INVESTMENT. An investment may roughly be defined as the depository of savings. The term is usually applied to money, but strictly speaking it is equally applicable to all kinds of property, such as land, buildings and furniture. In short, the whole of an individual's property, including the debts due to him at any time, may be described as his investments.
In considering the question, a broad distinction must first be drawn, between "forced" or "unconscious" and "voluntary" or "conscious" investment. Forced investments arise in several ways. The chief is that every business man has to grant credit to his customers, and most workers receive their wages or salary "in arrears," that is after they have performed their week's or month's work. Money thus due is clearly part of each man's in vestments, and the amount thus "invested" is dependent not on his voluntary act, but on the customs of the trade or on his terms of employment. Before considering voluntary or conscious investment, it is necessary to examine the various motives which induce saving and govern the choice of investments. First and foremost comes the desire to provide for old age, sickness and other emergencies. Here safety is the paramount consideration, and the interest on the investment need not be taken into ac count. To illustrate this, Lioo may be a godsend in case of an emergency, but until it is required, it makes little difference to the owner's annual income whether it is earning 24% on deposit in the bank, or 7% in some highly speculative mining shares. Next comes the question of interest, and this arises from the desire of the individual to use his savings to augment his income. In general, the rule is "the greater the yield, the greater the risk," and the application of this rule and the weighing-up of capital safety and income is one of the chief problems of the investor. Next comes the desire for that will o' the wisp, "capital appreciation," when the investor hopes that his property will rise in value. Here the distinction between investment and specu lation becomes very thin. Finally come a whole host of motives. One man invests his money in his own business because it is expanding, and will gain for him fresh profits and fresh prestige; another in his business because it is going downhill, and he has still to learn not to throw good money after bad, and another in real and personal property of one kind and another, simply be cause of the satisfaction the possession of such property will give him. Every investor must bear in mind one general warning. Every investment demands eternal vigilance on the part of the holder. Consols, which, before the World War, were regarded as the soundest of stocks, are themselves a striking warning to the unwary. In 1896 they were quoted at i i by 1907 they had fallen to 84, and by 1913 to 73k. Then came the War, and the inflation period, and by 1920 they had fallen to a minimum of 438. By the end of 1927 they had recovered to 56. It is true that the interest remained constant throughout this period at a steady 2J%, but 12 10– would buy much less in 1927 than in 1896, so that even this stability possesses a certain unreality.
(2) Where the rate of interest is fixed, a high yield means a low price; therefore, as the risk increases, the price falls.
(3) When money is scarce, interest rates rise, and prices fall.
(4) Rising commodity prices mean active trade and high profits, but ultimately scarce money; and falling prices the reverse.
(5) The capital value or yield on a share is not only its "money" value or yield, but depends also on the purchasing power of money. This and the preceding rule must be read to gether.
(6) When trade is active and money in demand to the point of scarcity and high interest rates, buy consols, war loan and similar gilt-edged fixed-interest stocks, for these will be cheap under rule (2) and will improve under the second part of rule (4).
(7) When trade is dull and money plentiful, buy ordinary shares whose value rises and falls with the course of business; these, provided the company is sound, will be cheap under rule (2), and will improve under the first part of rule (4).
(8) Last and most important of all, lay a solid foundation. Life insurance comes first, and see that insurance is added to if the cost of living rises or the assured's standard of life improves. A life policy for £500 taken out in 1896 when living was cheap, is only partial protection in 1928 when prices have approximately doubled. If prices rise, more insurance must be taken out to maintain the same degree of protection.
Next in turn for the British investor come savings certificates. Even at 16s./– these are an attractive investment; they are safe, realizable, independent of market fluctuations and free of income tax. These should be bought up to the limit. After that, the in vestor can consider other openings. These are discussed in detail below.
and there is always the risk of the property standing vacant for a time. Again rents can vary just as much as an "ordinary" dividend. Every time a lease expires, a fresh agreement has to be made, and it is not always the tenant that is the loser. Over and above this comes one important point. Land and house-room are a universal necessity, and the result is that so far as public opinion and legislation are articulate, they are more anxious that the tenant should have adequate housing at a rent he can afford, than that the landlord should earn on his property a net return commensurate with that to be obtained elsewhere. This par ticularly applies to the smaller class of houses, and the war and post-war Rent Restriction Acts in England are an example of this point. Those who before the War owned houses which were exempt from restriction, found they had an investment with all the advantages of an ordinary share, while those whose property came below the line, found it had many of the disad vantages of a fixed-interest stock. In short, when money de preciates violently and prices rise, the landlord of small property must expect to be debarred by law from raising rents accordingly. Provided that he can raise his rents enough to equal any in crease in maintenance costs, so that his net rent remains un changed, restriction is not inequitable. A landlord has no greater right to claim a larger net rent because of a rise in prices than the holder of 21% consols has to claim that in future the Government should pay him 4% or 5%. Sufficient has been said to show that house-property is a dangerous possession for the ignorant investor.
if things prosper, the gains go to the ordinary shareholder. The preference shareholder's measure of protection is clearly the size of the ordinary capital and ordinary dividend. If roo,000 Li preference shares have r oo,000 Li. ordinary shares behind them, and the usual ordinary dividend is o%, the "capital" protection is L roo,000, and the "dividend" protection is L i o,000. If the ordi nary shares are r oo,000 of is. each, and the ordinary dividend is 5o%, the "capital" protection falls to L5,000, and the "dividend" protection to L2,500, both of which figures are dangerously small. In other words, it will not take much of a loss to encroach upon preference dividends while the smaller ordinary capital will receive just as many plums as before.
Ordinary shareholders receive what is left out of profits, of ter debenture interest, preference dividend and allocations to reserve have been made. When times are bad, they get nothing, and when they are good they may receive much. Many companies try and maintain a constant ordinary dividend, and in good times declare a "cash bonus" which is really an extra dividend. One of the great merits of ordinary shares is that a proportion of the profits are every year "put back" into the business by the directors of the company. This is necessary if the business is to progress, but it also means that a proportion of the ordinary shareholder's income is forcibly saved for him and re-invested by his directors. Hence his shares are steadily appreciating in value all the time. The issue from time to time of bonus shares from reserves is simply the out ward and visible sign of this continuous progress. A bonus issue in itself adds nothing to the value or earning power of the property, and the reason why the market hails it as a bull point is that it marks a definite stage in the company's progress, releases to the shareholder some of his forced savings, and is considered by the ignorant to be of the nature of "receiving something for nothing." The fundamental principle of debentures, preference and ordi nary shares, is that the holder of the last-named is first in line for both the "kicks" and "half-pence" distributed by fortune. He also exercises full control over the company, and the debenture and Debentures represent money lent to a company, and principal and interest must alike be met, whether or not any profits are earned. Default is equivalent to an act of bankruptcy, so the way to regard them is whether or not the company possesses the re quired resources. Special points to remember are that as a rule trade creditors rank ahead of debenture-holders, and in many cases a company has the power to issue new debentures ranking ahead of the old ones. These points should be investigated by the prospective purchaser. Preference shareholders are part owners of the business. They only receive a fixed dividend, but in return have first claim to divisible profits, and first claim to repayment on the liquidation of the company. Thus, if things go wrong, the ordinary shareholder has to bear the brunt of the attack, while, preference shareholder can only intervene when surplus "kicks" start coming his way. It must be realized that this gives great scope for the unscrupulous ordinary shareholder to display his ingenuity. Thus, he can distribute two years' profits in advance to himself by a suitable manipulation of the accounts, and then ex plain to the others that the company is insolvent and all must make sacrifices. Conversely, he can by a fraudulent conservatism,
write down some of the assets to vanishing point, report insolv ency, buy up the preference shares cheap, and then restore the assets (and the preference shares) to their true value. Nor need debenture and preference shareholders' rights count for much. They can always surrender their rights, and when the voluntary surrender of their rights is put before them as the only alternative to bankruptcy, it is hard for the holder to resist.
There are too many cases where a company starts with, say, L i o,000 in LI preference and LIo,000 in LI ordinary shares. A good period ensues, and r o,000 more Li ordinary shares are issued from reserve by way of bonus, the future being partially mort gaged in the process. Then comes a slump, a loss of L ro,000 piled up, and eventually dealt with by writing the preference shares down to iss. and the ordinary shares down to r 2S. 6d. On the face of it, the ordinary shareholder has dropped 7s. 6d. to the preference shareholder's 5s. In reality, adding together the bonus issue and the reconstruction, the ordinary shareholder has taken 5s. from the preference shareholder.
A post-war development, which has nothing to commend it, is the splitting of a company's capital into L I preferred and is. deferred shares. It has already been shown how this weakens the bulwark between the preferred shareholder and disaster. It is also a means of reserving the "half-pence" for the deferred share holder, and sharing the "kicks" equally between the two classes. Take this case : Say these were four years' consecutive results. The deferred shareholders have received L27,000 on their original holding of £5,000, that is, their capital back and £22,000 to boot. They can ask the preferred shareholder to be brave in facing bankruptcy with them with perfect equanimity. Nor is this the wholz indict ment against the shilling deferred share. In 1927 when it first appeared in Great Britain in obnoxious quantities, the vendors or promoters of a company would often keep half the deferred shares for themselves. The public would be graciously allowed to buy the other half, provided that they also bought all the preferred shares. This was a reincarnation of the founders' share with a vengeance. To show the market's appreciation of the relative worth of Li preferred and is. deferred shares, the following examples may be quoted. The names are suppressed for obvious reasons: These figures speak for themselves.
The first two points are illustrated by this balance sheet :— Liquid assets are, therefore, L25,000-EL5o,000d-L45,000—L2o, 000 =1 r oo,000. The total value of the property is L470,000 —L20, 000=4450,000. Deducting preference shares, this is equivalent to 35s. per LI ordinary share.
The rate of interest on debentures and preference shares is fixed ; even if it falls into arrears, the arrears must be made up in the case of debentures and "cumulative" preference shares. So the potential investor must consider chiefly the risk of default. As regards ordinary shares, he must weigh the risk of no dividends against the chance of high dividends and cash bonuses. Capital appreciation and depreciation are dependent partly on the level of market interest rates, but mainly on the view taken as to the future of the company in particular and the industry in which it operates as a whole. The investor, therefore, must watch these points, accepting all rumours with a large grain of salt. Over and above the fluctuations of trade, ordinary shares in a company with a proper reserve policy should steadily appreciate in value. It is this that accounts for the new theory that ordinary shares are a "safer" investment than gilt-edged stocks. As regards wide changes in the purchasing power of money, to a large extent the ordinary share comes out best of all. When prices are rising, profits and dividends also rise, and the shares appreciate in money value to an amount roughly equivalent to the decline in money's purchasing power. The important point to watch is that the com pany uses this period to build up a good reserve fund. The reason for this is that a fall in prices operates so unevenly upon a trading company as to involve it temporarily in heavy loss. Once it sur vives this, the contraction in the money value of its shares is com pensated for by the higher purchasing power of money, but this is no consolation to the shareholder if the company fails altogether.
(2) The investor who wants to go further, should spread his money between gilt-edged stock, some sound debentures, and ordinary shares with a "good history." (3) With the return on gilt-edged stock at 41%, do not aim at more than 5j% on debentures or 7% on ordinaries.
(4) Avoid foreign and specialized shares and also new issues, unless you have personal knowledge of their peculiarities.
(5) Deal through a bank or member of a recognized stock exchange.
(6) Do not put too much into one company, or even one in dustry. To spread investments is to minimize losses.
(7) Watch your investments, and continue to watch. (See also STOCK EXCHANGE; MONEY; BALANCE SHEET.) (N. E. C.) The United States.—American investment habits are condi tioned by the newness of the country and the venturesomeness of the people. Securities which give a semblance of the safety of an investment and at the same time offer the prospect of profit of a speculation, have been in growing favour. Bonds which are con vertible into stock, bonds with stock purchase warrants attached, preferred shares which are convertible into common stock and preferred or so-called A shares which participate in profits under specified conditions with the common shares, constitute the chief banking devices for combining investment with speculation. To an increasing extent, the American investor, desiring to have his cake and eat it too, has been indulging in speculative investments.
Before the World War, it was commonly conceded that shares were for speculation and bonds for investment. It is now held that well selected common shares are suitable for long term invest ment for individuals who are less concerned with getting back a particular number of dollars than with assuring themselves of given purchasing power or command over commodities in the future. In a steadily growing country, such as the United States, a good case can be made out for the equities—or stock interest —in well managed companies, which perpetually increase their stake in the nation's business.
The growing preference for common stocks for long-term hold ing was rationalized as a new investment philosophy by Edgar Lawrence Smith in his volume Common Stocks as Long Term Investments and by Kenneth Van Strum in Investing in Pur chasing Power. As investors show a disposition to turn from con servative bonds to more speculative stocks, there has been a grow ing recognition of the need of timely statistical data and analy tical skill. Accordingly, the new profession of investment man agement has been springing up. Between 1924 and 1928, the American investor, desiring to invest by proxy through experts, showed widespread appreciation of the investment trust idea, a novelty in the United States. According to recent estimates, there were 208 investment trusts in the country, with total resources exceeding $1,000,000,000. Such agencies, which differ widely among themselves, take the form of corporations more frequently than of common law trusts. Such agencies have for the most part built up portfolios consisting largely, if not en tirely, of stocks instead of bonds. Moreover, investment coun sellors, who sell only advice, have tended to favour a balanced investment list, consisting of stocks as well as bonds.
The amateur, or lay buyer, has become in the last decade an increasingly important factor in the American investment mar ket. Before the war, it was estimated that there were only 400,000 bond buyers in the country. The Liberty Loan cam paigns during the World War gave millions of Americans their first experience as security owners. There is no reliable record of the number of security owners in the United States, though estimates run upwards of 10,000,000. Not only have American governmental agencies and private corporations dipped deeply into the reservoir of savings, but an increasing array of foreign governments and foreign private business enterprises have bor rowed funds in this market. New York city has accordingly be come a world financial capital sharing honors with London. In 1928 New York city stood pre-eminent as a lender of long term capital, whereas London retained the primacy in financing short term foreign trade operations.
The New York money market has become increasingly cosmo politan in character. The American investor, traditionally provin cial in his tastes, gradually developed a wider outlook, and began to buy foreign issues, their higher rate being usually the attracting feature. Also outside of New York city investment banking facilities have been enormously expanded. The South and West, which before the war were virtually without local agencies for cosmopolitan investment, were covered with a network of local investment bankers and branches of nation-wide organizations. Individuals in the hinterland, who had formerly invested surplus funds almost exclusively in farm and urban real estate mortgages, began to diversify their risks. Financial advertising developed enormously in quality and quantity. Recent broadening of activity reflects, in part, the carrying of ticker facilities to parts of the country hitherto uncovered, particularly in the South, the South west, the Far West and in Canadian provinces. As recently as 1915, there were only 2,000 stock tickers in the country, com pared with more than 7,000 in 1928. The expansion has been extremely rapid since the beginning of 1927.
In American practice, there is a sharp distinction between in vesting by individuals and investing by institutions. Although individuals are interested primarily in assuring purchasing power in the future, institutions, such as the savings banks and life insurance companies, with huge liabilities measured in dollars, rather than in purchasing power, are interested in assuring a spe cific number of dollars through their investment programmes. Accordingly, institutions for the most part favour bonds, which promise a given number of dollars at a specified date. The eligible investments for savings banks and life insurance companies are clearly set forth in State laws. In general, the life insurance com panies have more freedom than the savings banks. In some States, as also in Canada, insurance companies may purchase common stocks. The New York law respecting life insurance companies has recently been liberalized, permitting the purchase of the highest grade of preferred stocks as well as bonds, though corn mon shares are still ineligible for life insurance companies in that commonwealth. With the growth of the power and light industry in the last decade, numerous States have made public utility bonds eligible for investments for trustees, savings banks and other institutions. Life insurance companies have consis tently increased the proportion of their total investable funds placed in public utility securities.
An important new outlet for the investable funds of individuals has come through the conversion of hitherto privately owned close corporations into companies whose securities have been widely distributed. Department stores, chain stores, and other merchandising agencies have been conspicuous in this group. Holding companies have been set up, which have expanded rapidly through taking over local enterprises through an exchange of stock. The absorption has been profitable in most instances, for the public has usually placed a higher value on earning power when taken over by a large company, whose shares are readily market able, than when reported by an obscure company, whose securities were illiquid.
Before the war, conservative investors favoured railroad securities, shunning all others as too speculative. They have got away from this notion, partly because the railroads, with their rates fixed by public regulatory bodies, have been less spectacu larly prosperous than certain unregulated industrial corporations whose profits have been limited only by competition and the capacity of management. Seemingly, no successful product is too trivial or too unessential to win an investment following. As is usually the case when security prices are showing a long term upward trend, the security buyer exaggerates the importance as a determinant of value of current earning power and minimizes the effect of asset worth. (M. S. R.)