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Investment securities, essential characteristic and values, prevailing opportunities online

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nvestment securities



s.



Essential CKaracteristics
and Values

By
JAMES R. BANCROFT



President, American Institute of Finance. Manager, Investment

Department, Babson Statistical Organization, 1917-20. Instructor

in Investments, Babson Institute, 1919-20. En^a^ed in Banking

and Brokerage Business, 1907-16




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ttts: first, actual price fluctuations; second, the trend in terms of what the income will buy. They
r levels for bonds in terms of commodities give the real measure of opportunities that have been



Investment b



nvestment Securities

Essential Characteristics
and Values



By
JAMES R. Bi^NGROFT



President, American Institute of Finance. Manager, Investment

Department, Babson Statistical Org,anization, 1917-20. Instructor

in Investments, Bahson Institute, 1919-20. En^a^ed in Banking

and Brokerage Business, 1907-16



AMERICAN INSTITUTE OF FINANCE
BOSTON



OUR

"COMPLETE EDUCATIONAL COURSE"

IN THE SCIENCE OF

MAKING MONEY MAKE MORE MONEY

This list is arranged in the order of proper reading. The
books are accompanied by a series of test questions, key prob-
lems and analyses outlines, enabling the student to apply the
knowledge acquired to immediate stock market and investment
conditions.



1 . Developing Financial Skill

2. Forces Which Make Prices

3. Alanipulation and Market

Leadership

4. Handling a Brokerage Ac-

cotmt

5. Market Information

6. The Essential Features of

Securities

7. The Value of a Railroad

Security

8. Industrial Securities

9. Oil Securities

10. Mining Securities



IL Investment Securities

12. Business Cycles

13. Measuring arid Forecasting

General Business Condi-
tions

14. The Technical Position of the

Market

15. Money and Credit

16. Business Profits

17. Launching a New Enterprise

18. Securing Capital for Estab-

lished Enterprise

19. Internal Financial Manage-

ment

20. Search for Bargains



Copyright, 1922 by
American Institute of Finance



H6-



TABLE OF CONTENTS

-k

Pafee

Chapter I. Securities as Investments

Purposes of Investment 7

-^ Different Forms of Investment 8

Bonds as Investments 9

■^ Preferred Stocks as Investments 9

' Common Stocks as Investments 10

^ Returns on Investments 11

I

■s^ Chapter II. Different Types of Investment Bonds

Classification by Character of Issuer 13

Government Bonds 13

Municipal Bonds 14

Corporation Bonds 15

S^J^ Classification by Security 15

Different Types of Mortgage Bonds 16

pyO Second Mortgage Bonds Rare 17

v\ General Mortgage Issues 17

N Refunding Mortgages 18

^ Consolidated Mortgages 18

Prior Lien Bonds Merit Study 19

^ Closed and Open Mortgages 19

V^ Classification According to Maturity .20

S\ Long Term Bonds 20

^ Short Term Notes 21

Serial and Sinking Fund Bonds 21

Convertible Bonds 22

Coupon and Registered Bonds 23

^ Chapter III. Factors Affecting Bond Prices

^c-^ The Initial Consideration in Investments 25

^^ Two Types of Influencing Factors 26

Permanent Factors 26

Commodity Prices 27

Spending vs. Saving 28

Efficiency in Production 29

>^ -^ Forecasting Long Term Developments 30

^o Temporary Factors Affecting Bond Prices 31

Prosperity and Depression 31

Effect of Taxation on Investments . . .■ 32




447469



4 Contents

Chapter IV. The Trend of Bond Prices Pa^e

Temporary and Long-swing Movements 35

The Temporary C^^cle Movement 35

Bond Prices First to Decline 36

The Long Cycle Movement 36

The Period of 1865-1895 37

The Period of 1893-1898 38

The Period of 1900-1920 38

The Chance of a Lifetime 39



Chapter V. Railroad Bonds as Investments

Marketability a Prime Consideration 40

Capitalization of Our Railroads 40

The History of Railroad Development 41

Deterioration of Railroad Credit 42

Federal Operation 43

Recent Legislation 44

The Question of Valuations 45

What of the Future? 46

Railroad Issues Legal for Savings Banks 46



Chapter VI. PubHc UtiHty Bonds

Business Stability 48

Regulation by Commission 49

Gas Companies 49

Electric Lighting Companies 50

Electric Power Properties 51

Telephone Companies 52

Street Railways 53

Rapid Transit Lines 54

Surface Lines 54

Interurbans 55

The Future 55



Chapter VII. Industrial Bonds

History 57

Prevailing Types 58

Convertible Issues < 58

Recent Financing 59

Industrial Preferred Stocks 60



Co ntents 5

Chapter VIII. Government Bonds Pa^e

Characteristics 62

Wealth, Debt and Income 62

Liberty and Victory Loan Issues 63

The Market Action of Liberty Bonds 66

The Future 67

Position of Foreign Governments 68

Wealth and Income — a Comparison 68

Methods of Obtaining Income 70

Expansion of Note Issues 70

Domestic Securities Preferable 72



Chapter IX. Miscellaneous Issues

Municipal Bonds 73

Methods of Payment 73

Tax Position 74

Real Estate Bonds 75

Elements of Risk 75

Advantages and Disadvantages 76

Federal Farm Loan Bonds 76

Repayment of Loans 77

General Liability 77

Tax Exemption 77



Chapter X. Reading an Offering Circular

Position of Prospective Investor 78

Nature of the Business 79

Location of the Enterprise 79

Capitalization 80

Purposes of the New Issue 80

Amount of the New Issue 81

Security 82

Earnings 82

Balance Sheet 83

Summary 84



Test Questions

Analysis Outline for Utility Companies



CHAPTER I

SECURITIES AS INVESTMENTS

Purposes of Investment

Investment funds are accumulations from business prosperity
or successful speculation. The desire in investing these funds
is to conserve principal and by putting it to work to improve
one's income. Therefore, investments are made primarily for
the return they give and not for profits. For example, if any
individual who has accumulated, let's say, considerable money,
decides to use $10,000 in a conservative fashion, he would not
think of allowing it simply to lie in a bank at a low rate of interest.
If vigorous and forward-looking he would desire that such ac-
cumulated funds should earn a good return with safety. During
recent years his attention would have turned to the low prices
for long term investment securities. He could, for example,
have purchased $10,000 West Shore Railroad First Mortgage
4's, 2361. In doing so he would have had an absolute first
mortgage on a railroad property that would give him an annual
return on his money of 5^% or an annual income on an invest-
ment of $10,000 of $550. It is this annual income that interests
him primarily. The question of whether the market price of
his investment purchase is four or five points lower than six
months previous, or will be four or five points higher six months
later, is not of prime importance.

It is in this way that investment differs from speculation.
We must grasp this difference immediately. Speculations are
made absolutely for profit. Investments are made primarily
for income. While the desire to improve or at least maintain
the principal of an investment must always be present in order
to have the investment successful, the primary purpose is to
bring in additional income.



8 Investment Securities

Different Forms of Investment

Placing money in a savings bank is an elementary form of
investment. The advantages of this form of investment are
that, except in extremely critical times, the money can be with-
drawn immediately at its full value. The price paid for this
privilege is the relatively low return or income received from
such an investment. Savings banks are an excellent form of
investment for the uneducated individual and for the man who
does not care to or is not in a position to study the fundamentals
underlying investment values.

Insurance may be called another form of investment
although the primary purpose of insurance is protection. The
first thought of every young man with growing responsibilities
should be toward this form of investment. A growing family
needs protection.

Investments that give good returns, however, and which
appeal strongly to the average business man, are securities
and to some extent real estate. We will treat primarily of
securities as investments. The strongest and most satisfactory
form of investment security is bonds. A bondholder is in the
same position as the lender of money. He has a direct claim
against the assets of the borrower. With the increasing in-
dustrial prosperity of the past ten years, and perhaps to greater
extent with the increasing income taxation of the past five years,
preferred stocks have become a common form of investment.
The income received by any individual from bond purchases is
subject to both the federal normal and super-taxes. The
income received from investments in preferred stocks, on the
other hand, is exempt from the normal federal income tax.
Under war and post-war taxation, the net income received from
a preferred stock paying 6%, is quite a little larger than the
net income received from a bond paying the same rate.

Of equal or greater importance perhaps in accounting for
the popularity of preferred stocks as investments has been the
tax situation of the issuing corporation. Corporations have
been allowed to count money received from selling preferred



Securities as Investments 9

stock as invested capital. They were allowed a basic exemption
on invested capital under the war excess profits tax law. Money
obtained by selling bonds could not be counted as invested
capital. It is simply borrowed and the company agrees to
return it at a certain fixed date in the future.

The common stocks of certain properties that have paid
dividends uninterruptedly for a number of years are considered
investments by some individuals. Stocks of such properties
are called seasoned common issues.

The risks in these various forms of investment will be
discussed and carefully considered.

Bonds as Investments

Bonds with very few exceptions carry a definite promise as
regards the payment of principal and interest. The bondholder
simply stands in the position of a lender. For example, the
owner of $1,000 Pennsylvania Railroad General Mortgage 5's,
1968, has, in effect, loaned the Pennsylvania Railroad $1,000 on
which he receives a stipulated interest payment. The company
also agrees to repay the principal, $1,000, in 1968. In the event
of the failure of the Pennsylvania Railroad to pay either the
interest on this loan when due or the principal when due, the
owner has the same right of foreclosure as the holder of a per-
sonal mortgage note. In view of the form of corporate enter-
prise bondholders cannot and do not act individually in event
of default of interest or principal. A committee who looks
after the interests of the large number of scattered bondholders
is formed which is called a protective committee. The princi-
pal is exactly the same, however, as in an individual loan.

Preferred Stocks as Investments

A stockholder, on the other hand, whether preferred or
common is not a creditor of a corporation but is a partner in
the enterprise. As stated above, a corporation or company is a
borrower of money through its bonds. The bondholder is a lender.
Stock certificates are merely an evidence of ownership. They
certify a share in the fortunes and risks of business enterprises.



10 Investment Securities

Preferred stocks, however, have come to be a broad medium
of financing by corporations because of their favorable situa-
tion in regard to taxes, as pointed out above. Such financing
has been made attractive to investors by surrounding pre-
ferred issues with restrictions intended to protect the purchaser.
The clearest way to make this plain is by a specific illustration.

The Goodyear Tire & Rubber Company in offering its pre-
ferred stock, agreed that the dividends, which were fixed at 7%,
should be cumulative. That means that in return for the stock-
holder agreeing to accept maximum payment of 7% the company
agrees that if the full 7% dividends are not paid in any one year
it, nevertheless, tries to assure ultimate payment of the full 7%
and all unpaid back dividends before any distribution can be made
to common stockholders. This is about as favorable an offer
as could be made to preferred stockholders as they could not,
being partners and not creditors, have the right of foreclosure.
The Goodyear Tire & Rubber Company further agreed to
maintain its assets at the equivalent of 200% of the preferred
stock to be outstanding and to maintain its current assets at
110%. It agreed not to mortgage its property without the
consent of 75% of the preferred stockholders and it placed a
sinking fund of 2|% annually on the preferred stock issued.
In other words it tried to insure the stockholder against a frit-
tering away of its assets. It also protected the stockholder
through the sinking fund, which retires 2^% of the stock out-
standing annually, thus apparently constantly increasing the
strength of the balance remaining. In spite of such restrictions,
however, the right of foreclosure in event of difficulties was
lacking, and in the difficulties of 1921 these restrictions
amounted to practically nothing. Preferred stockholders
are now subject to $55,000,000 bonds and a large issue of
prior preferred stock has been placed ahead of them.

Common Stocks as Investments

Bearing in mind that a stock is simply a certificate of partner-
ship in an enterprise, and that common stocks cannot be sur-
rounded with restrictions as preferred stocks can, it is evident



Securities as Investments 11

that the puixhase of common issues as investments is quite
hazardous. Fluctuating earnings with periods of prosperity
and depression are reflected acutely in the earnings shown on
common stocks. Even stability of earning power over a number
of years is not sufihcient insurance of continued safety. Note,
American Sugar Common. Other illustrations of this fact are
the situations of the common stockholders of New Haven, Boston
& Maine, Chicago, Milwaukee & St. Paul. These stocks were
considered by many to be conservative investments a few
years ago. Yet today none are paying dividends and all are
selling for less than 50% of their par value. Common stocks
furnish attractive mediums for speculation but rarely for
investment.



Returns on Investments

In making investments clients will find that the majority of
banking and brokerage houses give the return obtained in
terms of yield. For example, if a 5% bond, due in 25 years, is
offered to the investor at 80, the yield on the investment is
6.70%; but let us consider what this includes. A pencil and
paper will show that a 5% bond, bought at 80, paying in other
words $50 on an investment of $800, gives a return of 6.25% a
year, not 6.70%. The yield of 6.70% takes into consideration
that 25 years hence the investor who today buys a $1,000 bond
for $800 will receive repayment of his principal, $1,000.

This yield of 6.70% cannot be figured easily by an individual.
It is apparent that no portion of the $200 premium that will
be received 25 years hence is obtained in any year prior to the
maturity of the bond. Again in figuring the yield on a bond
the presumption is made that the income received annually
would be reinvested as received at the same average interest
rate as the annual return. The yield on investments, therefore,
can be figured only through a mathematical process. It is obtained
for every -day use by referring to tables of bond values published
for the purpose. The annual return on an investment, however,
can be obtained simply, as shown above, hv dividing the income



12 Investment Securities

received by the price. When only annual return is considered
by an investor in figuring his income, the approach of the bond
to its par value as it nears maturity can be figured as apprecia-
tion. We feel, therefore, that in order to have an accurate
account of yearly income clients ought to give greater weight to
annual return in purchasing investments than to so-called yield.



-i



CHAPTER II
DIFFERENT TYPES OF INVESTMENT BONDS

Classification by Character of Issuer

Investing is a science; speculation an art. Investing must
be based on scientific principles and classification.

There are numerous ways of classifying investment securi-
ties. In order to treat the situation thoroughly we will discuss
their classification from the standpoint of the issuer, from the
standpoint of security, and from the standpoint of maturity.
All these classifications are important. The first classification
divides the types of investment securities from the most elemen-
tary point of view. The second allows the investor to study
the values underlying issues offered. The third brings out the
question of permanence or extent of the investment. Under
the classification by character of the issuer, the principal divi-
sions are Government Bonds, Municipal Bonds and Corporation
Issues.

Government Bonds

Government bonds have always been considered the highest
type of investment. To some extent, this conception has been
lowered in the last four years. It has been found that under
war conditions governments can put out bond issues at such
tremendous rates that the credit of the respective governments
deteriorates rapidly. Developments of the past five years in
Europe have shown that the credit behind government bonds
depends for its value on the confidence and respect which that
government commands. A government at peace, having a
small debt, levying comparatively light taxes on its people and
expressing and satisfying the ideals and aspirations of the great
mass of its people, has a high credit. Insofar, however, as



14 InvestmentSecurities

these conditions fail, public confidence fails and credit fails also.
In other words, the idea that has been prevalent for a number of
years, that behind the bonds of any nation are all the physical
or material assets of that nation, is an illusion. Furthermore,
it is not correct that the power to \exy taxes against such physi-
cal wealth is behind such bonds. While the government has
the legal right to levy taxes without limit, there is a limit to
its power, which limit depends on the confidence and respect
of its people. The real assets behind government bonds are
the good will of the people and the values behind government
bonds must rise and fall with the development of conditions
that improve or destroy such good will.

Municipal Bonds

Municipal bonds, so-called, are bonds issued by our states,
cities, counties or townships. The payment of principal and
interest on municipal bonds rests on the taxing power of the
issuing community. The taxes are collected in the majority
of cases, by a levy against the property of the issuing munici-
pality. This tax is levied in direct ratio to the assessed value
of taxable property. Such taxable property includes all land,
real and personal estates.

When municipalities issue bonds to obtain funds f^r proper-
ties that are self-supporting — waterworks, lighting plants or
street railways, for example — the bonds are nevertheless
supported by the taxing power against all property. An ex-
ample is the money issued by the City of New York to assist
in the construction of the enlarged subways, which has taken
place in the last five years. Increased rapid transit facilities
in any city or locality mean increased property values, and
thus an increased assessment value. Hence, all property
owners are taxed to provide finances.

Another form of municipal financing wliich is not as promi-
nent is the issue of bonds the principal and interest of which
are payable from a special tax levied only upon the property
benefited. These bonds are called "special assessment issues."



D iff event Types of Investment Bonds 15

Usually they cover such operations as school, highway, or drainage
improvements. The credit rating of this class of bonds is not
as high as municipal issues protected by taxes levied against
the entire taxable property.

Corporation Bonds

Corporation bonds are our most common form of investment
security. Neither government nor municipal issues carry a
mortgage claim against specific property value. Corporation
bonds are clearly a claim on the assets of the issuing corporation
according to priority of issue. For example, a mortgage bond
has the actual right of foreclosure against the particular property
on which it is a mortgage. A debenture bond, so-called, while
not a mortgage, still possesses, in event of difficulties, the right
of foreclosure against the assets, tangible and intangible, of the
issuing corporation. The tremendous commercial expansion
of our country in the last twenty years has given rise to great
diversification in corporation issues. Whereas, twenty years
ago, the position of a corporation bond could be readily as-
certained from its description, the interweaving of securities
has become so marked that we feel it necessary to point out
here some of the more important characteristics of the different
mortgage, debenture and collateral trust bonds that are put
out by our various corporations.

Classification by Security

The three most common forms of corporate bond issues
available to investors are mortgage issues, collateral trust bonds
and debentures. Mortgage bonds are exactly what the name
implies. They are an actual lien against certain physical
property which is enumerated in the indenture under which
the bonds are issued. That is, mortgage issues contain an
express stipulation in regard to the property against which
they are a mortgage.

Collateral trust bonds are not a mortgage. They are secured
on intangible porperty, that is on other stocks or bonds. An



16 InvestmentSecurities

example is the American Telephone Collateral Trust 5's, 1946.
The American Telephone & Telegraph Company is a holding
company owning or controlling numerous operating subsid-
iaries all over the United States, the majority of which are
corporations having stocks and bonds of their own outstanding.
It is naturally better to borrow large sums infrequently than to
be in the market constantly for small amounts. Therefore, the
parent corporation issues its own securities, putting up as
collateral various stocks and bonds of subsidiaries. The
actual security of the collateral trust bonds, it will readily be
seen, depends in turn on the ^•alue of the subsidiary collateral
plus the somewhat intangible credit of the holding organization.
Collateral trust bonds must be carefully studied as regards the


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Online LibraryJames R BancroftInvestment securities, essential characteristic and values, prevailing opportunities → online text (page 1 of 7)