Investment analysis; fundamentals in the analysis of investment securities

Front matter

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Preface

Numerous difficulties lie before the writer of a book on anybusiness subject. Particularly is this true in the field of investments, where many mooted points exist, and lack of standardization in many security issues still prevails. Every investment is an individual problem. Consequently to apply a standard form of analysis, and at the same time allow sufficient elasticity in treatment for the qualifications which must be constantly made in practice, places a large task upon the author. There is also no business subject in which one is forced to deal with the technical aspects of so many subjects. Some will doubtless criticize the present text, because of its large inclusions from the fields of corporation finance, accounting, law, banking, and engineering. Though every author would draw from all of these fields in varying degree, no author undertaking a complete analysis of investment securities would eliminate any one of them.

With so many complexities involved, the author may conceive his task too ambitiously and unconsciously sacrifice clearness and simplicity of plan which are so essential in the exposition of a large subject. In the attempt to be thorough and scientific, the author's treatment of the subject may be so complex that the expert alone can follow it. On the other hand, the author may be misled into a superficial treatment and fail to establish a foundation upon which the student may build in the future. Whether this book has succeeded in evading these dangers or not, the author has prepared it with the full realization of these difficulties.

An effort has been made to state the fundamentals of analysis of investment securities in such form that they will be understandable to an intelligent person who has not made a systematic study of investments. While the book has been written for beginners, no attempt has been made to avoid close

vii viii PREFACE

and difficult analysis, where it has been essential to make a complete presentation of a particular subject. Neither is it possible to make all things, in such a complicated subject, of "primer-simplicity" — and the author makes no such claim Any one who avoids close reasoning in the study of investments can never hope to have anything but a superficial knowledge of the subject — and this is too frequently an erroneous understanding.

While most of the material in this book has been gained from practical experience and investigations in bond and banking houses, the method of exposition has developed out of several years of experience in teaching the subject-matter to both college students and business men. The method which experience has shown to be the best adapted to these men, has seemed to the author to be the logical method of presentation. Books Two, Three and Four of the volume, assume an understanding of the material covered in Book One. To avoid constant repetition, this has been necessary, so that the reader should not draw the conclusion that some important general principle or condition has been omitted if he first reads chapters subsequent to Book One. While there are many miscellaneous facts, which it is hoped will be found useful and can be found through reference to the Table of Contents and the Index, the various parts of the book have been closely interwoven. For convenient reference of facts a very complete index has been made, and for the same purpose the various kinds of bonds have been alphabetically catalogued in the Appendix. No pretense has been made to make the bibliography exhaustive, though the claim can be made that it is representative in all respects.

Because of the meagre amount of material available on some securities, the chapters cannot be evenly balanced either in scope or character of treatment. Some topics, especially in closely allied fields, have already been so fully covered that a brief treatment has seemed quite sufficient. Lack of uniformity and standardization in other issues, make other than general conclusions impractical. While the author has been fully conscious of the exceptions, which must constantly be made in any attempt at standardization in the analysis of industrial seeuri-

PREFACE ix

ties, an attempt has been made to treat the more basic rules of analysis applying to these securities.

Though a discussion of telegraph, telephone and electric light company bonds also has been ventured, an analysis of these is rather difficult, as they have just passed through their initial development, added to which they possess in common with industrial securites, a lack of uniformity. In railroad finance, uniform standardization has long been well established. The constitutional and statutory regulations which control the issuance of civil obligation have established a fairly close uniformity thus making classification and analysis possible. There is, however, much still to be done in this field. It is surprising that with the wealth of material which has so long been available in the Commercial and Financial Chronicle that so little real original and constructive work has been done in the subject of municipal finance. Of such securities as irrigation, timber, etc., bonds, a briefer treatment might seem warranted than that given here. However, their unfortunate early experiences and the lessons a study of them contributes, would seem to justify the space given to their discussion. The discussion of steamship bonds is confined to the Great Lake Steamship bonds. While there are particular ocean steamship bonds which belong in the investment group, the lack of uniformity in these issues, does not seem to yet justify their inclusion.

Stocks, as such, have not been specifically treated. To have done so would have necessitated a considerable enlargement of the volume which is already large. As fof the evaluation of corporation stocks, the author believes that the discussions in this volume apply equally to stocks and bonds, though such particular things as preferred stock regulations are not considered. But here again, the value of those regulations to the investor is wholly dependent upon the financial strength of the corporation. Other suggestions, as to method of treatment, or inclusion, or exclusion of other securities do not seem to demand further discussion.

Whatever may be contributed in this book in the furtherance of an understanding of the reader in the field of investments, can in a very small measure be credited to the author. There

X PREFACE

are many persons both in the "give and take" of office contact and in seemingly endless conferences who are contributors to this volume. To all these people it is not possible to give public acknowledgment.

To those who have read parts of the manuscript and offered valuable suggestions, I desire to express my indebtedness, though space does not permit a detailed explanation of their readings, as the list itself is long. Though the author is responsible for the decision upon all disputed points and errors, he has attempted to secure the advice and suggestions of experts upon every kind of security. Particular acknowledgments are made to : Mr. H. W. Addinsell of Harris, Forbes & Co., New York City; Mr. Arthur Andersen of Andersen & Co., Chicago, and head of the Accounting Department of Northwestern University; Mr. H. S. Allen of Spencer, Trask & Co., New York City; Mr. John Bauer of the Corporation Counsel Office of New York City, and Consulting Tax and Public Utility Expert ; Professor Alfred Bays of Northwestern University School of Commerce and Practicing Attorney ; Mr. H. H. Beebe of Harris, Forbes & Co., New York City; Mr. Earnest D. Brooks, Asst. Manager of Sales of Continental and Commercial Trust and Savings Bank, Bond Department, Chicago; Mr. Clinton Colver of Lyman D. Smith & Co., New York City ; Mr. C. F. Childs of C. F. Childs & Co., Chicago ; Mr. William R. Compton of William R. Compton and Company, St. Louis; Professor George Bion Denton of Northwestern University ; Mr. Louis B. Ferguson, Manager of Sales, Bond Department of the Continental and Commercial Trust & Savings Bank, Chicago; Mr. J. E. Ferris of Ferris & Hardgrove, Spokane, Washington; Professor Stephen Gillman of Wisconsin University ; Mr. George A. Hurd, President of the Mortgage Bond Company, New York City; Professor E. W. Kemmerer of Princeton University; Professor Elmer Martin Leesman of Northwestern University Law School and Practicing Attorney ; Mr. F. J. Lisman of F. J. Lisman and Company, New York City; Mr. Robert Mallory of Spencer Trask and Company, New York City; Mr. Lester H. Monks of W. A. Harriman and Company, New York City; Professor E. J. Moulton of Northwestern University; Mr. Roy C. Osgood,

PREFACE xi

Vice President of First Trust and Savings Bank, Chicago; Mr. Julius Parmalee, Director of the Railways Economic Bureau, Washington, D. C. ; Mr. F. E. Payne, Vice-President of the Union Trust Company of Spokane, Washington ; Mr. George W. Pearson, Manager of Bond Department, Continental and Commercial Trust & Savings Bank, Chicago; Professor Guy Meredith Pelton of Northwestern University; Mr. Kingman Nott Robbins, Treasurer and Vice-President of Associated Mortgage Company, Rochester, New York; Mr. Shepard Smith, Vice-President of Mississippi Valley Trust Company, St. Louis ; Professor John Charles Teevan of Northwestern University and Practicing Attorney, Chicago ; Mr. Lewis K. Walker, Vice-President of Security Trust Company, Detroit; Mr. C. C. Wells of Northwestern University and the Bond Department of Continental and Commercial Trust and Savings Bank, Chicago.

I particularly wish to express my thanks to Professors Homer Bews Vanderblue and Walter Kay Smart who read the whole of the manuscript in its initial writing and to Mr. E. W. BuMey, senior member of Spencer Trask and Company of New York, Chicago, and Boston. Not only is the author indebted to Mr. Bulkley for assistance in this work, but for the opportunity and aid rendered him in acquiring his initial practical experience in investment banking.

Table Of Contents

Preface p. vii

Book I

GBNEEAL FUNDAMENTALS AND THEIR APPLICATION IN THE ANALYSIS OF INVESTMENT SECURITIES

CHAPTER PAGE

I. Introdtjction — The Meaning op Investments. 3 The General Problem— What the Field of Investments Includes — The Scope and Limitations of This Study.

II. General Principles op Investments 12

Safety of Principal and Income — Rates of Income— Marketability — Legality — Stability of Market Price — Appreciation — Diversification — Other Criteria of Investments.

in. What is Included Under Investment Securities, AND THE Classification of Investment Securities 32

General Statement — Classification of Bonds — Character of Corporation Issuing Bonds — ■ According to Purpose — According to the Character of the Lien — According to Methods of Payment and Redemption.

TV. Analysis of the Corporation Report 51

Management, Control, and Organization — Amount, Form, Priority, and Margin of Securities, as Related to Property Values— The Balance Sheet and Valuation of Assets.

V. Analysis of the Corporation Report {Continued) "^7

Gross Sales— Gross Revenue— Gross Earnings

xiii xiv TABLE OF CONTENTS

CHAPTER PAGE

—Operating Net Income— Other Income- Fixed Charges— Dividend and Surplus Policies—Statistical Units of Measurements Used in Analysis.

.VI. Negotiation and Issuance 95

Authorization of the Issue— The Investigation— Distribution of Corporate Securities — Distribution of Civil Loans — ^New York Stock Exchange Eules for Listing.

VII. The Coepoeation Mortgage 100

Limitations of Issue — General Provisions in the Corporate Mortgage Instrument — Other Creditors' Claims — Powers, Eights, and Liabilities of the Trustee — Eights, Powers, and Limitations in Foreclosure — Eeorganization Agreements and Procedure in Eelation to the Mortgage.

■^III. Eegistbation, Transfer, and Assignment of Securities, and Their Validity and Legality 131

Section I. Transfer of Stock — Classification of Transfer — Illustrations of a Transfer Under Fiduciaries' Powers — ^Lost, Destroyed or Stolen Stock Certificates — Transfer Taxes — Negotiable Instruments — ^Eegistered Bonds — Coupon Bonds — Transfer and Assignment of Bonds — Coupons.

Section II. Validity and Legality

IX. Interest Eates AND Net Yield ON Bonds 151

Section I. The Net Interest Yields— Obtaining the Net Yield with the Use of the Bond Table— Net Yields of Unrecorded Bond Table Prices— The Price of a Bond Where the Net Yield Does Not Appear in the Bond Table- Use of Bank Discount.

TABLE OF CONTENTS xv

CHAPTER PAGE

Section II. Book Values on Interest Payment Dates of Bonds Purchased at a Premium — Book Values on Interest Payment Dates of Discount Bonds — Bonds Purchased on Other Than Interest Dates — The Serial Bond Schedule.

X. Market Influences on Security Prices 168

Interest and Discount Kates — ^Loans, Deposits, and Eeserves — Bank Clearings — Import and Export of Gold — Miscellaneous Factors.

XI. Market Influences on SECxniiTT Prices

Seasonal Variations — The Business Cycle — Fluctuations in Individual Security Prices — Eising and Falling Prices and Their Eelation to Investment Yields.

XII. Eegulation OF THE Issuance OF Securities — 198 The General Problem — Publicity — Blue Sky Laws — Certification of Civil Loans — State Eegulation of Public Utility Issues.

XIII. Taxation of Securities 218

The Basis Upon Which the Security Tax Is Levied— The Effect of the Tax Levy— The More Common Methods of Taxing Mortgages, Bonds, and Other Securities — The Place of Taxation for the Holder — Incidence .of Taxation of Intangibles (Securities) — ^Exemptions.

Book II Coepoeation Bonds

XIV. Eailroad Bonds: Physical Factors, Traffic

Statistics, and Eegulation 245

Physical Determinates — Mileage — Equipxvi TABLE OF CONTENTS

CHAPTER ^^^^

ment— Passenger and Freight Traffic— Traffic Density— Trainload and Carload— Terminals — Regulation and Control.

XV. Railroad Bonds (Continued) : Revenues and

Expenditures 267

Income and Expenditures Accounts — Operating Revenues— Operating Expenses — Maintenance of Way— Maintenance of Equipment — Transportation and Other Expenses- Operating Ratio — Net Operating Revenue — Taxes — Other Income — Net Corporate Income— Distribution of the Current Surplus.

XVI, Railroad Bonds {Continued) : The Balanck

Sheet and Capital Accounts 293

The Property Account — Current Accounts — Liabilities and Capitalization.

XVII. Railroad Equipment Securities 313

The Origin — Classification — Trust Deed — Duration and Terms of Payment — Physical Factors of Equipment — Depreciation — Maintenance and Renewals — Insurance — Investment Position.

XVIII. Street Railways and Interurban Traction

Company's Bonds 328

History of Urban Companies — Consolidation with Other Public Utilities — Population Distribution and Its Effect on Traffic — Density of Traffic — Special Problems of the Interurban— Revenues and Costs of Operating.

XIX. Street Railway and Interurban Traction

Company Bonds {Continued) 350

Technical Units of Measurement and Comparison— Capital, Capitalization, and Property Investment — Depreciation — The Franchise — Regulation — General Characteristics of Bonds.

CHAPTER

TABLE OF CONTENTS xvii

PAGE

Electric Light and Power Bonds 369

Population, Physical Factors, and Territory Served — Capital, Capitalization, and Property Accounts — Depreciation — Earnings — Costs and Peak Load — Rates — Some General Characteristics of the Franchise — The Market for Electrical Securities.

XXI. Gas Company Bonds 388

History and Present Position — Industrial Uses and By Products — Population and Its Relation to Service — Gas Rates — Earnings and Cost of Production — Capitalization and Property Accounts — Depreciation — Special Features of the Gas Franchise — Bond Characteristics, Character, Market, and Yield.

XXII. Hydro-Electeic Power Bonds 407

Development — Character of the Business and the Market — Competition — "Water Supply, Storage, and Pondage — Riparian Rights — Public Regulations of Water Power — Construction Costs — Earnings and Operation Costs — Market and Bond Characteristics.

XXIII. Private Water Company Bonds 425

Territory and Population — Supply and Quality of Water — Plant and Equipment — Depreciation— Capitalization and Earnings — Franchise — Bond Market and Characteristics.

XXIV. Telephone and Telegraph Securities 435

Advantages of Large Organization — Cost of Construction and Operation — Depreciation and Maintenance — Rates — Bond Characteristics and Market.

XXV. Great Lakes Steamship Bonds 447

General Characteristics — Classes of Bonds — Physical Properties — Financial Status — xvm

TABLE OF CONTENTS

CHAPTER

XXVI.

XXVII.

PAGE

Trust Deed— Insurance— Michigan and Ohio Laws— Denomination, Duration and Yield.

Character and Size of Business— Competition —Management— Fixed Property Account- Depreciation — Maintenance — GoodwiE — Working Capital— Sales, Earnings, and Expenses— Legal Status of Industrial Securities —Possibilities in Industrial Bonds.

Supply and Consumption of Timber — Control of the Timber Supply — Legal Prerequisites— Fire Risks — The Timber Cruiser's Valuation — ^Balance Sheet and Income Statement—The Market.

Book III Bonds Secured By Land Or Real Estate

XXVIII. Real Estate Mortgages 483

Appraising of Real Estate Values — Appreciation of Land — The Effect of Structure Values — Depreciation of Building — ^Building as Related to Demand of Locality — Cost of Operating Property — ^Margin of Loan — Taxation of Mortgage — Convertibility and Hypothecation — Denomination, Maturity and Yield.

XXIX. Real Estate Bonds 496

Classification — Real Estate Mortgage Bonds — Debenture Mortgage Bonds — ^Leasehold Mortgage Bonds — Installment Payment Plans — Trust Agreement of the Company — Convertibility — Other Miscellaneous Characteristics.

TABLE OF CONTENTS

XIX

CHAPTEE

XXX.

XXXI.

XXXII.

PAGE

Farm Mortgage and Federal Farm Loan

History of Development — Increase in Land Values — Location and Distribution — Classes of Farm Securities — Physical Appraisement — Other Miscellaneous Factors — Period of Eedemption after Foreclosure — Farm Loan Bonds.

Irrigation Securities 526

Municipal Irrigation District Bonds — Carey Act Bonds — Private Corporation Bonds — Security of Irrigation Bonds — Water Supply Land Title — Costs — Capitalization — "Working Capital Eequirements for Settlers — ^Market.

Drainage and Levee Bonds 539

General Characteristics — Organization of Districts— Security — Taxes — The Market.

XXXIII.

Book IV Civil Obligations

The Issuing Political Unit and the Security

OF ITS Bond Issues 549

Jurisdiction and Function of Civil Divisions as Related to the Powers to Finance Themselves— Physical Resources — Financial Resources— Other Resources — Population — The Financial History and Integrity of the Civil Unit.

Valuation, Tax Rate, and Validity as Related TO Civil Loans 564

Valuation — Taxation and the Tax Rate — Rate — Creation of the Special Tax District — ^Legality and Validity.

PCX

TABLE OF CONTENTS

CHAPTER

XXXV.

PAGE

The Debt of the Civil Division 582

The Funded Debt— Other Debts— The Actual Debt Per Capita— The Net Debt— Debt Restrictions—Duration of the Funded Debt— —Payment of the Debt— Repudiation of the Debt.

XxXXyj/ Special Factors Affecting the Market and

/ y^ Price of Civil Obligations 606

V_--^^ The Market— Protection to the Investor in

Certification — The Purpose of Issue vs. Market Price — Denomination and Duration — Civil Loans as Collateral — Their Convertibility— Tax Exemption.

United States Government Bonds 622

Summary of the History of the United States Bond Debt — Security of National Bonds — Wealth and Income of the United States — The Circulation Privilege — Rate, Amount, Denomination and Taxation — The Markets, Prices, and Net Yield.

Foreign Government 648

What Determines the Flow of Investment between Countries — The Character of the Money System and Its Effect on the National Debt — Forms of Indebtedness — Repudiation and Defalcation — Foreign Investment Trusts — The American Market for Foreign Securities — Price of Government Bonds.

XXXVII.

XXXVIII.

Appendix

A. Catalogue of Bonds 675

B. Table of the Present Outstanding Liberty Bonds

OP the United States Together With Their Important Regulations 698

TABLE OF CONTENTS xxi

PAGE

C. Income Analysis of the American Temigraph and

Telephone Company 702

D. Suggested Topical Bibliography 703

Index 775