How to Invest Money by George Garr Henry (best novels for teenagers .txt) 📕

Is a security possessing these characteristics a suitable investment for a business surplus? Only to a limited extent. The safety, high return, and assurance against loss in quoted value of principal are all highly desirable qualities for this purpose, but the lack of convertibility is a fatal defect. No consideration is of greater importance in the investment of a business surplus than a high degree of convertibility, so that if the need should arise the investment may be instantly liquidated. The fact that real-estate mortgages can not be readily disposed of makes it practically impossible to employ them for the investment of a business surplus.

Where convertibility is not an essential requirement, and where the want of promise of appreciation in value is not a serious matter, mortgages afford a very desirable form of investment. The characteristics which they possess in an eminent degree—safety, high return, and assurance against loss in quoted value of principal—are exactly suited to the ordinary requirements of savings-banks. Generally speaking, only a small proportion of a savings-bank's assets need be kept in liquid form or readily convertible, and accordingly they find mortgages highly desirable.

For the purpose of private investment the attractiveness of mortgages is not so easy to determine. Ordinarily, fluctations in quoted values are of no great importance to the private investor, so that the absence of quotation which mortgages enjoy is not especially valuable. Their safety and high return are attractive qualities, but their want of convertibility and of prospect of appreciation in value are drawbacks. On the whole, the private investor may probably employ with advantage a certain part, but not too much of his estate in mortgage investments.

As part of a scientific and comprehensive scheme of investment, the special advantages of real-estate mortgages appear most prominently in the years following a business depression. During such a period real-estate values are usually relatively low, but beginning to advance, so that mortgages present their maximum margin of security. At such a time they compare most favorably with bonds and other investment securities which are subject to changing quotations, because such securities are then apt to be at their highest point under the combined influence of restored confidence and the low money rates which usually prevail. After several years of continued and increasing business prosperity the positions are just reversed.

No discussion of real-estate mortgages would be complete without allusion to the guaranteed mortgages which have been placed upon the market in great quantities within the past few years. Guaranteed mortgages are real-estate mortgages guaranteed as to principal and interest by substantial companies having large capital and surplus. In addition to the guaranty, the companies usually search and guarantee the title, see to it that the taxes, assessments, and insurance are paid, and perform the other services of a real-estate broker. Their compensation varies somewhat, but probably averages ½ per cent—that is, for example, they loan at 5 per cent and sell guaranteed mortgages to the investor at 4½.

The value of the guaranty may be considered from two points of view—first, in the event of a general decline in real-estate values, and, secondly, when a fall occurs in a particular piece of property or in a particular locality.

If a severe decline in real-estate values takes place, affecting all localities, it might become necessary for the holders of guaranteed mortgages to test the value of their guaranties. In such a case the question would arise how far the capital and surplus of the guaranteeing companies would extend in liquidating the mortgages which they had guaranteed. This would depend entirely upon the proportion between the capital and surplus of the companies and the total amount of outstanding mortgages guaranteed. Ordinarily the capital and surplus do not exceed 5 per cent of the mortgages, so that the average guaranty is good for about 5 per cent additional equity. On a piece of property worth $100,000, upon which a guaranteed mortgage of $60,000 exists, the guaranty would be worth $3,000, and would margin the property down to $57,000. This additional equity is of little value. It is probably unlikely that a 40-per-cent depreciation in value will take place, but the guaranty is not needed unless it does, and if it should occur, the depreciation is quite as likely to go to 50 per cent or more as to stop at 43.

From the second point of view the value of the guaranty is much greater. The distribution of risk, as in the case of fire-insurance, protects the holder against loss in the event of a fall in the particular piece of property upon which he holds a mortgage, or even in a particular locality. It can not be said, however, that the records are yet sufficiently complete to form a conclusion as to what is a safe proportion between capital and surplus and outstanding mortgages. Further than that the guaranteeing companies, generally speaking, have been operating since their inception upon a rising market, so that their success hitherto has not been remarkable. Allowing for these drawbacks, however, the private investor, unless so situated as to give personal attention to the details of his investments, will probably do well to purchase his mortgages in guaranteed form.

Industrial bonds include the obligations of all manufacturing and mercantile companies, and miscellaneous companies of a private character. They form a class quite distinct from railroad bonds or public-utility bonds.

I. Safety of Principal and Interest. The safety of industrial bonds, in common with the safety of all forms of investment, depends upon the margin of security in excess of the amount of the obligation. In the case of industrial bonds the amount of this margin is not always easy to determine. Even when determined, the rule is difficult of application because a margin which may seem insufficient from the point of view of physical valuation may be satisfactory when considered as the equity of a working concern. The indications most to be relied upon in estimating the safety of industrial bonds are as follows:

(a) Value of real estate. The first point to be determined in considering the purchase of an industrial bond is the value of the real estate upon which it is a first mortgage. If the appraised value of the ground, irrespective of the buildings and machinery upon it, is greater by a substantial sum than the amount of the bond issue, the obligation is practically a real-estate mortgage. In such a case, while possibly "slow," i.e., secured by an assets difficult to realize upon—the safety of the bond can hardly be questioned. In judging a bond upon its real-estate value, it is not always safe to take the cost price of the land as shown by the company's books, because frequently the cost upon the books is artificially raised by payment having been made in securities whose market value is less than par, or in other ways. As stated above, judgment should be based upon the appraised value of the land.

If the bond meets this test satisfactorily, the prospective investor may feel reasonably sure that the safety of his principal is not in question, and may buy the bond without anxiety if it satisfies his other requirements. On the other hand, if the bond only partially meets this test, and it appears that some part of its value comes from plant and equipment and from the strength of the company as a working concern, then it is necessary for the investor to consider carefully several other factors.

(b) Net quick assets. The balance-sheet of every industrial company can be divided horizontally into two parts. Its assets are of two kinds—property assets, which are fixt, and current assets, which are fluid. Similarly, its liabilities are of two kinds—capital liabilities and current liabilities. It requires no very extended business experience to pick out the items which make up these totals. Plant and property assets are usually lumped together under the head, "Cost of Property." Current assets include inventories, bills and accounts receivable, agents' balances, marketable securities, and cash on hand and in banks—everything, in short, which can be quickly converted into cash. On the other side of the balance-sheet, capital liabilities are easily determined. They consist of the par amounts of bonds and stocks outstanding. Current liabilities comprise bills and accounts payable, including borrowed money, pay-rolls, and interest and taxes accrued but not due.

The real strength of every industrial concern is to be learned from the figures relating to its current accounts. Property assets and capital liabilities are not of the same significance. If the cost of plant and equipment as shown by the books exceeds its real value, the market usually makes the necessary adjustment by putting a price less than par upon the bonds and stocks.

No such process is possible in the case of the current accounts. If the current liabilities exceed the current assets the company shows a deficit, whatever its surplus may show on the books. On the other hand, if the current assets are greater than the current liabilities, the company possesses a working capital, represented by the difference between the two, and known as net quick assets.

There are three things to consider in connection with net quick assets: First, the proportion between current assets and current liabilities. To put a company in good shape its current assets should be at least twice as great as its current liabilities. Two for one is a fair proportion, tho some companies show as much as six to one. The stronger a company is in this proportion the better.

Secondly, the proportion between net quick assets and bonded debt. The bonded debt should never exceed net quick assets, except when the company possesses real estate, in which case two-thirds of the real-estate value plus the net quick assets should cover the bonds. Some companies do much better than that. One prominent company in this country, altho it possesses real estate of considerable value, has agreed in the indenture securing its bonds to keep net quick assets at all times greater by a substantial margin than the amount of bonds outstanding.

Thirdly, the proportion between net quick assets and the surplus as shown in the balance-sheet. If the capital liabilities exactly balance the property assets, it is plain that the surplus will exactly balance the net quick assets. If the surplus is smaller than net quick assets, it is usually a sign that capital liabilities have been created to provide working capital. Opinions differ as to the wisdom of this course. Generally speaking, it is better to provide working capital by means of a stock issue than to depend upon the banks for accommodation. The exception to this rule occurs in the case of companies that require a great deal of working capital for part of the year and only a little at other times. If they have the best banking connections, such companies may be safe in depending upon their banks to carry them, but if they do so, they should have no bonded or other fixt indebtedness which would prevent their paper from being a first lien upon their entire assets.

If working capital is to be created by the issue of capital liabilities, it is much better that it should be done by stocks than by bonds. The ideal method, however, is to provide only such an amount of working capital at the organization of a company as is necessary for the conduct of its business, and then, as the volume of its business grows, to accumulate the additional amount necessary out of earnings, refraining from the payment of dividends until the fund is complete.

Before leaving the subject of net quick assets, it is well to note the importance