FINANCING OF INDUSTRY.

Auckland Star, Volume LVI, Issue 246, 17 October 1925, Page 16

FINANCING OF INDUSTRY.

FORM OF CAPITAL SOME ENGLISH FIGURES. (By HARTLEY WITHERS.) In a recent issue of the Midland Bank's monthly circular, v very interesting analysis was presented, showing' the methods of financing adopted by \arious classes of British companies during the period from 1919 to l!)_4. the circular pointed out, "the sphere of joint stock company operation has now become so that it may well be possible to obtain valuable light on fundamental trade conditions through a study of these methods."' Since, however, the investigation necessarily refers to a period that is past, the new light can do little more than confirm impressions that have already been gathered. More informing light is thrown on the effect of trade conditions on the form in which companies issue new capital, whether in that of debt —bonds, debentures and notes usually payable at short date — or in ordinary share and stocks. From the point of view of the holder, the distinction between these two forms is highly important; by buying the debts of companies lie becomes a creditor, entitled to a fixed rate of interest and usually with a promise of repayment at a certain date, or by annual drawings; and his claim for interest and redemption ranks before the ordinary shareholders receive anything in the way of dividend. He is thus in a strong position with regard to safety of income and capital, as compared with the more speculative interest of the ordinary shareholder, who takes what is left, if anything, after the claims of the creditors and allowances for depreciation have been met. From one of the tables drawn up in the course of the Midland Bank's investigation, showing the percentage of debt to new money raised by various classes of companies, it appears that two extremes emerge. At one end are oil and tea, coffee and rubber companies, which "since they possess no assets beyond what may prove either highly profitable or desperately disappointing, have in general no sure basis on which to secure debt." Such companies, therefore, together with mines, have to finance themselves almost entirely by means of shareholders' capital. At the other end are tramways and omnibuses and electric light and power companies, which have no difficulty in raising capital by means of debt, since they own valuable assets and "enjoy tbe prospect of regiilar earnings."

The most interesting figures produced by this investigation, however, were contained in a table showing the types of securities issued year by year during the period. In the boom years. 1919 and 1920, ordinary capital was the fashion, being 90 and 85 per cent of tbe total issued. In the two following years this proportion dropped to slightly over one half, rising again to three-fifths in 1924, when there were indications of a slight revival in British trade. To complete the significance of the figures, it should be added that the aggregate total, of debt and ordinary stocks together, was £220,----000,000 in 1919, and £308,000,000 in 1920, theii dropped like a stone to £90,000,000 in 1921, and' has remained between £90,----000,000 and £100,000,000 sine. then. As we all remember, some of us to our cost, the two first years, of very large aggregate issues, with a high proportion of ordinary capital, were those in which industry was busily engaged in recapitalising itself on the basis of war-time profits, inviting the active partnership of the public, as ordinary shareholders in a scale of profits which was shortly to be seriously diminished. In the last three years of tbe period investigated, "investors could be attracted only by offering greater security for their savings than they demanded in more prosperous times. Debt, therefore, took the place, to a large extent, of capital, and impetus was added to the movement by the fact that in order to repay short-term indebtedness on bills and other accounts,- longterm securities of some sort were issued. In many cases debentures'' (or bonds as they would be called abroad | "were the only kind of security issuable."

It thus appears that when trade is actiye and profits are favourable the public take shares i and insists on debts when times are bad. This is, of course, the natural tendency which makes speculators buy securities when they are booming, and refuse to touch the market when they are flat; but it is totally opposed to the doctrine of scientific investment and speculation, which tries to anticipate the movements of the trade cycle by buying what is cheap and selling what is dear, hoping that the swing of trade will reverse the position.

As to whether the public secures the safety that it believes when it buys debts rather than ordinary shares, is a matter concerning which doubt has been raised by investigations lately carried out in New York, by a school which teaches that, as proved by a series of tests oyer a long term of years, the holder of common stocks gets a larger income and more capital appreciation, than he would have had if he had confined himself to high-grade bonds. The result of those investigations are set forth in a book called "Common Slocks as Long Term Investments," by Mr. E. L. Smith, published by Messrs.* Maemillan, in New York. Its results are certainly surprising, though a large amount of allowance has to be made for the fact that the investigation covers a period iii which the industries of the United States to which country it was confirmed, enjoyed amazing prosperity and expansion interrupted by severe reactions. But it is proved that in a diversified list of industrial common stocks there is a degree of safety for the holder that would not have been expected.

Mr. Smith accounts for this safety of income and capital, which he did "not expect to find in periods when commodity prices are falling and profits are consequently diminishing, by the fact that well financed industrial concerns habitually distribute less in dividends than they earn in profit, re-investing the balance on behalf of the shareholders in the further expansion of the business, whose capital and earning power thus tend to grow; with the result that while the bond-holder gets his interest and no more, the shareholder gets the benefit of a steadily expanding income.

The debt-holder thus buys safety, which in the case of industrial debfs is comparative rather than absolute, but cuts himself off from the rising profits which good finance procures for the shareholder; but good finance can only do so, of course, if the industry is not only well financed but also well conducted on the productive side. This last named condition of success is so difficult to count on, however, that the ordinary investor, who is not in a position to distribute his risks very widely, is well advised in preferring the safety that he gets from bonds and debentures.