How to Invest Money, George Garr Henry [interesting books to read .txt] 📗

of the figure showing the actual amount of current liabilities. If a company has outstanding large amounts of bills and notes payable, it occupies a vulnerable position. Inability to renew maturing notes was the cause of most of the industrial failures of last year.

(c) Net Earnings. The amount of net earnings is of great importance in estimating the strength of an industrial company. The figures for a number of years should be examined to determine whether the earnings are increasing or decreasing, and to discover whether or not the earning power of the company is stable. This will depend largely upon the nature of the article which the company produces or trades in. If its product enjoys a steady demand at a fairly uniform price, it is justifiable that some of its capital should be in the form of bonds; but if its earnings are subject to violent fluctuations due to rapid changes in the price of its product, there is little justification for conducting the business on borrowed money.

In this connection it should always be considered how greatly a falling off in gross earnings will affect net earnings; and the proportion between net earnings and fixt charges should be carefully noted.

In order for an industrial bond to receive favorable consideration, the average yearly net earnings of the company should amount to about three times the annual bond interest, taxes, and sinking funds. The greater the protection is in this respect the better.

(d) Form of Issue. The form in which an industrial bond is issued is a matter of some importance. If the principal of the bond does not become due for a number of years, there is danger that the property will depreciate so far in value as to leave the bond without sufficient margin of protection. There are two ways to overcome this difficulty. One way is to establish a sinking-fund which will retire a certain proportion of the bonds by lot each year. Another way is to issue the bonds in serial form, with a definite instalment maturing every year. In either case the annual sinking-fund or annual instalment should be greater than the probable depreciation so that the margin of security will be constantly increasing.

(e) Management and Control. No question is of greater importance in estimating the strength of an industrial company than the reputation of the men in charge. The ability and integrity of the men who control the policy of the company and the efficiency of the operating officials are the principal factors in the success of an industrial undertaking. Vacillating policies, weakly executed, will ruin the most promising enterprise. This is particularly true in the case of small companies. Every man of business experience will understand the importance of this factor and be guided by it in the selection of industrial securities.

Based upon the foregoing considerations it is of interest to inquire what degree of safety really attaches to the average industrial bond? How far does it meet the foregoing requirements? The question is difficult to answer. Industrial bonds vary greatly in point of safety, some issues possessing great strength and others being highly speculative. No general conclusions can be depended upon, and the investor is forced to consider each issue upon its own merits.

II. Rate of Income. The average net return upon industrial bonds is probably higher than upon any other form of funded corporate obligation. This constitutes one of the chief advantages of industrial bonds.

III. Convertibility. It is impossible to make any general statement in regard to the convertibility of industrial bonds. Some industrial bonds, notably the larger issues of well-known trusts, command a broad and active market. Such bonds can be sold in large amounts at almost any time without seriously affecting the price. On the other hand, small underlying issues of such companies, usually high-grade in point of security, or the obligations of smaller companies, are almost as unmarketable as real-estate mortgages. Between these two extremes all varieties of industrial bonds are to be found. The degree of convertibility which a security possesses is usually a matter of some importance, and the investor should make a careful examination of each bond in this respect.

IV. Prospect of Appreciation in Value. To what extent a bond may improve in security during the time that an investor holds it is of little importance unless the improvement be reflected in the market price of the bond. Only so can the investor take advantage of its appreciation in value. In order for the improvement in security to be reflected in market price and thus add to the principal invested, it is necessary that a bond should possess a fairly active market. For this reason the industrial bonds which hold out the greatest promise of appreciation in value are the larger, more speculative issues, which possess the greatest convertibility. The purchase of such bonds frequently results in substantial profits.

V. Stability of Market Price. The four points above touched upon—safety, rate of income, convertibility, and likelihood of improvement in intrinsic value—are all inherent characteristics of every bond. The likelihood of favorable or unfavorable fluctation in market price is largely external in its nature and depends upon general financial and business conditions.

As a class, industrial bonds can not be said to possess much stability of market price. Some of the smaller issues enjoy a fictitious stability because of their inactivity, but generally speaking industrial bonds are subject to wide fluctations in accordance with changes in the business outlook.

The foregoing is a summary, necessarily brief and imperfect, of the main points to be considered in judging the value of industrial bonds. The question remains whether such securities are desirable for the investment of a business surplus and of private funds.

Except in special cases industrial bonds are not suitable for a business surplus. It is impossible to find an industrial bond which combines all the characteristics necessary for that purpose. The requirements are great safety of principal and interest, a relatively high return, ready convertibility, and stability of market price. Many industrial bonds can be found which combine two of these requirements, some even which combine three, but the full combination, if it exists at all, is unknown to the writer.

In addition, the principle of distribution of risk should prevent one industrial company from investing its reserve funds in the securities of another industrial company.

For private investment the case is somewhat different. A man of good business judgment, who desires to obtain a high yield for which he is prepared to sacrifice something in the way of convertibility and prospect of appreciation in value, may buy the underlying issues of strong companies with every confidence in the safety of his principal. Again, the investor who wants a high yield and quick convertibility, who is prepared to take a business man's risk and to sacrifice stability of market price, may make a large profit by buying second-grade industrial bonds. No investor, however, should deceive himself with the idea that any industrial bond will satisfy all the requirements of the ideal investment.

VI PUBLIC-UTILITY BONDS

It was a common saying among bond-dealers a few years ago that the day of the municipal bond had passed, the day of the railroad bond was passing, and the day of the public-utility bond was to be. Municipal bonds were selling at fancy prices in consequence of the low rates for money which then prevailed, and railroad bonds appeared to be following in their wake. Public-utility bonds alone afforded a satisfactory yield, and it was felt that the investing public would be forced to turn to them.

This prediction, like many others which were based upon the assumption of continued ease in money, was destined to be unfulfilled. Almost immediately there appeared an added demand for capital, and in the face of this demand, supplies of capital which had before seemed ample became suddenly scarce. Money rates rose rapidly and as a necessary consequence municipal and railroad bonds fell in price to a point where their net return was commensurate with that obtained from the loaning of free capital. The investment situation was thus completely reversed. It was no longer a question as to what form of security investors must seek in order to obtain a satisfactory yield, but rather could the highest grade of municipal and railroad bonds be floated at any price. Under these circumstances the contemplated necessity of turning to public-utility bonds never arose, and the general investing public remains for the most part unfamiliar with their elements of strength and of weakness.

The term "public-utility company" denotes a private corporation supplying public needs under authority of a public franchise. The franchise may be of definite date or perpetual, and may be partial or exclusive.

Public-utility companies include street-railway, gas, electric-light and power, and water companies. Properly speaking, telephone companies should also be included, but they are not usually regarded as belonging to the class of public-service corporations.

It is impossible, within the limits of a single chapter, to discuss each kind of company separately. The investment value of street-railway bonds will be here considered, and it is felt that the general principles advanced, with slight modifications of detail, will be found equally applicable to a judgment of other forms of public-service securities.

I. Safety of Principal and Interest. In order to determine the safety of a street-railway company's bonds, the company must be subjected to a threefold examination, physical, financial, and political.

An examination must be made into the extent and condition of the physical property in order to ascertain whether the bonded debt is secured by property having a real market value in excess of the face amount of bonds issued. The first point to be determined is the extent and valuation of the company's real estate. If the appraised value of the land upon which power-houses and car-barns have been erected is alone greater than the amount of bonds outstanding, the investigation need go no further, for the bonds, in such a case, would be practically a real-estate mortgage. In most instances, however, this is very far from being the case; and after careful appraisal of the real estate it is then necessary to make a careful valuation of the other physical property; namely, power-plants, depots, car-sheds, roadway, and equipment.

It is usually impossible for the average investor to make such an examination himself, nor is it likely that he would possess sufficient technical knowledge to render his investigation of much value. For an accurate estimate of the value of a street-railway's physical property, it is usually necessary to depend upon the expert opinion of a trained engineer. It is a matter of regret that the average street-railway report can not be relied upon to furnish an accurate valuation of the physical property; and it is accordingly customary for careful bond-dealers, when they contemplate taking an issue of street-railway bonds for distribution among their clients, to have the property examined by a competent engineer, whose report then determines for them the question of taking the issue.

Disregarding the figures which show the cost of property and equipment upon the company's books, the engineer proceeds to make a careful estimate of the replacement value of the property, including real estate. If the result of the examination shows that the property could not be duplicated for the amount of the bond issue, the company occupies an unusually strong position—altho even in such a case some part of the value of the bonds comes from the strength of the company as a going concern.

In most cases, however, it is probably found that the bond issue is in excess of the value of real estate and the replacement value of the physical property, the balance representing a capitalization of the franchise.

To determine the real value of the franchise or franchises is a difficult matter and