Guaranteed Stocks

Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
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Shares of stock, preferred or common, the payment or dividends on which have been guaranteed by a corporation other than the issuer.  Guaranteed stocks arise under much the same circumstances as GUARANTEED BONDS, but they are particularly found in railroad finance, although occasionally they occur among public utilities.

Guaranteed RAILROAD STOCKS arise by reason of one railroad company's lease of its property to another, under the terms of which the lessee railroad guarantees the payment of dividends at a stipulated rate on the stock of the lessor corporation.  In default of payment of dividends or dis-affirmance of the lease, the lessor may take back its property, in addition to having claim for the default upon the lessee.  Leased line stocks particularly arose during the era of expansion of U.S. railroads when the major trunk lines found it necessary to resort to leases for the acquisition of divisional or branch mileage, such leases running for very long terms.

Dividends on guaranteed stocks are part of the fixed charges of the lessee company operating the property, and thus such dividends are a charge on the gross income of the operating or lessee company ranking with the interest on the operating company's own bonds.  Consequently they are a charge ranking prior to the operating company's own dividends.  Failure to pay the guaranteed rate abrogates the lease.  In the final analysis, the importance and essentiality of the leased line to the lessee are determining factors in continued interest of the lessee in the leased line.  In some railroad re-organizations of the late 1930s, reduction in fixed charges of railroad debtors involved dis-affirmance of some leases on lines whose importance and essentiality to the system had declined over the long term.

Thus railroad guaranteed stocks are rated, among other factors, on the essentiality of the leased line to the lessee in modern times.  The seasoned and better quality guaranteed railroad stocks sell on a yield basis comparable to the higher-grade railroad bonds of the lessee systems, with which they are comparable because of the fixed nature of the lease obligation.

Erroneously, preferred stocks having no connection with guaranteed dividends are sometimes referred to as guaranteed stocks, although preferred dividends, even if cumulative, are in no sense guaranteed by the issuer in the absence of specific guarantee.

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