r^OOG
j\)iJi-i^-^^ —
Southern Branch
of the
University of California
Los Angeles
Form L 1
SOOQd
This book is DUE on the last date stamped below
UL 1 7 1928
MAY 12 mS'
JUL ^ ^931
OCT 16 ^^^^
MAY 1 7 1935
FEB 4 1938
Form L-9-15to-8,'26
XXIII— 1
A SERIES OF TEXTS PREPARED AS
PART OF THE MODERN BUSINESS
COURSE AND SERVICE OF THE
ALEXANDER HAMILTON
INSTITUTE
ALEXAIVDER HAMILTON INSTITUTE
NEW YORK
J 6 1
Modern Business
EDITOR-IN-CHIEF
JOSEPH FRENCH JOHNSON
Dean, New York University Scliool of
Commerce, Accomits and Finance
MANAGING EDITOR
Roland P. Falkner
ASSOCIATE editors
Leo Greendlinger, Charles W. Hurd
Volume Titles Authors
1. Business and the Man Joseph French Johnson
2. Economics of Business The Editors
3. Organization and Control .... Charles W. Gerstenberg
4. Plant Management Dexter S. Kimball
5. Marketing and Merchandising . . . The Editors
6. Advertising Principles Herbert F. de Bower
7. Salesmanship and Sales Management . John G. Jones
8. Credit and the Credit Man .... The Editors
9. Accounting Principles The Editors
10. Cost Finding Dexter S. Kimball
11. Corporation Finance William H. Walker
12. Business Correspondence Harrison Mc Johnston
13. Advertising Campaigns Mac Martin
14. Railway Traffic Edwin J. Clapp
15. Foreign Trade and Shipping .... J. Anton de Haas
16. Banking Major B. Foster
17. Domestic and Foreign Exchange . . E. L. Stewart Patterson
18. Insurance The Editors
19. Office Management The Editors
20. The Exchanges and Speculation . . Albert W. Atwood
21. Accounting Practice and Audfting . John T. Madden
22. Financial and Business Statements . Leo Greendlinger
23. Investment Edward D. Jones
24. Business and the Government . . . Jeremiah W. Jenks
INVESTMENT
BY
EDWARD D. JONES, Ph.D.
Professor of Commerce and Industry,
University of Michigan
MODERN BUSINESS
VOLUME 23
ALEXANDER HAMILTON INSTITUTE
NEW YORK
COPYRIGHT, 1918, 1919, BY
ALEXANDER HAMILTON INSTITUTE
COPYRIGHT IN GREAT BRITAIN, 1918, 1919, BY
ALEXANDER HAMILTON INSTITUTE
The title and contents of this volume as well as the
business growing out of it, are further protected
by laws relating to trade marks and unfair trade.
All rights reserved, including translation into
Scandinavian.
Registered trade mark, Reg. TJ. S. Pat. Off., Marca
Registrada, M. de F.
Made in U. S. A.
/,
PREFACE
The subject of investment, regarded as a body of
knowledge, is an assemblage of material derived from
many different sources. One can recognize in it
ideas taken from law, from accounting, from corpora-
tion finance, from mathematics, and from the general
literature of industry and commerce.
The matters which appear to be in some degree ex-
clusive to the subject are the study of security fluctu-
ations and trade cycles, together with information as
to the technique of trading. To deal exclusively with
such subjects would mean writing a book upon specu-
lation rather than upon investment. Altho invest-
ment and speculation cannot be kept entirely apart, it
is precisely because investment rests upon the basis of
organized knowledge above referred to, that it aspires
to be scientific in method, while s])eculation is an art.
In presenting a general text upon investment,
which aims to preserve some sort of balance and pro-
portion between the various topics, an author must
lay aside, or severely abbreviate, his special studies,
and off'er a book of general or introductory character.
Of the utility of such books there can be no question.
The daily losses of investors' capital bear sufficient
testimony to that. But such a book should be looked
upon by the reader as an introduction to the subject
vi PREFACE
and not as something upon the completion of the last
page of which he may arise and go forth to deal with
the complexities of the modern security market as a
full-fledged expert.
If such a book is a synthesis of law, accounting, cor-
poration finance, etc., and an application and illus-
tration of them, it should move the reader to return to
the study of those subjects with renewed zeal.
Another result should be to make somewhat more
clear in the reader's mind what expertness or compe-
tence or science in investment means. If the veil has
been drawn aside for a brief time, and he has seen the
work upon which the staffs of bond houses and great
banks and consultation services spend their lives, the
reader should more highly value the expert, and so
place his confidence and patronage with greater dis-
crimination.
Edavard D. Jones.
Ann Arbor, Mich.
TABLE OF CONTENTS
CHAPTER I
FARM MORTGAGES
SECTION PAQK
1. History and Importance 1
2. Investments for Corporations 2
3. Agricultural Districts 5
4. Geography of Interest Rates 6
5. Judging a District 7
6. Use of Agricultural Statistics 8
7. Soil Survey Studies 9
CHAPTER II
FARM MORTGAGES (continued)
1. Choice of an Agent '16
2. Agent's Service 16
3. Agent's Safeguards 18
4. Agent's Commissions 19
5. Choice of a Borrower 20
6. Agent's Circulars and Reports 21
7. Term 30
8. Legal and Technical Points 30
9. Interest Payment 32
10. Prepayment 32
11. Foreclosure 33
12. Equities of Redemption 33
13. Other Laws 34
14. Documents 35
15. Farm Mortgage Bonds 36
vil
viii INVESTMENT
CHAPTER III
URBAN REAL ESTATE
SECTION PAOB
1. Structure of a City 39
2. Mercantile Section 41
3. Manufacturing Section 41
4. Residential Section 42
5. Chances Incident to Growth 43
6. Lot Valuation 44
7. Variation of Value with Depth 46
8. Corner Influence 49
9. Plottage 50
10. Buildings 51
11. Unit Building Costs 52
12. Over-Improvement 53
13. Improvement and Change of Utility .... 55
14. The '^Taxpayer" 56
CHAPTER IV
URBAN REAL ESTATE (continued)
1. From Rentals to Values 58
2. From Rental to Renters 60
3. Elements in the Valuation of Real Estate . . 62
4. Real Estate Mortgages 64
5. Guaranteed Mortgages 67
6. Second Mortgages and Participating Mortgages 67
7. Leasehold Mortgages 68
8. Amortization 69
9. Mortgage Bonds on Individual Properties . . 70
10. Construction Bonds 72
11. Collateral Trust Real Estate Bonds .... 74
12. Real Estate Debentures 78
CONTENTS ix
CHAPTER V
PUBLIC BONDS OF DOMESTIC ORIGIN
SECTION PAGE
1. Federal Bonds 80
2. State Bonds . 83
3. Municipal Bonds . 85
4. Municipal Bonds and Savings Banks .... 87
5. Fluctuations 88
6. Street Improvement Bonds 89
7. Special District Obligations 90
8. Municipalities as Commercial Hazards ... 91
9. Population 92
10. Financial Conditions 93
11, Statistical Materials 94
CHAPTER VI
LAW OF MUNICIPAL BONDS
1. Importance of Correct Procedure 96
2. Power 97
3. Purpose 97
4. Debt Limit 99
5. Term 100
6. Authorization 101
7. Sale 101
8. Execution 102
9. Validation 103
10. Repayment 104
11. Obligation 105
12. Warrants 108
13. Defects and Defaults 108
CHAPTER VII
PUBLIC BONDS OF FOREIGN ORIGIN
1. Canada; Development of Field 110
2. Canadian Provinces Ill
X INVESTMENT
BECTION PAGB
3. Canadian Cities 114>
4f. Europe and Latin America — International Invest-
ment 117
5. Argentine Government 119
6. Anglo-French Joint Loan 119
7. Russian Roubles 120
8. American Foreign Securities Company . . . 121
9. British Secured Loan 122
10. Quotations 123
11. Scientific Distribution of Investment .... 124
CHAPTER VIII
SECURITIES OF CORPORATIONS
1. Assets Versus Investments 127
2. Bonds 127
3. Denomination 128
4. Registration 129
5. Price and Yield 130
6. Security 131
7. Blanket and Open-End Mortgages 132
8. Collateral Trust Bonds 133
9. Debentures 134
10. Income Bonds 135
11. Convertible Bonds 135
12. Short-Term Notes 139
13. Receivers' Certificates 141
14. Retirement and Foreclosure of Bonds .... 142
15. What Constitutes a Standard Bond . . . .143
16. Bonds and Farm Mortgages Contrasted . . . 143
17. Stock 145
18. Safeguards for Preferred Stock 147
19. Tests of Good Preferred Stock 147
20. Tests of Good Common Stock . . . . . . 148
CONTENTS xi
CHAPTER IX
CORPORATION REPORTS: ASSETS
SECTION PAGE
1. Character of Reports 150
2. Balance Sheet 151
3. Fixed or Capital Assets . . . ... . 153
4. Intangible Assets 153
5. Lumping of Assets 156
6. Securities 156
7. Working and Trading Assets: Inventories . . 159
8. Current Assets 160
9. Working Capital .160
10. Deferred Assets 161
CHAPTER X
CORPORATION REPORTS: LIABILITIES— INCOME
ACCOUNTS
1. Capital Liabilities 162
2. Current Liabilities 162
3. Deferred Liabilities 163
4. Reserves 163
5. Contingent Liabilities 164
6. Surplus 164
7. Income Account 165
8. Depreciation 166
9. Total Net Income 169
10. Fixed Charges 170
11. Sinking Funds 171
12. Unappropriated Surplus . 172
13. Series of Margins of Safety 172
14. Columnar Arrangement 173
15. Appraisals and Audits 173
xii INVESTMENT
CHAPTER XI
RAILWAY SECURITIES
SECTION PAGE
1. Characteristics of Railways 177
2. Integration of Properties 179
3. Collateral Trust Bonds 182
4. Guaranteed Stocks 182
5. Effects of Rate Control and Rising Costs , . . 182
6. Equipment Trusts 186
CHAPTER XII
PUBLIC UTILITY SECURITIES
1. Definition 190
2. Types of Securities 190
3. Escrow Conditions 195
4>. Commercial Analysis 197
5. Earnings in Depression 199
CHAPTER XIII
PUBLIC UTILITY SECURITIES (continued)
1. Analysis of Reports 201
2. Public Control 206
3. Gas 209
4. Electric Light and Power 211
5. Street Railways 214
CHAPTER XIV
INDUSTRIAL SECURITIES
1. Industrial Development 218
2. Lack of Standardization 218
3. Fluctuations 219
4. Financial Structure 221
5. Administration 224
CONTENTS xiii
SECTION PAGE
Public Policy 227
The Tariff 227
Restraint of Trade 229
Causes of Failure 230
Rules for Selection 231
Listing . 233
Inflated Conditions 233
Classification of Industrials 234
CHAPTER XV
THE CYCLE OF TRADE
1. Market Movements 237
2. Minor Fluctuations 238
3. Accidental Disturbances 239
4. Seasonal Changes 239
5. Underlying Drift 241
6. Cycle of Trade 242
7. Three Markets .......*... 244
8. Period of Improvement 244
9. Period of Over-development â– . 246
10. Period of Reaction 247
11. Period of Depression 249
12. Interpretation 250
13. Converting at the Top and Bottom .... 252
14. Signs That the Bottom Has Been Reached . . 253
15. Signs That the Top Has Been Reached . . .253
CHAPTER XVI
INVESTMENT BAROMETERS
1. Gauging Business Conditions 255
2. Crop Statistics 256
3. Statistics of the Steel Trade 259
4. Railroad Statistics 261
xiv INVESTMENT
8E0TI0N PAGE
5. Building Statistics 262
6. Employment, Wages and Immigration . . . 264
7. Commodity Prices 265
8. Clearings . 269
CHAPTER XVII
INVESTMENT BAROMETERS (continued)
1. Imports and Exports 272
2. Commercial Failures 274
3. The Money Market 276
4. Banking Barometers 279
5. Bond Barometers 282
6. Stock Barometers 284
7. Investor's Service 286
8. Brookmire Economic Service of New York City 286
9. Moody's Investors Service 287
10. Babson Statistical Organization . . . jl .. 288
CHAPTER XVIII
MINING INVESTMENTS
1. Shadow on a Great Industry 290
2. Reputation of a Camp 292
3. History of a Promotion 294
4. Protection 296
5. Professional Services 297
6. Commercial Conditions 298
7. Geological Conditions 299
8. Metallurgical and Engineering Conditions . . 301
9. Financial Conditions 302
10. Leave Prospects Alone 305
11. Signs of Danger 306
12. Test Questions 808
SECTION
CONTENTS ^
CHAPTER XIX
THE FAIRY LAND OF FINANCE
PAGB
1. Signs of Fraud 310
2. High-Sounding Names 313
3. Every Prospect Pleases 313
4. A Very Small Amount of Stock 315
5. Telegraph Your Order at Once 316
6. An Immediate Rise in Price 317
7. Profits of Other Businesses 317
8. Unrelated Matters 319
9. Ridicule of Bank Rates of Interest .... 322
10. Pointing to the Rascals 322
11. The Inside Offer 323
12. Testimony of the Amateur 325
13. Guaranteeing One's Own Securities .... 326
14. Blue Sky Legislation 327
CHAPTER XX
GENERAL RULES
1. Thoroness 829
2. Promotion Versus Investment 330
3. The Man Behind the Guns 330
4. Trustee System 331
5. Developing Properties 1331
6. Speculation Versus Investment 331
7. Limitation of Risk 332
8. Distribution of Risk 333
9. Take Advantage of the Long Swings .... 334
10. Price Versus Intrinsic Value 335
11. Previous Prices 336
12. Corporation Reports 336
13. Certified Public Accountants 336
14. Capital Versus Earning Power 336
XXIII— 2
XVI INVESTMENT
SUCTION PAGB
15. Bonded Debt 337
16. Wasting Assets 337
17. Gross Income ; Operating Expenses ; Net Income ;
Surplus 337
18. Dividend Record 338
19. Characteristics of Securities 338
20. Convertibility 339
21. Sources of Information 340
22. Investment Bankers '340
Index 345
INVESTMENT
CHAPTER I
FARM MORTGAGES
1. History and importance. — It has been estimated
recently by the Federal Government that approxi-
mately $3,500,000,000 in farm mortgages upon the
agricultural lands of the United States is in exist-
ence. Of this sum the life insurance companies hold
$660,000,000, the savings banks and trust companies
$542,000,000, and foreign investors $250,000,000,
leaving over $2,000,000,000 as the share of American
private investors. These figures are a sufficient an-
swer to the question of how farm mortgages rank as a
seasoned form of investment, and as to how satisfac-
tory the terms of the investment with respect to yield
and security are to the borrowing and investing pub-
lic. Mr. C. M. Harger has said:
The farm mortgage is about the only security on the mar-
ket which presents to the investor a concrete and definite
picture of what is behind it. The average investor, who is
not dealing in a large way with securities, hkes to visualize
his security. With the modern application for a loan be-
fore him, telling as it does the story of the applicant, and
a full description of the land, lie can form a mental represen-
tation of just what it is that stands behind the note. This
1
g INVESTMENT
is the strongest appeal of the farm mortgage, and out of It
grows a confidence that begets sound sleep.
In the eighties the railroads engineered an ill-con-
sidered rush to settle that portion of the prairie states
where the rainfall averages twenty inches. This
movement was financed, in part, by means of
farm mortgages. The farm practice attempted was
not suited to the locality, so that, when the crash
which was inevitable occurred, a blow was given
to the reputation of western farm mortgages from
which it took a generation to recover. There can
never be another abandonment of a great agri-
cultural region such as this was, however, for the
last American frontier has vanished, and the gov-
ernment can no longer give away free land of
standard grade in the humid portion of the
country. The long decline of commodity prices
which ruined so many farmers ceased in the middle
nineties, and since that time a rapid upward turn of
prices has established agricultural prosperity upon a
firm basis.
The Bank Examiner of Vermont reported in 1915
that in six years of service he had seen the farm mort-
gage holdings of Vermont banks increase from
$27,000,000 to $43,000,000. In this period his duties
called for an examination of these securities twice
each year, and he found that the total loss did not
exceed $12,000, practically all of which was tliru the
dishonesty of one agent in the West.
2. Investments for corporations. — The life insur-
FARM MORTGAGES 3
ance companies have long been wholesale buyers of
farm mortgages. The estimated amount held in 1916
was $693,940,000, or about 20 per cent of all farm
mortgages. The iEtna Life, the Massachusetts Mu-
tual, the Northwestern, the Connecticut Mutual, the
National of Vermont, the Mutual Benefit and the
Union Central, have each over 25 per cent of their as-
sets invested in this type of mortgage. The propor-
tion of fmids so invested by some of these companies is
over 50 per cent. State banks uniformly place a por-
tion of their reserves in farm mortgages; while for
savings banks it is estimated that from 55 to 60 per
cent of the assets are loaned on farm or city real
estate. The Federal Reserve banks are authorized
to invest in farm mortgages by section 24 of the Fed-
eral Reserve Act, which reads as follows:
Any national banking association not situated in a central
reserve city may make loans secured by improved and un-
encumbered farm land, situated within its Federal reserve
district, but no such loan shall be made for a longer time
than five years, nor for an amount exceeding fifty per centum
of the actual value of the property offered as security. Any
such bank may make such loans in an aggregate sum equal
to twenty-five per centum of its capital and surplus or to
one-third of its time deposits, and such banks may continue
thereafter, as heretofore, to receive time deposits and to pay
interest on the same.
The rules established by the Federal Reserve
Board on February 10, 1915, form an excellent guide
to be followed by the investor in judging of the value
of such investments. They are:
4 INVESTMENT
National banks not located in central reserve cities may
now legally make loans secured by mortgages on real es-
tate within the following limitations :
1. The real estate security must be farm land.
2. It must be improved.
3. There must be no prior lien ; in other words, the lend-
ing bank must hold an absolute first mortgage or deed of
trust.
4. The property must be located in the same Federal Re-
serve District as the bank making the loan.
5. The amount of the loan must not exceed 50 per centum
of the actual value of the property upon which it is secured,
6. The loan must be for a period not longer than five
years.
7. The maximum amount of loans which a national bank
may make on real estate under the terms of the Act shall be
limited to an amount not in excess of one-third of its time
deposits at the time of the making of the loan, and not in
excess of one-third of its average time deposits during the
preceding calendar year; provided, however, that if one-
third of such time deposits as of the date of making the loan,
or one-third of the average time deposits for the preceding
calendar year, shall have amounted to less than one-fourth
of the capital and surplus of the bank as of the date indi-
cated; in such event the bank shall have authority to make
loans upon real estate under the terms of the Act to the
extent of one-fourth of the bank's capital and surplus as of
the date of making the loan.
A further aid to this .field of investment has just
been created thru provision by Congress of a sys-
tem of Federal Land Banks, modeled after the Fed-
eral Reserve banks. These banks are to make first
mortgage farm loans, not exceeding $10,000 in
amount, to farmers who are occupying their farms.
The applicants must subscribe 5 per cent of their loans
FARM MORTGAGES 5
to the capital of the local farm loan bank. The loans
must not exceed 50 per cent of the value of the land
and 20 per cent of the insurable value of the improve-
ments. These land banks will have authority to raise
money by the sale of tax-exempt farm loan bonds,
which are to be quasi-government bonds, described
as "instrumentalities of government." It is yet too
early to say how this plan will work out. There are
apparently some difficulties that may arise. It is a
question as to how the scheme will apply to regions
where farming is very uncertain. Other doubtful
points are the attempt to establish one interest rate,
namely, 6 per cent for the entire country, and the
allowance of but thirty days for agents to make good
defaulted loans.
3. Agricultural districts. — If the investor desires
to go outside of his own neighborhood in search of
satisfactory mortgages, the first step will be to de-
cide upon the agi'icultural districts which he con-
siders safe and attractive for loaning purposes. East
of the line of 20 inches of annual average rainfall
there lies a broad belt of country extending from the
Red River Valley on the north to the "black, waxy
soils" of Texas. This region does not entirely fi-
nance itself, and the distant investor is brought into
touch with the opportunities that lie there thru mort-
gage brokers who offer a standardized service. West
of this region the best loaning territory consists of
distinct and circumscribed areas which enjoy special
advantages of rainfall and topography in comparison
6 INVESTMENT
with the region surrounding them. Typical of such
areas are the Blackfoot Valley, the Judith Basin, the
Gallatin Valley, the Bitter Root Valley and the Yel-
lowstone Valley in Montana. In Washington, con-
spicuously prosperous districts are the Palouse coun-
try, which extends into Idaho, the Big Bend country
and the Walla Walla country. In Oregon there is
the Willamette Valley, and in Idaho the Twin Falls
district and the Idaho Falls district. Colorado pre-
sents the San Luis Valley and the Arkansas Valley.
Utah contains the successful irrigation belt extend-
ing southward from Salt Lake City. California
possesses the Sacramento Valley and the Imperial
Valley.
4. Geography of interest rates. — Thruout New
England, the Middle Atlantic States and the north-
eastern Middle States, including Iowa, mortgages
purchased thru brokers may be expected to yield 5/4
per cent. In Virginia, North Carolina and West
Virginia, and the states around Iowa (Minnesota,
Nebraska, Kansas and JNIissouri) the yield is 6 per
cent. In the northern portion of the Great Plains
(North Dakota and South Dakota)' and the north-
ern and middle South (Kentucky, Tennessee,
Georgia, South Carolina and Oklahoma) from 6/4
to 7 per cent is the average. Seven to 8 per cent
may be had in Mississippi, Louisiana and Texas,
in the Rocky Mountain states, such as Montana and
Colorado, and on the Pacific Coast. Eight per cent
and over is characteristic of the frontier southern
FARM MORTGAGES 7
states, Arkansas, Florida and Alabama, and of the
less developed West and Southwest, notably Wyo-
ming, Utah, Nevada, Arizona and New Mexico.
The higher interest rates are due to several causes.
They naturally attend a loan on land situated in
frontier regions, or in states which are uneven in
agricultural worth so that safety in loaning demands
careful discrimination and an intimate knowledge of
agricultural geography. One-crop methods of farm-
ing and burdensome legal requirements are other fac-
tors which tend to make the loaning of money less se-
cure and more involved, and which consequently tend
toward a higher rate of interest.
5. Judging a district. — In judging a district the
investor will desire to give attention principally to
soil, the climate, the type of farming which prevails,
the maturity of the region, the nationality, thrift and
intelligence of the population, the transportation
facilities and the homestead laws. By "maturity of
the region" is meant the verdict of time as to whether
the agricultural practice of the district is fitted to
the physical conditions which prevail, so that the farm-
ers' prosperity is likely to be permanent. This ques-
tion is the all-important one in the dry-farming coun-
try. The growth of population of the region in-
volved maj^ be investigated for a series of years to
ascertain whether an increase is the result of a normal,
healthy growth or of a series of land booms. There are
some advantages possessed by a section whicli is still
in a pioneer condition. There the land values are
8 INVESTMENT
likely to be moderate. The majority of the popula-
tion will be in the prime of life and virile. The hab-
its of living will be frugal. The surplus wealth of
such a region will go back largely into the property
pledged. Land will be cleared; fences, barns and
houses will be built; and these activities will serve to
increase the margin of safety. The country roads
will be improving ; the railways will be extending their
branches; and the villages will be multiplying the
number of mills and elevators. All of these improve-
ments will tend to lift the price of farming land and
so add to the value of the collateral.
6. Use of agricultural statistics. — The effect of
annual fluctuations of heat and moisture upon agri-
culture can be discovered best by consulting the rec-