How to Invest Money by George Garr Henry (finding audrey txt) 📖

The first question which arises is whether the franchise is perpetual or for a definite time, and the second whether it is partial or exclusive. Franchises vary greatly in these respects. Sometimes a franchise, apparently partial, is practically exclusive, owing to the fact that all the available space in the streets is already occupied by the company's own tracks. If the franchises of a company are limited as to time, it is expedient, if not imperative, that the bonds should mature before the expiration of the franchises.

If the company whose bonds are under examination satisfactorily passes this physical test—if it possesses real estate of considerable value, if the replacement value of the property is as great or nearly as great as the amount of the bonds, and if the franchises, while perhaps not perpetual or exclusive, are yet of longer duration than the bonds and render successful competition unlikely—the next step may then be taken; that is to say, an examination of the company's financial condition and earning capacity may be made.

The amount of its gross earnings should be examined and the figures scrutinized for a number of years back to discover whether its earnings are increasing or decreasing. The position in which the company stands for obtaining new traffic must be noted, and some estimate must be made of the stability of its earning power. In this connection the relations of the company to the public are of great importance. It must be learned whether the company follows the policy of conciliating or ignoring public sentiment.

The net earnings of the company must then be examined. This involves a criticism of operating expenses. The payments of the road must be analyzed to determine whether the proper amounts have been expended for renewal of track, replenishment of rolling stock, and other improvement sufficient to keep the property in good physical condition. This is the most intricate subject in the investigation of a street-railway property. Unless proper allowance be made for depreciation, in addition to the expenses of direct operation, it is only a question of time before the strongest company will become bankrupt.

Deterioration of plant and equipment, which goes on constantly, can only be offset in two ways: one is out of earnings and the other is out of the security-holders—that is, by decreases in the market value of the securities. The first takes prosperity or courage; the second leads to bankruptcy. It is difficult to measure depreciation accurately, but a safe rule is to write off ten per cent of gross earnings each month for depreciation. In this way the charge for depreciation will be proportionate to the traffic, which provides automatic adjustment.

If the net earnings, after making this allowance for depreciation, and after providing all expenses of operation including ordinary repairs, amount to as much as twice the interest charges upon the bonds outstanding, it is probable that the bonds may be taken with safety.

Before finally determining the question, however, certain political factors must be taken into consideration. The relations of the company to the leaders of the dominant political party must be investigated. The likelihood of agitation looking toward a reduction of fares must be considered and the possibility of increase in taxes (if below the legal limit) must be weighed. The probable attitude of the legislature on the question of renewing the franchises when they expire must be considered. In general, it must be learned whether any real ground of contention exists between the company on the one hand and the public and its representatives on the other, because it is inevitable that the company will weaken its independence of position by too close a connection with politics, and that the physical property will suffer if there is any lack of uninterrupted attention to it.

Finally one other thing should be investigated—the amount of the accident account and its proportion to the net earnings of the company. On small lines a single case of heavy damages will sometimes make serious inroads upon the earnings.

The foregoing is a summary, necessarily brief and imperfect, but true in its essential outlines, of the main points which should be considered in judging the safety of street-railway bonds. The question remains, how far does the average street-railway company satisfy these requirements? Broadly speaking, street-railway bonds are not yet to be classed in the first rank of investment securities. The troubles which have come to a head in the financial operations of the traction systems in New York and Chicago are typical of troubles which are likely to occur elsewhere from the same general causes—overcapitalization in the first place and insufficient allowance for depreciation in the second place. In both New York and Chicago the crisis was hastened by open and obvious overcapitalization, which is almost inevitable when many independent lines are merged into one system. The same trouble, however, is apt to occur in other traction systems where this evil appeared less flagrant at the outset.

The advantages of electricity over horsepower naturally led to the multiplication of electric street lines, as the system ten or fifteen years ago passed beyond the experimental stage. As in all new enterprises, speculation ran ahead of the reality and financing built upon oversanguine calculations has too often had difficulty in squaring accounts when brought face to face with facts. In most of the calculations insufficient allowance was made for the wear and tear of service; in other words, for renewal of road and equipment. After a few years' test of earnings against expenses, it became evident that a proper allowance for depreciation of plant would show a heavy deficit in the income account. In most cases therefore no allowance or only a meager one was made. For a time this method of bookkeeping proved less disastrous than might have been expected owing to the rapid growth of population and business in American cities. It was possible in many cases to consider the enhanced value given to the franchise by growth of business as an offset to the depreciation of tracks and equipment. In so far also as the plant was kept up to a high degree of efficiency by charging the expense of repairs to operating expenses, the absence of a depreciation account was partially offset.

With the progress of recent years, however, a new factor has been entering into the problem which promises to make the situation still more serious for the traction systems. This new factor is the rise in prices and wages. Temporarily the influence of this factor may be checked by diminished business activity, but when normal conditions are restored, it will commence to act again upon the railways with accumulated effect.

In most cases a proposition to increase the standard street-railway fare above five cents as an offset to the increased operating expenses would be so revolutionary a proposal that it could hardly be carried through. With the line of cost converging upon the line of receipts and with no proper allowance made for depreciation, the traction systems of the country seem to be facing a difficult problem. In the long run it can not be doubted that the problem will be met and solved in a way to afford justice alike to the public who use the cars and to the capitalists who have made street traction on a large scale possible, but in the meantime the investor who desires perfect safety should exercise great care and discrimination in his purchases of street-railway obligations.

II. Rate of Income. As a general rule, street-railway bonds in common with the obligations of all public-service corporations sell upon about the same income basis as high-grade industrial bonds—that is to say, under normal conditions they return considerably more than railroad or municipal bonds.

III. Convertibility. It is difficult to speak of the convertibility of public-utility bonds as a class for the reason that they differ widely from one another in this respect. In general, it is certainly more difficult to dispose of public-utility bonds than railroad bonds. They do not possess sufficient convertibility to justify their purchase by any one who may need to realize quickly on his holdings.

IV. Prospect of Appreciation in Value. Public-utility bonds, except such issues as are convertible into stock, possess little prospect of appreciation in value. It was pointed out above that depreciation is not properly allowed for, and it is very difficult for the securities to advance in the face of this obstacle.

V. Stability of Market Price. The bonds of public-service corporations are relatively more stable than railroad bonds because their earnings are not subject to the fluctations which occur in railroad properties between years of prosperity and years of depression. At the same time, it should be pointed out that their stability of price is largely fictitious, owing to the comparative inactivity of the issues. In other words, while the quotation may be maintained, it is usually difficult to sell any large quantity of a public-service corporation's bonds in a period of financial disturbance, while railroad bonds are more easily liquidated even if at a sacrifice.

The question remains, do public-utility bonds afford a desirable security for the investment of a business surplus and of private funds? In regard to the former, it may be said at once that public-utility bonds do not meet the necessary conditions. The security is too doubtful, the convertibility is too small, and the stability of price too uncertain.

For private investment the case is somewhat different. Keeping in mind the desirability of diversifying investments and admitting the attractiveness of investing in a class of property whose earnings are comparatively stable, it seems clear that public-utility bonds can not be dismissed without consideration. When a company is found whose property is substantially equal in real value to its bonded debt, whose allowance for depreciation is ample, whose franchises are satisfactory, whose earning capacity is large, and whose management is capable and upright, the investor is justified in giving careful consideration to its issues. Unless all these points are found to be satisfactory, however, the investor should content himself with some other form of security. For some years to come it is to be feared that many of our public-service corporations will suffer from the war of discordant elements—disregard of the rights of the public on the part of the management and socialistic agitation for control on the part of the community. Until these warring factions are reconciled and the questions at issue adjusted with fairness to the security-holders and the public, the investor should be most prudent in his purchases of public-utility obligations.

The previous chapters have considered, in turn, the investment value of railroad bonds, real-estate mortgages, industrial bonds, and public-utility bonds. The desirability of each of these different classes of security has been judged in accordance with the general principles laid down in the introductory chapter; that is to say, each class has been analyzed in relation to safety, rate of income, convertibility, prospect of appreciation in value and stability of market price. The same determining factors must now be applied to a judgment of government, State, and municipal bonds.

Bonds issued by a national government, by a State, or by a municipality are based primarily on some form of the power of taxation, tho the bonds are usually tax exempt within the political unit which creates them.

When the power of taxation is unlimited, as in the case of the national government and the sovereign States, there can be no question as to the ability of the political unit to meet its obligation, and the question becomes entirely one of good faith. It is probable that the obligations of the United States Government, by reason of the fact that the