The Case for Equities

This department is designed to help readers to a better understanding of the general business conditions which affect their investments. It is obviously impossible to give advice as to specific investments.

by C. T. REVERE

AMID the cross currents and contradictions that tend to confuse financial opinion, it is possible to find an outstanding paradox on one side a mountain load of debt, on the other an overwhelming flood of idle capital seeking investment. Already, in this fear-distraught country of ours, these hoards are peeping out of their cyclone cellars, and trial balloons of new issues have been met by sharp competition from underwriting houses, followed by gratifying public absorption and occasional over-subscription.

More striking examples of the urge of capital to find investment outlet are furnished by the English market. The following extract from a London financial letter loes not overstate the case: ‘The glut of funds in the discount market is parallel to the abundance of money awaiting long-term investment. . . . Almost every new capital issue is absorbed within a few moments of the opening of the lists. Subscription totals are becoming fantastic in their volume. For instance, £10,000,000 was offered for a £500,000 loan issued by a small municipal corporation, and cash applications for the Mersey Docks and Harbour Hoard’s £2,000,000 conversion issue reached £21,000,000.‘

How soon may we expect similar manifestations in our own financial centres? When we look at our backlog of gold and our colossal excess reserves, it would seem that the one element required for the effective functioning of our capital resources would be to have the seal of verity placed on the growing indications of constructive coöperation between government and private enterprise. Present signs are cheering in this respect. Business seems to have tempered its concern over whether the political trend is to the ‘ Right or to the ’ Left. Apparently it is hopeful that the experiment with ‘trial and error’ has resulted in official conclusions to the effect that the time has come to grant more latitude to chastened individual initiative and that the economic machine will run more smoothly if lubricated with profits.

Nevertheless, in order to visualize our problem it is essential to examine, even if it is impossible fully to explain, the paradox of a superabundance of capital in a world which but yesterday was believed on the verge of being buried under an avalanche of debt. In part, and in a fundamental sense also, this may be ascribed to the miraculous vitality of the capitalistic instinct its recourse to thrift in adversity, its amazing capacity for working out collective automatic adjustments. Debt remains, of course, in many cases of moratorium or ‘ stand-still ’ status, an appalling proportion either hovering on or definitely destined to repudiation.

Yet, a substantial nest egg has been saved — enough, vitalized by the energy and resourcefulness of the race, if fostered by wise and helpful governmental policies, to provide a fund for progress toward new and higher achievements. In the United States the attainment of urgently needed liquidity was aided to an incalculable extent by administration measures designed for thawing out’ frozen private obligations. The assumption of these burdens by government bestowed a benefit on individual capital which has not yet been fully recognized. It is incumbent on American business to make full acknowledgment by loyal reciprocity.

In periods of depression, doubt, and insecurity, the quest of the investor is for ‘security, rather than yield or price appreciation. At present this impulse persists with but slight moderation of its neurasthenic intensity. Gilt-edged bonds continue in supreme favor. In fact, if it were not for recurrent fears of inflation, the demand for high-grade bonds would force them up to a ridiculously low yield basis.

However, if budding hopes find justification and acceptance, if fears of monetary tinkering and radical inflation are relegated to the nightmare past and ‘Leftist’ spectres are laid, a new factor enters the picture. The profit urge gradually takes precedence over the crave for safety, and the more courageous element in the investment community directs its attention to promising opportunities in equities.

It will be conceded that even the approximate timing of this movement involves the hazard of prophecy. However, the cyclic inevitability of the recurrence justifies an examination of its potentialities. In his search for desirabilities, the exploring investor is likely to become disturbingly aware that he has entered what has become practically a terra incognita. The security landscape has undergone some cataclysmic changes in the last five years. Some of the familiar landmarks have been erased, and the shape and character of others, in a financial sense, have undergone confusing alterations.

In the new ‘bull market,’ if one is permitted to apply old nomenclature to rising prices and volume activity in share turnover, the transcendent sine qua non will be selectivity. In periods of public speculative fervor, the element of psychological kinship may impart a flutter of galvanized life to issues fundamentally moribund, but the strictures imposed by the S. E. C. should reduce these deluding practices to a negligible minimum. The disclosures of performance in a period of business revival, further certified by the realistic test inherent in markets, should permit a reasonable appraisal of values.

Without injecting a speculative taint into these observations, attention might be called to the career of equities in the recovery from previous depressions. Out of the ashes of these crises, a Phœix in the form of outstanding profit opportunity frequently has risen.

In fact, it might be contended that these periods of adversity, imposing as they do the obligation of self-examination by management and scientific research, spur executive talent to evolve some new product, some new method to add to the nation’s wealth, with the result that unusual profits provide a backlog of reserves that place the common shareholder in the investment class.

It is not essential here to furnish individual examples to support this claim, as market history, even dating back to the depression of the ’90’s and the panic of 1907, will disclose convincing specific evidence. In most cases these issues are related to the production of consumers’ goods as distinguished from capital goods.

Owing to the complexities, many of them political in origin, that have been injected into our economic position, the task of solving the problem of selectivity bristles with exceptional difficulties. Economic studies and recourse to statistical data will have to be supplemented by much original research through personal contact with corporation executives. More than the usual number of pitfalls will have to be avoided.

1. Obsolescence. — It is almost impossible to measure the extent to which five years of neglect of plant modernization has impaired the efficiency of American industry. Theoretically, this has been taken care of by charges for depreciation. In many instances, however, these have been largely in the nature of bookkeeping entries, and careful inquiry should be instituted to determine expenditures for keeping equipment up to date. More than one corporation whose securities have been in high favor with the speculative public comes within this category, and even if the allied industry has good promise the field should be examined carefully to determine whether new and more efficient units have not. superseded old favorites.

2. Industries suffering from overproduction. — The fundamentals in this factor are so self-evident that detailed comment would be superfluous. Examples are to be found in textiles and petroleum.

3. Excessive competition.—Numerous instances might be cited, but a familiar illustration may be found in the refining and distribution of petroleum products, with filling stations greeting the eye of the motorist on mile after mile of highways. Numbers 2 and 3 do not necessarily mean the wholesale rejection of the securities of the petroleum industry. Selections, however, should be confined to those of exceptionally strong liquid asset position and ample petroleum reserves.

4.Overhead. — This item calls for special scrutiny. Interest charges and taxes are particularly important. In all probability, location of plants would play a large part.

5. Character of products.— It should be kept in mind that obsolescence is not confined to inferior and worn-out equipment. A company manufacturing outmoded products is equally in the obsolescent class.

6. Hostile legislation. This feature at the moment applies particularly to the utilities, but it also constitutes a threat to chain-store organizations in some portions of the country.

7. Federal or state regulation. — This profit deterrent is not only applicable to regulation of productive and distributive activities, but also vitally concerns raw materials for processing. Certain agricultural and food products, petroleum, tobacco, sugar, and others liable to governmental supervision or price control, are embraced in this list.

While this does not by any means complete the catalogue of negative suggestions, it also is essential to offer general constructive recommendations. In progress toward emergence from previous depressions, consumers’ goods almost invariably have led the way. Modification of stringent public thrift finds expression in purchases for individual needs. Industries ministering to settled habits also find an increase in public demand. In this category may be placed companies manufacturing and distributing foods, containers, machinery for processing raw food materials, necessities or luxuries that wear out and have to be replaced, and soon. Leading units in the fields of the automobile and automobile accessories occupy a strong position in the American economic scene. The same may be said of the established tobacco companies. The heavy taxes on their products are paid by the consumer, without materially affecting demand.

The industry least cursed by obsolescence, perhaps because it is one of our newest and the one which is most progressive in scientific research, is the chemical group. Selections should be dictated largely by demonstrated efficiency, character of products, and financial strength.

Outstanding in the investment requisites is the type of management, with particular attention paid to its progressive quality. Many a corporation, after having established a reputation for efficiency, has been content to rest upon its laurels and permit either overconfidence or nepotism to sap its strength.

This analysis probably would be inadequate if it omitted concluding comment on the constructive repercussions ensuing from a substantial and sustained rise in equities. Any objection to an advance in commodity prices, with the burdens laid upon the consuming public, would not apply to an upward movement in this class of securities. Price appreciation not only would be a stimulus to confidence, but would add materially to public buying power.