Ben Graham is the father of modern equity analysis, but he also had some really smart ideas about buying bonds.
A brief recap for those not familiar with how various forms of debt work. When a company can’t afford to pay off their creditors, they stand in line in a particular order as to who gets paid. First are the senior bond (debenture) holders then various junior bonds, then the preferred stock shareholder and finally common stockholders. If a company goes into insolvency, this usually means there isn’t much left for preferred and common stockholders.
This is something that many investors pay attention to, where they are in the pecking order, because it’s somewhat safer to own a senior security (like a first mortgage bond) versus owning some preferred stocks. But Graham’s point is a particularly pithy one. He said that if you have to be concerned about where you may stand in the pecking order for a company’s debt, it’s probably not a good investment. If there is a reasonable chance that you’ll have to stand in that line, you’re better off looking elsewhere. Instead, he suggested that you look for companies that will have no problem covering any of their debts, and then buy the lowest rated stuff (i.e. highest yielding) debt for that company. If you know the company can pay all their bills no matter what, it doesn’t matter where you stand in line, so you might as well get a little higher interest rate.
There are exceptions to this advice, where some bonds and preferred stocks may be significantly undervalued. But that’s research that is very difficult for the general public to do. So in this period where high interest rates are tough to come by, Ben Graham’s advice might put a few more dollars (safely) in your pocket.