Common Stocks and Commodity Prices

by HERMAN GASTRELL SEELY

AMONG the theories of the ’new era’ which are now being discarded in favor of more time-honored maxims of pre-war vintage is the one that we are on a permanently higher plane of commodity prices. Under its influence,, a few years ago, index numbers were revised to compare with 1926, as more typical of new conditions than those of twelve years earlier, and the whole scheme of business operations went forward on this rather comforting premise. Minor swings in prices, it was conceded, might develop in specific industrial and trade groupings from time to time, but a wholesale readjustment downward was deemed out of the question.

For several years under the influence of abnormally large gold reserves and certain other aftermaths of ther World War, it seemed as if this theory might be verified in practice. With theadvent of 1930, however, has come a sharp and startling decline in the prices of grains, rubber, sugar, coffee, cotton, silk, hides, silver, and copper, and other metals, and a slower recession in the products which are derived therefrom.

INSTEAD of looking forward to stabilization on a 1926 basis, the debate between economists now is whether the declines have spent themselves or whether wo must descend further until pre-war commodity levels are reached.

The optimists cling tenaciously to the belief that new methods of banking, a better understanding of economies possible for the goldstandard nations in the use of this all-important metal, and the functioning of some new international agency like the Bank for international Settlements may prevent any new and drastic breaks.

The more pessimistic insist that we have seen only the initial stages of the decline and that still lower prices are inevitable for nearly everything except, possibly, farm products, which are already well deflated. This group, which is gaining recruits steadily, cites the price trends following the War of 1812 and the War of the Rebellion as precedent. The conclusion of the earlier war coincided roughly with the end of the Napoleonic struggles in Europe and therefore was a period of world reaction. The Civil War entailed the use of national resources more nearly comparable with that of the World War than did the armed debates with Mexico and Spain,

In each of these post-war periods, a smash in wholesale prices and raw materials developed soon after pence was declared, to be followed by a period of partial recovery. Then followed a long, gradual, and irregular decline which, in the case of the Civil War, persisted for twenty-three years. Something of this sort, it is insisted, is in prospect at present.

SHOULD future events justify the pessimists, just what is in store for the holder of common stocks whose returns are fixed by the decisions of a board of directors as business conditions present themselves?

In the first place, a decline in commodity prices does not bar periods of prosperity. Many of the years between 1873 and l896, for example, saw very excellent business. What does happen, how - ever, with a decline of this type is the intensification of competition to a survival of-the-fittest degree. Nor is it hard to understand why.

If a corporation selling articles at a dollar in a competitive market finds suddenly that the unit price has sagged to ninety cents, there is only oneway to maintain the old sales totals and net profits available for common dividends. That is to sell ten such articles where nine were sold before. The stronger corporations in many eases will do this, but it will be at the expense of their less successful competitors.

Recent company reports offer excellent examples of the difficulties imposed by lower commodity prices. A large grocery chain reported July 1930 sales 3.2 per cent ahead of July 1929 in dollars, but it was necessary to increase the tonnage of goods moved 14.3 per cent to accomplish this. The semiannual report of an automobile tire company pointed out that although the dollar sales volume was 11½ per cent below 1929, the actual number of casings and tubes sold was higher. Copper companies, fared by a decline both in volume and in price, have been forced to cut their dividends mercilessly. Other specific evidence may be culled almost any day from the financial columns of the newspapers.

THIS intensification of competition does not mean the passing of the common stock as an investment medium until commodity stability is again in sight. It does, however, justify the careful scrutiny of holdings of this nature, and the submission of each individual security to a questionnaire somewhat along these lines:

Is the company likely to meet increasingly severe competition? (Some of the utilities, for example, are practically immune from it.)

If competition is assured, how old is the company? Has it ever been tested by adversity?

What is the character of the management? Is it seasoned, or the product of post-war years with little or no experience in coping with a prolonged period of irregnlar business?

What were the company’s earnings in the slower of the years between 1922 and 1930?

What is its capital structure? Is there an unwieldy percentage of senior securities outstanding whose fixed interest charges and preferred dividends must be met before the common-stock payments can be made?

Has the number of common shares outstanding been inflated dangerously by the declaration of frequent stock dividends and ‘melons’?

What are the bookkeeping methods? Have adequate deductions for depreciation and reserves been made, even in the leaner years?

How strong is the cash position? Will the surplus permit payment of dividends on the common stock even though the actual earnings may be below the amount, thus involved during an adverse quarter or two?

Of what type arc the products or the services sold by the company? Are they to be classed as semi-necessities, or are they luxuries or novelties which suffer inevitably in a period of reduced public buying power?

How strongly organized is the distributing or dealer organization?

Common stocks of corporations which can answer questions such as these satisfactorily should be considered fairly permanent tenants of any investor’s safety-deposit box. For those which cannot, eviction notices should be prepared to be served ruthlessly if the commodity price decline gains further momentum.