Chapter 13 - Different Corporate Characteristics

With almost 50,000 different securities on the market to choose from, including issues of many thousands of individual corporations, it might be well to devote a few pages to the structural differences among the various corporate enterprises and the different forms of government regulation which may affect their capitalizations and earning powers.

Public Utilities

Well start with public utilities. Certain companies which supply broad and vital services are by nature almost monopolistic, and competition in the same area among them would be both illogical and wasteful. For instance, on a given block or in a single city, there would be great waste if two or three electric power companies served the identical district. The duplication of power lines, generating plants, etc., would not improve service but greatly add to the cost thereof. So it is that in our enterprise system electric power and light companies, water, gas, and telephone companies are regarded as essential monopolies. But in order to assure proper service and expansion and to prevent the companies from charging unfair prices (because they have no competition), these privately owned public utilities have invariably come under public regulation usually by state public service commissions.

Regulation by these authorities usually includes supervision of rates charged, public financing, property valuation, and determination of the proper rate (in the public interest) of return on company capitalization. In general, rates on fair property valuation of from 6% to 7% have been approved; and some states have been notably more generous than others in what they would permit utilities to earn.

This broadspread regulation has prevented any substantial plow-back in earnings, for if retained earnings appeared large, there would be public clamor for rate reduction. So it is that utility companies generally pay out 60% to 80% of net dividends; and, as they expand their plants, they come frequently to the money markets for public sale of bonds and stocks. As a result, among electric operating utilities a somewhat uniform financial pattern of capitalization has emerged, roughly 50% in bonds, 15% in preferred stock, and 35% in common stock. This is not, of course, any absolute formula but is probably fairly representative. Thus utility stockholders get frequent opportunities to subscribe to new stock; and the largest utility, American Telephone & Telegraph, has raised billions in the post-war era by sale to shareholders of either common stock or debentures convertible into it.

Railroad Regulation

Right after the Civil War, railway financing and building boomed; and unfortunately there were wolves and villains who milked and raided railway treasuries to the detriment of bond stockholders, and who quoted freight rates that differed greatly between customers. So the Interstate Commerce Commission came into being to regulate railway rates in the public interest and to exercise some control over railway financial operation. This Commission was probably more effective in regulation and standardization of rate structures than in its financial supervision since, in 1933, over one-third of our railway mileage landed in receivership or bankruptcy. However that may be, railroad companies have traditionally done their major financing by long-term bonds, and only since the Depression have sinking funds been used to reduce debt. In many cases the size of total indebtedness has created great leverage for railway commons. Even today, on a road such as New York Central, a 20% rise in gross revenue can create a dramatic rise in net per share. Since the railways have not grown to any extent in recent years, there has been virtually no new stock financing.

Other Transport Forms

The regulation which began in the case of railroads has now spread to other forms of transportation. Truck and water common carriers must report to the Interstate Commerce Commission, and airlines to the Civil Aeronautics Board. All of this regulation imposes obvious limits on rates charged and the extent to which earnings can increase without some demand for reduction of tariffs or rates.

Banking and Insurance

Financial institutions, especially since the welter of bank failures in the early thirties, have also undergone increasing regulation and supervision, particularly for the benefit and protection of bank depositors. There is state supervision as well as federal; and regular reports made to, and inspection by, bank and insurance company examiners. These supervisions prevent improper financial practice and provide some assurance to stockholders that there is no financial juggling by the managements.

There are 14,000 commercial banks in the United States, most of them with stock publicly held. With these, as well as with casualty, fire, and stock life insurance companies, there is customarily only one class of security capital stock. Banks pay out 45% to 65% of earnings in cash dividends generally, while life insurance companies pay out only 10% or 15%, preferring to plow back the rest. As a result, many life companies have delivered exciting market gains and split their shares repeatedly. Life companies (and mutual funds) have been our fastest growing financial institutions.

Industrial Companies

No such broad generalizations are possible with industrial companies as with the more regulated corporations we have just touched upon. Each industrial company is a law unto itself. For decades enterprises were boastful of the fact that they had no debt, and there are still quite a few such Alpha Cement, Pullman Co., Coca Cola, etc. But partly for more rapid expansion and partly due to tax reasons (interest is tax deductible before net earnings), most companies have taken on some form of debt ranging from term bank loans to long-term debentures. So the extent of prior debt should be considered in the case of each company equity you may be considering. Mining, coal, and lumber companies are expending their assets, while chemical and electronics may be building up theirs. The companies building up plant for greater future earnings usually pay out the least in cash; so you may not prefer these equities if your goal is high current income.

Certain industrials have much larger plant investment than others. Cement, steel, and paper companies, oil refining companies, and smelting companies have very large fixed plant investments while chewing gum, cosmetic, and proprietary medicine companies have relatively light plant investment but extremely heavy annual budgets for advertising.

The foregoing swift commentary on certain corporate characteristics is obviously sketchy. It was designed, however, to encourage your analysis of the special financial, regulatory, or structural differences that make some types of shares more attractive or protective than others.

Resume

1. Utilities and transportation companies are heavily regulated in regard to the rates they can charge and their corporate financial structures.

2. Banks and other financial institutions are regulated in particular for protection of depositors and in the case of insurance companies, the premium payers.
3. Industrial companies vary widely in capital structure, with more debt financing (relatively) in recent years.

4. You should observe these differences in corporate characteristics in making your own security selection.

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