a list of high performers in a field and send for company prospectuses, which are readily available on request.

One caution on growth stock: The term should not always be taken to mean "nonrisk," especially when an exciting new industry or company is involved. Take a careful look at what the SEC terms "risk investments". Always keep in mind that at one time IBM and Xerox were considered risk investments.

Advantages of Growth Stock Ownership: Some of the advantages of owning growth stock are: growth stock offers an excellent opportunity for capital gains. This can represent a big saving over the ordinary income
rates he or she would have to pay if the stock owned was that of a company paying out most of its earnings in the form of dividends.

Commission expenses are reduced by holding on to a stock in anticipation of growth and not continually trading. This also eliminates to a large degree the need for management of the portfolio.

Growth stock offers an excellent opportunity for meeting retirement needs because the hoped-for appreciation may be realized at retirement when it's needed and taxes will be less because of reduced income.

Disadvantages of Growth Stock Ownership: Owning a growth stock is not without its disadvantages. Some disadvantages are:

In the early years of ownership there is a relatively poor rate of income return in terms of dividends. So if immediate income is needed, the average person wouldn't want to look to growth stock.

It is difficult to determine when a growth stock stops growing; a phenomenon usually reflected by a drastic price change and often resulting in a substantial loss.

It is not always easy to find a good growth stock.

A long period of time may be needed to realize any appreciable gain.

Income Stocks - Not much need to be said about income stocks other than that the yield should, in general, be higher than that of savings banks, and the quality should be as good as a bond with a comparable yield. As with growth stocks, brokerage firms will be happy to provide lists of good-quality, high-yield companies that pay out most of their net earnings quarterly in dividends. The yield naturally will change as the price of the stock fluctuates. If the company is well chosen, with attributes of good management, quality product, growing industry, good standing in the industry, marketability of product, well-known name, and other factors that
the research department of firms decide make it a quality stock, the dividend income should not fluctuate to any great degree. As a matter of policy, the client should be advised that the dividend in this type of stock is rarely affected by temporary fluctuations.

Blue Chips - Blue chip stocks can be found on any number of selective lists and are those of tried-and-true companies with long histories of earnings, such as American Telephone and Telegraph, F.W. Woolworth, Exxon,
and General Electric, to name a few. Stock in these companies is probably as close as one can come to a bond and still have stock ownership. However, don't forget that blue chip stocks are not bonds and some have
shown disappointing market results in recent years.

Glamour Stocks - Glamour stocks are the darlings of the market and the ones most frequently read about in the newspapers and touted whenever two or more investors get together. The glamour of a company stock may stem
from its president, its introduction of a revolutionary new camera, its discovery of a new oil find in Canada or Alaska, etc. Like the glamour of movie stars, however, it may be fleeting.

You may think you are overly conservative if your portfolio isn't laden with glamour stocks, just remember that by the time a stock has become glamorous, professional investors and other people with their ears to the ground might well have gotten in at the precise moment so that by the time you invest the stock may be "topping out". Generally, the best advice is to avoid glamour stocks unless there is convincing evidence of the basic soundness of the company and its product and the future growth potential of its industry.

Speculative Stock - Speculation can't be likened to gambling, since it involves a reasoning process based on calculated risk, a concept that surpasses the chance shake of the dice. While much of this country's
economic growth could not have evolved without it, the fact remains that any speculative stock is highly volatile and a high risk.

Speculative fever is high when the market is in the doldrums or declining. But a heavy purchase of speculative stock is just not good financial planning. Highly speculative stocks have no place in the average investor's portfolio, and you should be advised against them unless you have a good deal of "extra" money and are well prepared to lose it.

The same things that can be said about speculative stocks in general go for cyclical stocks, such as the toy industry and the textile industry, which have wide fluctuations in inventories throughout the year. The same principles are also applicable to "hot issues", the slew of new issues with fancy names that flood the market with their attractiveness in terms of low prices and high promises.

Overall, the dilution factor, the amount of equity the stockholder will actually have in terms of his or her shares per dollar after the entrepreneurs have taken their shares (often without putting up any money), coupled with a relatively inexperienced management, in most cases has added up to an appalling number of failures in speculative companies.

Lastly, there are tax considerations that can't be overlooked, since profits are usually short- rather than long-term.

Preferred Stock

Preferred stock has often been ignored by financial planners, but certainly should not be. It has preference over common in the distribution of dividends and may also have privileges in connection with the distribution of assets in the event of dissolution. Preferred stock generally has no voting rights unless some specified event occurs, such as the nonpayment of a dividend or the sale of mortgaged assets. Preferred pays fixed percentage rates that become debts of the corporation after the board of directors has declared the percentage.

Preferred stock can be broken down into two categories: participating preferred, which is entitled to dividends in excess of the stipulated rate under certain conditions, and cumulative preferred, which means simply that if a dividend is declared but not paid for a given year, preferred stockholders would be entitled to the accrued dividend until such time as it can be paid and even before common stockholders receive a dividend.

Attractiveness of Fixed Rate: The fixed interest rate makes the preferred attractive when the market is on the downside. Many people who want relatively secure investments will find a haven in preferred stock.

Disadvantages of Preferred Stock: Owning preferred stock has its disadvantages. For instance, as we have mentioned, there are no voting rights. However, voting privileges aren't too important to the average stockholder. But one disadvantage is that most preferred stocks have a call provision that permits the company to buy back the stock at full value, which often happens when interest rates decline. Another disadvantage is that there is no certainty of capital recapture as in the case of bonds. The preferred usually sells well above the common stock, but this is by no means always the case. Preferred stock is not a hedge against inflation, since its fixed rate does not reflect the rise in prices received by the corporation and returned by way of increased dividends. Consequently, a more attractive investment is convertible preferred, a type of stock that has become increasingly popular in recent years.

Convertible Preferred Stock - Convertible preferred is merely a preferred stock that is exchangeable for common stock at a given ratio of, say, one share of convertible for five shares of common. The fixed dividend rate is usually slightly less than the preferred because of the right to convert.

Tax reference verification 1-800-829-1040

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