4. Investigation should be thoro.—If the proposi tion is based upon a patent, or other monopoly right, it is necessary, in addition, to investigate the validity and value of the protection thus afforded. The un certainties of capitalizing patents, franchises and good-will have been discussed in another chapter. The validity of a patent cannot be finally determined before the courts have passed upon it, while a better idea may render the patent valueless any day. The value of patents is ordinarily much greater to an old, established business than to a new concern, since the former is in better position to judge their practical value, put them into immediate use and resist in fringements. This is well illustrated by the visible autographing device for which the Eastman Kodak Company is said to have paid three hundred thou sand dollars. A new company might not realize half the return from this invention that the Eastman Com pany is able to obtain with its large business. If space permitted, the writer could cite from his own knowledge a dozen instances in which the capitaliza tion of patents has totally ruined both the bank ac counts and the dispositions of stockholders, who have paid more attention to the cleverness of the patent than to its commercial possibilities.
The estimates in each phase of the undertaking should be substantiated by men of experience and rep utation in that particular field, and compared, when possible, with the actual results obtained in other sim ilar enterprises. The estimated cost of buildings and equipment, for instance, may be checked by securing bids upon them. The cost of production may often be determined, under specified conditions, from the experience and records of other concerns. Usually the production costs of the new company are under estimated. Optimism and error in this respect, and in under-estimating capital requirements, may sell the stock, but ruin the stockholder. From the report of the Federal Trade Commission, it is quite safe to conclude that not over ten per cent of our corpora tions have any accurate record of their production costs. How much more difficult must it be to esti mate in advance the capital or production costs of a new and untried venture. Obviously, where patents, mining resources, and other similar elusive assets are concerned, the estimate must be based more upon im agination than upon fact.
5. Perils of promotion.—The reader must not be discouraged if a pessimistic attitude seems to pervade this Text whenever speculative securities are dis cussed. The pessimism is real, and will serve its true purpose if it convinces the reader of the tremendous risks which attend such stocks. It is aimed only to impress upon the reader the necessity for that keen perception, and careful discrimination, which even the best informed find it difficult to apply in analyz ing corporate securities. At no point is this more im
portant than in scrutinizing the facts or conclusions arrived at thru partisan investigation. Often the in vestigation turns out to be nothing more than a per functory estimate, based upon more or less accurate hearsay, and tinged with self interest.
To illustrate. A small company was incorporated in Erie, Pennsylvania, to manufacture condensed milk. One week before the plant was to open for operation, it was clearly demonstrated to the embryo promoter by an experienced business man that, in competition with the existing concerns, the new corn parry would be losing two cents upon every case sold, even if it should succeed in finding a market for its product. The new plant went into the junk heap without ever turning a wheel.
A consolidation was formed, based upon an oppor tunity investigated by a professional promoter from New York City, who operated in connection with one of the largest and best known underwriting banks. The investigation purported to show that the new consolidation would control 80 per cent of the output of the country; that the profits of the then existing separate plants, would, if added together, pay inter est and dividends exceeding six per cent upon the en tire proposed capitalization; and that the earnings re sulting from market control and economies of com bination would still further enhance the income. Within a short time after the consolidation, it was found that only two plants out of the seven which had been combined, were earning actual cash profits, and that the combine had taken in a number of weak brothers while leaving some good live ones outside. The water in this capitalization drowned most of the stockholders.
A company was promoted to manufacture life boats, unquestionably the safest life boat ever de signed, only to learn afterwards that the boats would not sell because they occupied too much deck space and were too expensive. In other words, the investi gation had failed to disclose that life boats were not made to save lives, but rather to meet the minimum legal requirements of the various countries. This was before the "safety-first" campaign.
Another notable example of this type of prospectus was that of a canning company with headquarters in western Canada. It was described by a critic, as "a curious document, voluminous, and in parts, lu minous, but about as airy as anything placed upon the market for some time." The investor was assured that an annual dividend of 200 per cent was "a very moderate anticipation for a company organized on the sound basis this one is." The most notable omission from the prospectus was the cost of raw material. Estimated profits of 200 per cent were figured on the basis that the raw material would cost nothing. Ob viously that is one of the mistakes which do not oc cur in well-regulated promotions.