0 ILLINOIS UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN PRODUCTION NOTE University of Illinois at Urbana-Champaign Library Brittle Books Project, 2019.COPYRIGHT NOTIFICATION In Public Domain. Published prior to 1923. This digital copy was made from the printed version held by the University of Illinois at Urbana-Champaign. It was made in compliance with copyright law. Prepared for the Brittle Books Project, Main Library, University of Illinois at Urbana-Champaign by Northern Micrographics Brookhaven Bindery La Crosse, Wisconsin 2019 <#//?*• iy NDUSTRIAL BONDS Facts Regarding Their Issue and Their Security By Frederick LownhauptINDUSTRIAL BONDS FACTS REGARDING THEIR ISSUE AND THEIR SECURITY BY FREDERICK LOWNHAUPT Author of "Investment Bonds" BOOKLET NO. 3 OF A SERIES ON BONDS See Page 4 for other titles MOODY'S MAGAZINE NEW YORK, N. Y.Copyright, 1010 by A. W. Ferriw*3, 3 { O \> ! CONTENTS An Industrial Nation . . 5 Relative Investment Position . . 6 Industrial Earnings Highly Variable . 7 Constancy of Demand for Product . 8 Competition .... 9 Tariff Changes . . . . 9 Extent of Market ... 10 Managerial Efficiency . .11 Capitalization and Other Financial Considerations . . .12 f orking Capital ... 13 Physical Properties . . . 14 Net Earnings . . . .14 Depreciation of Plant . . . 15 P 40006A SERIES OF BOOKLETS Treating The Subject of Bonds in an instructive and popular manner Booklet No. l--Railroad Bonds. Booklet No. 2--Public Utility Bonds. Booklet No. 3--Industrial Bonds. Booklet No. 4 Municipal Bonds. Booklet No. 5--Irrigation Bonds. Booklet No. 6-Timber Bonds. PRICE TEN CENTS EACH MOODY'S MAGAZINE 35 NASSAU STREET NEW YORK, N. Y.INDUSTRIAL BONDS INDUSTRIAL bonds as a factor in the finan- cial and investment markets are compara- tively new. They include principally the obligations of all manufacturing com- panies of a private character, and as a class are jquite distinct from all other bonds. The earli- est were issued hardly more than twenty-five jyears ago, and a round dozen years would cov- er the period since they have taken a place of any importance among securities. Within that period, however, the growth has been rapid, so ithat of late years bond flotations of this type have become more common and more popular with investors. Ten years ago this class of bonds found small favor with investors, and the companies were financed by stock issues rather than by bond flotations, i An Industrial Nation. ; The fact that the industrial bond is yet young is directly associated with the fact that the industrial development of this country is but in its early stages, the beginnings of which 5were not more than thirty years ago. The tre-j mendous resources awaiting development and exploitation testify to the truth of this asser-i tion. Though our industrial development is* still in this condition, it is of remarkable dif versity. There are probably four hundrec| types of industry, including some three hun- dred thousand establishments, with an invest! ed capital of fully fifteen billions of dollars ana ranging from the great United States Steel Corporation down to the smallest factory of half a dozen workmen. The field is broad ancj interesting and the securities representing ilj: are destined to have greater prominence in the future. I Relative Investment Position. [' Taken as a whole, industrial bonds do nojfc rank quite as high as municipal or good rail- road bonds, although there are some very at- tractive and sound investments among them. In the very nature of the case, the investor must exercise due caution, although, as a mat- ter of fact, that is necessary in buying all other securities. The industrial bond involves many vital considerations. A satisfactory a'n- swer to a few important questions relative j to railroad bonds in a way answers many scsc- 6 iondary questions. Equally as many or per- haps a few more questions arise about indus- trial bonds. They are characterized by sev- eral variations from other bonds. Industrial Earnings Highly Variable, j The first and main reason why they require careful consideration is because of the vari- ability of earnings of some manufacturing cor- porations. When industry is running to full ca- pacity, a company with bonds outstanding may be earning several times its fixed charges, that is, its expenses of operation and management, aind after taking care of all needful expenses it may have sufficient money remaining to take care of its bond interest easily. The high tide ou business does not stay, however. These de- pressions of business affect the income of such companies and reduc^ their net earn- ings. Some of the larger and stronger in- dustrial concerns, of course, are not seri- ously affected by shrinkage in earnings. The United States Steel Corporation, the larg- est of all, for instance, in many years has earned a substantial surplus over bond interest and has always been able to maintain a seven per cent, dividend on its preferred stock. This surplus may be drawn upon in lean years. 7Since the earnings of a company are the corj ner-stone of its financial structure, it follow^ that much variation, occasioned by the changes in business conditions of the country, is unfaj- vorable. Constancy of Demand for Product. Another consideration is that some industries are subject to uncertainty as to the continued demand for their product, something growing out of other conditions than those which affecjt general business conditions the country over. Perhaps the best illustration of this is the bi- cycle industry. About ten years ago the market value of this product was fully twenty-five mil- lions of dollars in one year. It is safe to say that it is not now five millions of dollars p^r annum. Somewhat akin is the now flourishing automobile industry, although it must be said that mechanical traction in this form hks come to stay. There is not likely to ]he such a pronounced slump in the automjo- mobile business. In the heydey of the bi- cycle there was a great corporation for its manufacture which paid large dividends for a time. Popular fancy changed suddenly and the demand for this article of great popularity died off and with it the manufacturing cor- 8poration. There are, of course, varying de- crees of mortality from such conditions, and in many cases it is a fairly easy matter of judg- ment to know whether the demand for the product of a concern is likely to be ephemeral car of long duration. I Competition. ( Competition is a factor in industrial af- fairs. It is well-nigh axiomatic that suc- cessful business and large profits stimulate similar enterprises. Prosperity engenders competition. Other companies grow up. Moreover, companies already in existence through improved processes, the discovery of better methods or something of this sort may be able to manufacture and sell the special article or line of wares more cheaply. < Tariff Changes. »We have mentioned variation in earnings due to general business depressions. There is an influence that affects business conditions occasionally which was in evidence not many mionths back. The effect of the recent tariff agitation and changes is remembered. It oc- curs infrequently, however. The term of many industrial bonds is for twenty-five 9years, a period of sufficient length to spari at least two tariff revisions, if history rej- peats itself. It is therefore proper to includte this in a discussion of industrial bonds anp catalogue it among the influences that must be considered as affecting their stability anjd worth in the long run. Extent of Market. 1 I Industrial bonds as a class are yet too young to be regarded as savings banks investments generally however wrorthy they may be. The^y are permitted among the securities of such in- stitutions in a limited number of States, btkt 7 i these laws stipulate only the highest grade df such bonds may be held. A banking hous'e that accepts an issue may dispose of them in the community of the business, especially if the amount of bonds be small. Then, if sorrie of these investors would sell, the banking house will generally endeavor to make tjhe market. The States having about the most rigid la^vs are New York and Massachusetts, together with Connecticut, New Jersey and Pennsyl- vania. One or two of the New England States allow their purchase under the restriction thatthe industries must be native to the State by incorporation and operation and have been paying a specified amount of dividends for a certain time. Managerial Efficiency. * We have thus far taken note of general con- siderations only. Specific questions arise when an industry is analyzed. Most of these ques- tions are of a financial character, yet one very important point is of a very different nature. It is the personal element in the operation and stability of a manufacturing corporation, one which enters more largely into the manage- ment of such a company than of a railroad. In manufacturing there must be economies in management, utilization of all by-products and complete system in everything. This personal equation counts for much. Efficient heads can mean profit even in lean years. Nowhere is the quality of management so quickly perceived as in manufacturing. It is a measure of assur- ance for the securities if the company is ably conducted. Banking houses handling the is- sues of many industrial concerns look to this and the possibility of complete changes in management before the bonds mature. 11Capitalization and Other Financial Con- siderations. ' The financial considerations are capitaliza- tion, the operation of the plant as a going con- cern, the relationship between the amount of current assets and current liabilities, the pro- portion between net quick (or current) assets and the bonded debt, the net earnings and their relation to fixed charges. No stereotyped rule can be laid down as a dictum for any of these questions, for the safety of principal and inter- est is not so easily determined as by hard and fast application of any rule or rules. Briefly, the capitalization of a company is represented by the stocks and bonds and these are the Capi- tal Liabilities. The Current Liabilities comprise bills and accounts payable, including borrowed money, pay-rolls and interest and taxes ac- crued, but not due. Current assets are com- posed of all inventories, bills and accounts re- ceivable, agents' balances, marketable securities and cash. So far as the aggregate capitalization of industrials in general goes, the proportion is about four of stock to one of bonds. With railroads it is nearly two of bonds to one of stock. These rough comparisons indicate the extent of stock issue. It must be remembered, 12however, that all of this stock of industrials is not paid in. Much of it is given in the form of bonus or in some similar way. And again, in the analysis of a company's position the amount of stock outstanding has practically no bearing because dividends on it are a last claim on earnings, and if not earned can be generally passed. Working Capital. As to the relationship between current as- sets and current liabilities, it is best that the assets be at least twice the amount of the lia- bilities. The greater the assets are, however, the stronger is the position of the company. The relationship between these items and the bonded debt is about as follows in the best practice: that the current assets are at least equal to the sum of the current liabilities and the bonded debt. The difference between cur- rent assets and current liabilities when the assets are in excess is known as the net quick or current assets, and is also called working capital. The bonded debt should be repre- sented by the working capital. Stated some- what differently, an industrial company which has outstanding any fixed obligations, such a9 13bonds are, ought to have always sufficient net current assets to pay off the bonds. Physical Properties. The safety of an industrial bond may be based somewhat on the physical value of the property on which it is a mortgage. From this viewpoint the real estate is the main con- sideration. Its appraised value (not its book value) is the basis to work on. If it represents value to the extent of the bond issue, the lien is strong. The plant and equipment is worth something, yet comparatively little when not used for its purposes. In the case of scattered real estate and property the question becomes more complex. Many large industries own property in various States and are, therefore, working under a variety of laws. The validity of a mortgage on all this non-integrated prop- erty must be pretty firmly established to make the bonds really good. Ordinarily consider- able difficulty would be encountered in fore- closing such a mortgage. Net Earnings. Net earnings are a vital point. Generally speaking, they are arrived at by deducting ex- penses of operation from gros§ earnings. They should be several times the amount of bond in- 14terest and sinking funds combined under en- tirely safe conditions. Comparison of several years should be made when this point is studied. Stability of earnings, naturally, is strength to the bonds. Depreciation of Plant. One of the most difficult of the questions connected with industrial bonds is that of de- preciation, that is, the lessening of the worth of the plant and equipment because of age and wear. In the minds of many this matter rises into a definite objection to the securities. The wear and tear on a manufacturing plant is very great in some industries, while in others it is not so pronounced. The variation in this re- spect practically prohibits the application of any standard of maintenance and depreciation. What one company does, though considered liberal, might represent only sufficient for an- other. The percentage of write-off that is proper is difficult to state. We have manufac- turing concerns of one kind and another, pos- sessing property of various kinds to which no standard of depreciation seems applicable. This is in contrast to what may be said of railroads. With railroads we know that a certain charge is reasonable for main- 15tenance of way, another reasonable for main- tenance of a high standard of service and equip- ment—so much per mile in the first case, and so much per car mile in the second. This also applies to street as well as steam railroads. The compilation of much data has enabled bankers to determine with a considerable de- gree of certainty just what depreciation should be made, and about what should be put into a railroad property for its up-keep and the main- tenance of a high standard of service and equip- ment. To arrive at a close figure for industri- als a thorough examination of each case by accountants is necessary; and yet no matter how conservative the figures of depreciation, it is small help in case of default of interest pay- ment. For the ordinary investor it is difficult to settle such fine points. The broad points to be considered about industrial bonds are about as follows: Variability of earnings. Continuance of demand for product. Competition. Tariff changes. Management. > Financial position. ^ 16This book is a preservation facsimile produced for the University of Illinois, Urbana-Champaign. It is made in compliance with copyright law and produced on acid-free archival 60# book weight paper which meets the requirements of ANSI/NISO Z39.48-1992 (permanence of paper). Preservation facsimile printing and binding by Northern Micrographics Brookhaven Bindery La Crosse, Wisconsin 2019