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

per-capita debt of the country is so small, the wealth of the country so great, and the good faith of the American people so clearly established, represent the highest type of security to be found in the world. It is quite possible, therefore, that the 2-per-cent United States Consols would sell in any case at a relatively higher price than the obligations of any other country, but it can not be denied that the chief reason which causes them to sell at the remarkably high price which they have attained is the fact that they are required by national banks as security for circulation. This fact is doubtless the controlling element in their market position, and at once accounts for their special strength and removes them from the field of private investment.

Only less secure than United States bonds are the obligations of the sovereign States of the Union. State bonds usually sell upon a basis which may be taken as the equivalent of pure interest, with no element of risk or speculation involved. The obligations of different States sell at different prices, in accordance with market conditions and the relations of supply and demand, but there can be no question of the equal ability of all States to pay their obligations. Repudiation of State debts has occurred in our history, but only in cases where an overwhelming majority of the citizens were opposed to the creation of the debt at the time of its issue, but lacked the means to control the situation. Such instances are chiefly to be found in the case of the so-called carpet-bag governments of the Southern States after the Civil War.

Municipal bonds—i.e., the bonds of cities, counties, and townships—are indirectly a first lien upon all taxable property in the municipality, and take precedence of every form of mortgage or judgment lien. This lien is enforced through a tax levy to meet interest and principal, and this tax levy the courts will compel in the rare cases in which a municipality attempts to repudiate a valid bond. This priority of the tax lien is the foundation of the prime position of municipal bonds. The case rarely occurs where a bond held valid by the courts proves uncollectable if sufficient taxing power existed when the bond was issued to provide for its redemption. It is only when the municipality itself diminishes in population and taxable property to the vanishing-point that such a default can occur. An investor can judge for himself as to the likelihood of such a catastrophe in any particular community, and can feel sure that his bond, if valid and protected by a sufficient taxing power, is as secure in its principal and interest as the municipality which issues it is secure in its continued existence. The following are the chief points which should be considered in the investigation of a municipal bond: (1) The proportion which the total debt of the municipality bears to the assessed valuation of the property subject to taxation. Usually a maximum rate is fixt by constitutional provision which rarely exceeds 10 per cent. (2) The purpose of issue. This must be a proper and suitable one. (3) The proceedings under which the bonds were issued. These proceedings, the form of bonds, their execution, and their legal details must be in full compliance with the law.

If these points are found to be satisfactory, the investor may rest content that no other form of security is so greatly safeguarded and that his bond ranks upon a substantial equality with government and State obligations.

The rate of income to be derived from investment in municipal bonds varies in accordance with the obligations selected. Like other forms of security, municipal bonds are controlled by market conditions, and their price is determined by the relations of supply and demand, and by adjustment to prevailing money rates. While differing only moderately from one another in point of safety and income return, municipal bonds may be divided into two distinct classes in accordance with the degree of convertibility which they possess. Some municipal bonds possess great convertibility; others almost none. The feature which chiefly determines the activity or inactivity of a municipal issue is the size and importance of the municipality, together with the amount of bonds which it has outstanding. The bonds of large and important cities, whose outstanding debt reaches considerable proportions, usually possess great activity. They are constantly traded in and command a broad market because dealers are willing to buy or sell them in blocks at prices within a fraction of 1 per cent apart.

On the other hand, the bonds of counties, townships, and small cities are usually quite inactive. Transactions rarely occur in them, dealers do not make a market in them, and they can be sold only to genuine investors. It is often impossible to have them even quoted.

At first sight, it would appear that active municipal bonds would be much more desirable, but inactive municipals possess a special advantage which the active ones do not enjoy. They possess more stability of market price. It is true that their stability of value is due to the fact that they are not traded in or quoted and is, therefore, largely fictitious, but nevertheless it accomplished a useful purpose. It enables the investor to carry inactive municipals at cost price upon his books through periods in which active market bonds would require to be marked down in conformity with prevailing market prices. No other class of investment except real-estate mortgages possesses to the same degree this quality of price stability. For many classes of buyers—savings-banks, for example—stability of price is a consideration of prime importance. The preservation of the savings-bank's surplus and, indeed, the continued solvency of the institution depend upon maintaining the integrity of the principal which it has invested. A savings-bank requires, also, great safety of principal and interest; i.e., the certainty that principal and interest instalments will be paid at maturity. It needs only a fair but not high yield, and it does not need to place emphasis upon convertibility or prospect of appreciation in value. Comparison of these requirements with the characteristics of inactive municipal bonds discloses a striking adaptability on their part to the real needs of the case. As a consequence, it is not surprizing to discover that inactive municipals are greatly sought by savings-banks.

The desirability of inactive municipals for savings-bank investment was never more forcibly illustrated than on the first of last January, when the savings-banks came to make up their annual statements. Broadly speaking, there can be no doubt that they were saved by the large quantity of inactive municipals and real-estate mortgages which they carried. Had any considerable portion of their assets consisted of railroad bonds and active municipals, upon which they should have had to write off a loss of ten to fifteen points, their solvency would almost certainly have been impaired.

But we are chiefly concerned in these pages with the advantages and disadvantages of different forms of investment from the point of view of a business man, both for the investment of his business surplus and of his private funds. Do municipal bonds, either active or inactive, conform to the requirements of the business surplus? It can not be said that they do. Municipal bonds possess either convertibility without stability of price or stability of price without convertibility. Both qualities are necessary for a business surplus. The only form of municipal security which is at all adapted for the investment of a business surplus is a short-term issue of an active municipal bond. If it has only a very few years to run, its constant approach to maturity will invest it with the necessary stability of price. But even in this case equal safety and equal stability of price combined with a higher yield can probably be found in some high-grade railroad issue—either a short-term mortgage or equipment bond.

For private investment the case is somewhat different. Enough has been said in the preceding chapters to impress upon the reader the importance of buying securities only in accordance with his real requirements. If any investor, after careful comparison of the characteristics of municipal bonds, either active or inactive, with his necessities, decides that he can more closely satisfy his requirements with municipals than with any other form of security, he should not hesitate to purchase them. It is the opinion of the writer, however, that a thorough survey of the field of investment will generally disclose to the investor some security in either the railroad or corporation field which will suit his requirements as well as the municipal bond and at the same time provide him with a greater income.

VIII STOCKS

Passing to the consideration of stocks as investments, it is necessary at the outset that the reader should have clearly in mind the fundamental difference between stocks and bonds. This distinction was drawn in the introductory chapter, but it will be well to amplify it here, even at the risk of carrying the reader over familiar ground.

The distinction between bonds and stocks is that between promises to pay and equities. Bonds, loans on collateral, and real-estate mortgages represent some one's promise to pay a sum of money at a future date; and if the promise be valid and the security ample, the holder of the promise will be paid the money on the date due. Stocks, on the other hand, represent only a beneficial interest or residuary share in the assets and profits of a working concern after payment of its obligations and fixt charges. The value of the residuary share may be large or small, may increase or diminish, but in no case can the holder of such a share require any one, least of all the company itself, to take his share off his hands at the price he paid for it, or, indeed, at any price. If a man buys a $1,000 railroad bond, he knows that the railroad, if solvent, will pay him $1,000 in cash when the bond matures, but if he buys a share of railroad stock his only chance of getting his money back, if he should wish it, is that some one else will want to buy his share from him at the price he paid for it or more. If he buys a bond he becomes a creditor of the company, without voice in its management, but entitled to receive his principal and interest when due under pain of forfeiture of the security which the company made over to the trustee to insure payment. If he buys stock, he becomes a partner in a business enterprise, exercising his proportionate share in the direction of the company's affairs, and sharing ratably in its profits and losses. In the one case he buys a promise to pay and in the other an equity.

This distinction, which appears plainly marked in theory, has been much obscured in recent years by the influence of two factors. As the country grew in size, the large corporations—the railroads, for example—required greater capital in order to provide facilities for the handling of their growing business. It was impossible to provide this capital wholly by means of bond issues without destroying the proportion between bonds and stocks, which alone could give to the bondholders the protection of a substantial equity. It was therefore necessary to obtain a large part of the capital required in the form of stock. The railway-managers were thus confronted with a difficult problem. It was imperative that they should obtain more capital, and it was impossible to dispose of sufficient stock on the basis of a speculative risk in a business venture. It was therefore necessary for the railway-managers to emphasize, as far as possible, the investment character of their stock, and various expedients were adopted