Discounting Luck

The FINANCIAL COUNSELOR

by JONATHAN C. BOYLE

POTENTIALITIES of danger for investors will not disappear with the passing of the depression.Potentialities for a fortune, for a competence, or for just plain profits, according to the scope of the investor, were never so bright. But the necessity of using sound common sense and good judgment was never greater. It is comparatively easy to follow up the securities market, but it is far harder to follow the market up.

This is a buyers’ market. Sound first-grade bonds are cheap, dirt-cheap. Stocks, both preferred and common, in long-established, reputable, and prosperous corporations, are to be had at prices so low as to be totally unwarranted even by the severe economic situation of the country. Prices of securities of this character have been deflated until even the most pessimistic declare that further declines are unwarranted.

Purchases of such securities cannot but yield a profit, not only from the point of view of those who invest for income, but also from the point of view of those who buy for accretion in capital value. But it is the worst possible mistake to assume, as do many investors of only brief experience, that, because the entire list on the reputable exchanges dropped in the period of financial unrest, all will advance when that period is replaced by prosperity. Comments to the effect that an investor can pick out any stock on the list and be sure of an increase in price of 100 per cent or more are frequently heard. It is usually added that if the purchaser picks ‘lucky ones’ the advance may yield profits of 200, 300, or 400 per cent.

There are no ‘lucky ones.’

There are worthy bonds and stocks which have been reduced to their present price levels in sympathy with the general movement of the entire list and by reason or the general economic difficulties through which the country has been struggling. These, if bought at present prices, unquestionably will return a profit, and a magnificent profit. Then there are stocks and bonds which have reached their present levels because they deserved to sell at no higher figures. They in turn are divided into bad and worse. Some will reach higher levels, but the advance will be slow and not extensive. The latter classification probably will have further declines.

IT is to be seen plainly that this is a time to separate carefully the sheep from the goats. This cannot be done by guesswork. Many people, when they speak of ‘cheap stocks,’mean stocks which are selling at comparatively few dollars a share. The fact of the matter is that some stocks are dear at any price, while the cheapest stock on the list may be one selling at one hundred dollars a share or more. Present prices in dollars, therefore, are not reliable indicators of present or potential values.

The first necessary step toward safe and profitable investment is to gather all information possible about the companies whose securities are under consideration. During the 1928-29 advance thousands of people bought securities of companies without knowing what business the companies were engaged in. To attempt to pick a safe investment in this way is to court disaster.

No better way is known to the writer for the present-day investor to make a selection than to go through the list and make a diversified choice of stocks or bonds in concerns which seem likely to continue to earn fixed charges or dividends or to possess big possibilities for future earning expansion. He should then familiarize himself, not only with the financial set-up of each concern, but with the company’s policies as to reserves, depreciation, and expansion, with the character of its management, and with the type of its customers.

The last is by no means to be overlooked. Practically all business corporations secure their incomes from selling something, whether it be service, raw materials, or manufactured products. Unless the customers want to buy, unless they will buy, and unless they can pay, there can be no satisfactory profits. Therefore a concern whose customers have had their buying power badly curtailed should be avoided until this condition is rectified.

Another and most valuable test is to examme closely how the companies in question have come through the desperately hard years since 1929. No commander can judge whether a man is a good soldier until he has seen him under fire. Then his actual value is shown past all mistaking. One should be sure his investment selections are not parade soldiers who make a great showing when there is little or no opposition.

Those companies which have come, scarred but victorious, through the fire test of depression are entitled to more than a fair share of confidence.

Tim book value applicable to a stock or bond is of great use as a matter of comparison from year to year, but, after all, it does not give a true picture of the position of a corporation, for it takes into account only tangible assets. Intangible assets are sometimes of equal or greater value. Good will, appraised on the balance sheet at the nominal value of one dollar, has added millions to the assets and earning power of some concerns in the last two years, and the loss of good will has dealt a blow to others from which they will not recover for a generation. Other intangibles, including patents, processes, formulæ, copyrights, and trade-marks, and, most important of all, efficiency of management, should be given broad consideration.

The investor should determine from the information available, analyzed and considered carefully, what, in his best judgment, is the actual value of the security under consideration as distinct from its present market value. Then he should make up his mind firmly not to hold that security a single day after it has passed above that value. To do so is to invite disaster.

THESE are some of the tests by which holdings of the highest type may he selected. It will be these high-type securities which will show the first response to the impulse upward. And the time to secure such holdings is now. Stocks and bonds have pretty well discounted in their price levels the developments which can be foreseen. The danger that some unexpected happening will depress them still further is less than the possibility that the market may creep up gradually an appreciable number of points before the buyer makes up his mind to act. It is as profitable to buy low as to sell high.

THERE should be no real difficulty in selecting a list of investments that suit each individual need, and which have, at the same time, the advantage of diversification, so that isolated happenings in one industry will not affect the entire list. At a conservative estimate there are on the New York Stock Exchange from ten to thirty bonds, and an equal number of stocks in each of the main divisions. — the rails, the utilities, and the industrials, — any one of which would answer the strictest requirements.

Bonds, for those who are seeking a high yield on a fixed-rate basis, are selling at prices which may not occur again for many years to come, if ever. Bonds of a slightly lower grade are selling at prices promising a high yield and a decided capital appreciation also. Many sound preferred stocks are at low points for all time. For those who seek increase in selling value, and for whom the problem of yield is for the time being of secondary importance, there are excellent opportunities in common stocks of companies in essential industries which stand up above others in their respective lines of endeavor.

THERE never was a better sermon preached for the investor than the parable of the ten talents. The wise investors in that story received their rewards, and the gentleman who buried his talents in a napkin also got just what he deserved. Every person with money which he can possibly use for such purposes should go into investments, but he should go in with his eyes open and keep them open. Eternal vigilance is the price of safety in the investment field. And the investments should be made on judgment, not on tips. A tip is a poor herald for Opportunity.