Chapter 1 - Spare Money And Marketable Securities

M ou can't be an investor unless you have money to spare. Fortunately, in America today we have the highest per capita income of any nation in the world. Tens of millions of people have money to spare surplus money above living needs, and after the basic thrift program, namely, savings accounts and life insurance, has been established.

You have two choices when you have money to spare: Either to spend it or to invest it. A great percentage of our substantial citizenry is now doing some of both. People are buying cars, cruises, cruisers, cameras, and cottages. They are also very busy building up their net worth and providing income for their future by investing in real estate and marketable securities, usually in that order. Sixty per cent of American families now own their homes; and thousands own other real property as well; from vacant land and timber acreage to motels and office buildings.

Real estate is great. Everyone should have some. But real estate, however attractive, is not the subject of this book. Our beat is marketable securities, zooming forward in popularity among well-heeled Americans. Millions already own some. It is for these and for others eager to invest that this book was written. If you're going to stake your hard-earned cash in marketable securities, you certainly want to know something about them. Ignorance in this field can be costly; contrariwise, knowledge can add zest to your life, greatly expand your income and, with a little luck, make you wealthy.

The Corporation Creator of Marketable Securities

One thing had to happen before marketable securities entered the financial scene. The corporation had to be invented. What is a corporation anyway? It is an intangible legal being designed to assure an organization unlimited life and limited liability. Corporations are of three main types: (1) government or municipal, (2) stock (private) corporations, and (3) religious, charitable, membership or endowment. The first two provide almost all of our marketable securities (although on occasion a church or club may sell bonds publicly to build a new edifice).

The corporation first appeared in Europe around the fourteenth century. Queen Elizabeth I was the moving light in the East India Company, and probably was the first woman stockholder. Of more interest to Americans, however, is the charter granted by Charles II of England to "The Governor and Company of Adventurers of England Trading into Hudson's Bay." This famous company, with its clumsy corporate name, began business on May 2, 1670, and is still going strong. It's the oldest company doing business in North America, and its capital stock has been a marketable security for almost three centuries.

Now these corporations have another feature giving them a great advantage over an individual proprietorship or partnership. They provide a vehicle for the gathering together of large amounts of permanent capital from many individuals, for the operation and expansion of an organization. This capital is raised in two ways by borrowing money or by selling stock.

Government and Municipal Securities

Government and municipal corporations (whose main revenues are from taxes) do their security financing almost entirely by borrowing. If they plan to repay this borrowed money in less than a year, the security issued is called a bill; if they plan repayment from one year to five years after issuance, it's called a note. Securities issued for longer terms are called bonds. When you, as an investor, buy any of these securities, you become a creditor entitled to two things: (1) the return in full of the precise face amount of the note or bond on the maturity date specified, and (2) regular interest payment at a stated rate in the meanwhile. Failure of the issuing organization to do either of these things promptly is called a default.

Billions of municipal and government securities are outstanding. Most of them are readily marketable. Relatively few individuals own state or city bonds, but millions of Americans became government bond owners as a result of sales campaigns in World Wars I and II. Government obligations finance our national institutions, while municipals provide for our school systems, roads and public works, police and fire departments, parks, sewage disposal systems, etc., locally in cities, towns, counties, and districts.

Salting Away Profits in Tax-Exempt Income

After making rewarding gains in the market many investors like to salt them away for dependable income and, if their bracket status is sufficiently high, they seek some form of tax shelter. Perhaps the most popular vehicle for this purpose is the tax-exempt bond.
The obligations of states, cities, counties, and districts, and many special purpose issues (parks, fire protection, sewage, highway, school district, etc.) are exempt from Federal Income Tax, regardless of the tax bracket of the holder. They are also exempt from state income taxes (if any) to the holder, if he is a resident of the state of issuance.

The advantage of such tax-exempt income can be really important. For example if an individual has a taxable income bracket of $20,000 then a 4% yield on a municipal bond is equal to 9% return from a taxable security. If the bracket level is $30,000 then a 4% tax exempt return to an individual is equal to a 10½% taxable return. At $50,000 the same 4% return is the equal of a 16% return on a taxable security.

Not only is this tax saving of great value, but quality municipal bonds are regarded as among the choicest and safest investments in the world. In selecting municipal bonds for permanent investment income, maturities of twenty years or longer are recommended and the bonds should have a quality rating of AA or better. Consult your broker for municipal bonds; he can help you secure the best yield values at the time of your purchase. It must be borne in mind, however, that municipal bonds are not actively traded and all of them are bought, sold and quoted over-the counter.

Stock Corporations and the Securities They Issue

Stock corporations may raise money both by borrowing and by selling stock. Corporate borrowing has certain advantages: (1) It permits the use of a specific sum of money for a definite period of time at a stated rental (the interest rate); (2) Interest is deductible as a business cost before calculation of net profits; (3) The borrowed money adds substantially to the total capital on which a profit may be earned, and often accelerates the acquisition of new equipment. The disadvantage of corporate borrowing is that the interest must be paid and the money paid back to the investors, or they may, by enforcing their claims as creditors, take over the company.

Types of Corporation Bonds

When a company borrows, it has a wide selection of obligations to choose from. It may issue short-term notes five years or less. Or it may issue bonds. There, in turn, are several varieties of these. The oldest is the first mortgage bond. The corporation, in this security, promises to repay the borrowed funds at some remote future date 10, 15, or 50 years away and for the protection of investors pledges its property under a first mortgage or lien. Northern Pacific Prior Lien 4's, and

West Shore Railroad 1st Mortgage 4's are good examples.
If, later on, a company fails to pay interest on its mortgage bonds, the bondholders have the legal right to foreclose, i.e., take over the mortgaged property, and either sell it or operate it to satisfy their claims against the borrower.

There are some other types of bonds you should know about. There's the collateral trust bond wherein specific assets, usually securities (either bonds or stocks), may be pledged to assure payment of principal and interest. There are debentures which are long-term, unsecured promissory notes; and there are subordinated debentures which come after existing debentures or other indebtedness in the corporate structure. And there are bonds convertible into other securities.

Finally, there is the income bond differs from others in that interest can be skipped without penalty. This is the weakest sort of bond. Income bonds, in most cases, came into being as the result of a corporate organization. They pay interest only if it is earned. If the issuing company has a bad year, it may pay no interest at all, although there is usually a provision that if interest payment is omitted in one year, it will become cumulative and be paid later on when earnings may permit. The disadvantage of the income bond lies in this uncertainty of interest payment.

Summary about Bonds

Bonds, whether of the mortgage or debenture variety, are pretty well standardized. They come in $1,000 denominations (sometimes $500 and $100 as well); they pay interest semi-annually by coupons attached to each bond. All you do is clip the coupons when due and present them to any bank for collection and payment. Many investors find this coupon-clipping a pleasant pastime! (Some bonds may be registered, in which case the interest is paid by check.)

You must remember, however, that as a bondholder you are always a creditor. Your bond income is limited to the stated rate, and the payment at maturity is at the face amount. Bonds (except convertible ones which well go into in a later chapter) are seldom bought for speculation. If you buy a bond at a great discount from its face amount, it may be because there is considerable doubt about continuity of interest.

Uses of Bonds

Bonds, both government and corporation, are highly marketable securities and excellent collateral when or if you need to borrow money. You won't get rich buying bonds, but for generations bonds have been regarded as the backlog of any conservative investment portfolio. If they have been less popular with individuals in recent years, it has been because (until the late fifties) yields were unattractive and millions were lured away by the opportunity for capital gains afforded by common stocks. There are times, however, particularly if the stock market is receding, when ownership of bonds is desirable as a defense against capital erosion. Good bonds make up the basic investment portfolios of savings banks, life insurance companies, endowed institutions, and pension funds. If you're a timid sort and get frightened at wide market fluctuations, then you'll probably be happier owning bonds than stocks; and you may even prefer a savings account to either!

Stockholders Are Owners

So far in viewing the panorama of marketable securities we've talked only about bonds, wherein interest income and the ultimate return of your capital are limited to stated amounts. Now we're going to envision you, not as a creditor, but as a part owner a proprietor. That's what you become when you buy stock. You get away from the sheltered and static position of having a prior call on a certain sum of money and become instead a partner sharing in the risks as well as in the profits of a business.

What Is a Stockholder?

Bonds are sold when the raising of long-term money is done by borrowing. When permanent capital is sought by attracting new corporate partners, the arrangement is entirely different. The part ownership in a corporation is represented by an engraved or printed piece of paper called a stock certificate. You are frequently given a choice of ownerships. You can, in certain companies, become a limited partner by buying preferred stocks; or you can buy common stock, which is the indispensable evidence of equity ownership in every stock corporation.

The preferred stock appeals to those who are content to accept a lesser risk in return for a more certain income. If you own a preferred stock, you are a limited partner. You are entitled to dividends at a certain stated rate before any dividend is paid to common shareholders. These dividends, however, may only be paid to you if the company has earned them. Sometimes a company will lose money in one year but continue paying preferred dividends from the accumulated profits of earlier years. Most preferred shares are cumulative, which means the company, if it skips one or more dividend payments, is obligated to make them up at a later date when and if earnings permit. The principal feature about preferred stocks is that they give the holder this prior position in the distribution in any net profits earned. Bond interest (if a company has bonds) comes ahead of preferred dividends, but the preferred shareholders must get their full dividend at the stated rate before common stockholders receive anything.

Preferred stocks are usually given a definite par value. The most popular value is either $50 or $100, but there are many preferreds with a $5 or $10 par. The description of a preferred stock written on the certificate will usually spell out the dividend rate either as so many dollars a year or a percentage of the par amount  and outline any convertible provision or any dividend participation with common stock. Dividends are customarily paid quarterly by check to registered holders. Preferred stocks are usually callable, that is, they may be bought in and redeemed by the issuing company at a specified price, usually above par value. For example, a $100 preferred stock may have a $110 "call" price. A few preferred stocks, such as Virginia Carolina Chemical and National Biscuit, are non-callable.

Preferred stocks are the least popular of marketable securities. In general, they provide less safety of principal and certainty of income than good bonds and lack (unless convertible) any chance of sharing in the fat earnings accruing to common stocks in outstandingly profitable years. A good preferred stock will usually yield about 1% more than bonds of the same company. The most popular preferred stocks are those of electric utility companies whose record for continuous preferred stock dividend payments has been remarkable.

About Common Stocks

Stock companies can issue bonds, preferred or common stock; but the one security they must issue is common or capital stock. This not only represents the actual ownership and equity in the business, but the common stock, voted by those who own it, determines who shall manage the company. Common stockholders elect the directors, who in turn elect the officers who actually run the company.

A common stock is a subdivision of ownership. As part owner of a business, the common stockholder shares in the corporate fortune. In good times he gets dividends; in bad times, headaches. And his security, the common stock certificate, may fluctuate widely in market value in reflection of the various changes in corporate welfare. It is in being a common stockholder that you get the big kick out of investing.

About Par and No Par Value Common Stock

Common stocks may have a stated par value such as $50 or $100 or $1, or more commonly they may have no par value. Fifty years ago almost all common stocks had stated par values (usually $100). This figure representing par value actually was supposed to represent the original capital contribution made into the company. But accountants realized, in due course, that that original contribution, say $100, would not remain as a permanent value but would change drastically. It would attain much greater value if the company proved a good earner, and it would shrink if earnings did not materialize as original assets depreciated. So gradually par value in common stock came to be regarded as a fiction, and nowadays either a quite nominal figure from IOC to $1, or no par shares are used.

Common Stock the Marketable Security with the Glamour

You might call the twentieth century the Age of the Common Stock. For, since the early 1900's, common stocks have not only become desirable but widely sought for long-term investment. There are several reasons for this: (1) the sustained growth of our economy; (2) the remarkable expansion in size and profitability of our great corporations, such as General Motors, oil companies, IBM, du Pont, General Electric, and Texas Instruments; (3) the fabulous rise in dividend payments over the years; (4) the amazing fortunes made by even modest investment in many companies in their early stages; (5) the defense common stocks have offered against inflation and a depreciating dollar; (6) dissemination of accurate information about corporate affairs; (7) active daily trading markets.

The common stock is now an accepted and much sought after investment not only by individuals but by mutual funds, endowments, trusts, pensions, savings banks, and life insurance companies. In 1959, Harvard University, the wealthiest private educational institution in the U. S., had over half its endowment funds in diversified common stocks.

With your surplus funds available for marketable securities, you’ll doubtless want to purchase selected common stocks. In a later chapter, we'll outline some specific personalized programs for this selection, geared to your own particular needs for income, growth, diversification, etc.

Common stocks, preferreds, bonds and Mutual Funds (described later) these are the standard types of marketable securities. In the next chapter well describe the markets in which these are traded.

Resume

1. Marketable securities were created in volume when the corporation was invented.

2. Bonds are for safety of principal and assurance of fixed return.

3. Preferred stocks are in general less secure investments than bonds but yield somewhat more.

4. The favorite preferred shares are those of public utilities.

5. Common stocks are the most glamorous and volatile equity securities.

6. Common stocks have proved their worth as long-term investments, but they require their holders to accept with equanimity wide swings in market price.

7. Well-selected common stocks can add to your income and resources and may even make you rich.

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