Through the Wringer

The FINANCIAL COUNSELOR

by JONATHAN C. ROYLE

COMMERCIAL and industrial concerns can no longer afford to capitalize their hopes. If they do, their securities cannot be considered safe and sound investments. To-day the wise investor acts with extreme caution. Securities must be put through the wringer, their false values squeezed from them, before he will accept them.

There was a time, during the pioneer period of the United States, when it was both necessary and proper for industry to capitalize its hopes. Vast territories then awaited exploitation and development. Railroads were opening new traffic possibilities. New markets were being found for manufacturers. Tremendous riches were being piled up from natural resources. And population was growing at an unheard-of rate.

The pioneer period of America is now past. The potentialities of each business and industry are definitely known. The limits to the volume of profits are set. The false values of the pre-depression period have gone, never, economists hope, to return. The prudent investor will bear these things in mind, and will select the securities of those companies or industries which have readjusted their capitalization to a post-depression level.

Bonds and stock certificates of over-capitalized firms make the most expensive wall paper there is, and often that is all they are good for eventually. Capitalization, many economists declare, should be on a basis of profits, not of hopes. If a concern can make but $500,000 a year profit, it is justified in fixing its capitalization only at a figure on which $500,000 represents a fair profit, in other words, capital investment should be fixed on a basis of what can be earned, and not on a basis of the money which was originally sunk in the enterprise.

An office building may have been valued at $6,000,000 in 1929, but if it will only give a net return above expenses of $100,000 a year under present conditions, it is only worth, as an investment, approximately $2,000,000. The same is true of nearly all sorts of capital investment, It should not be forgotten that costs of real estate, construction, machinery, and other forms of capital investment have dropped 20 to 50 per cent in the last three years. The writing off of these false values is a bitter dose for any corporation or individual. But the business man has a chance to take it voluntarily, while the investor has already had it forced down his throat by the terrific drop in security prices.

Corporations must come to a readjustment. If they do not do so voluntarily, they are likely to be forced to do so through receiverships. No company which clings to false pre-depression values can expect to make an adequate showing to-day.

Even though the reasonable expectations of each line of business endeavor are now pretty well established, it does not follow from this that there are no brilliant investment possibilities in prospect. New business developments will take place and give opportunities similar to those provided by radio, electric refrigeration, air conditioning, aviation, sound-motion pictures, household electrical appliances, and the automobile. Yet it should be noted that, with every one of those great developments, promoters misjudged the limits of expansion, and encountered difficulties — in some cases disaster — before they adjusted themselves to a true, instead of a fictitious and unjustified, demand.

So long as materials wear out, there is no such thing as saturation of a market, but there is a stage in every industry where sales resistance rises to such a point as to obliterate profits. If a concern has to earn profits on a fictitious capitalization, it is hard to see how it can maintain its business health under the conditions which are likely to prevail during the next five years.

Normal growth, many business men state, should be taken into consideration in capital readjustments. But, according to census authorities, the business man cannot at present even depend on normal growth in population. There was a time when immigrants swarmed to this country, and they were readily absorbed. The birth rate was comparatively high, and the business man could count on an increase in population, with consequent expansion of markets, of 1,500,000 a year. The population was 105,710,620 in 1920 and rose to 122,775,046 in 1930. But now we seem to be entering upon a period of relative stability in this respect.

Foreign arrivals are being checked by the immigration quotas. More foreign-born residents have left these shores in the last year than have arrived. The birth rate and the marriage rate are declining, and the age characteristics of the population, which affect a wide variety of industries, are changing. This trend will be felt more acutely later, for, while the birth rate is dropping, the average length of life is longer.

It will be apparent, therefore, that this is a time for conservative estimates of future business. There are already hundreds of companies which have adjusted their capitalization upon a sound basis. Others are following suit. They are in about the same position as the coon on which Davy Crockett was drawing a bead. 4 Don’t shoot, Colonel,’ said the coon; 4 I’ll come down.’ The investor, on his part, can exert an influence in the right direction by making sure that the securities which he buys have been put through the wringer.