Look before you leap

Press, 31 August 1977, Page 32

Look before you leap

What should New Zea-1 landers look for when theyj are considering investing | their money? The question, and the answers to it, have significance at all times, but I more particularly today, in view of events which have undermined confidence in some areas of the investment market.

j The average citizen with ' money to invest has very ! little experience in determinling the best type of investment to suit his particular needs.

Yet, in many cases the decision involves a lifetime of savings and for this reason alone it should be made only after careful study of all the considerations.

It is natural that any accumulated savings should be employed in an investment which will provide security, an attractive interest rate and some protection against inflation.

The ravages of inflation have made the yield the investor will get from his money a vital consideration, j Interest rates of some organ[isations which measure up to the criteria for safe investment fall far short of meeting the effects of inflation. An investment in such an area might not always appear sound in terms of effective return.

It really becomes a matter

iof finding an organisation I which meets the criteria but | which offers a return on investment which comes near!est to cancelling out the ero|sion of money value through j inflation. : We all see endless offers to the public being made by [both well-known and virI tually unknown organisa-

tions, all encouraging members of the public to invest their savings with them to provide a satisfactory return. These advertisements appear daily in newspapers, on TV and in magazines.

I In some cases the organisations behind these advertisements produce prospectuses which set out in detail I the financial standing of the company concerned and, in this respect, they comply with the the requirements of the Companies Act. In many other cases the I advertisements come from i intermediaries who take a | commission from these > deposits and invest the balance on behalf of the individual concerned. In these | circumstances, the individual [investor very often has little lor no knowledge of or control over the placement andi

[administration of his investment.

When reaching any investment decision it is important to weigh up certain factors. And prime among these is to look for an organisation which fully discloses its financial structure and its adaptability to economic changes in the years ahead.

An individual contemplating an investment will naturally survey the field of possibilities. He may consider going into an industrial company which is on the market for mone> r with a debenture issue.

He may look at a finance company, a building society, a contributory mortgage scheme, a property developer — any number of avenues which are open for investment in New’ Zealand.

An impulsive decision should be avoided. Whichever avenue appeals it is wise to study and compare the financial statements and reports of the various companies operating in that field.

An assessment of the company, its performance and financial stability can be accurate only if that company consistently and regularly makes a full disclosure of its affairs.

Investors are strongly recommended to read the

notes to the accounts and the auditor’s report to ensure that they are not qualified, and this information should give a full appreciation of the company’s strength. If an individual feels he does not have the ability to interpret such statements he should consult someone competent to do so. Audited statements, as provided by reputable organisations, provide an assurance that all the questions asked by the auditors have been fully explained and that the accounts comply with the provisions of legislation affecting these companies. One of the thoughts usually uppermost in an investor’s mind is the security of his investment. It must be safe.

There are two aspects to the question of security.

One is the nature of the organisation itself — how well it is managed, its profitability and cash flow, its ability to adapt to change. The other aspect is technical. The investor should know exactly what his investment is — a debenture

security, a mortgage, a commercial bill or even an unsecured deposit. He should also appreciate his rights and interest under the security given and this requires full and proper documentation so that he has a clear record of the investment he holds.

The prudent investor will i have recognised the nature of the organisation in which he has chosen to invest and will have assessed its ability ' to adapt to changing condi- ] tions, and its capacity to meet its commitments as they fall due in the future. There is a golden rule in the world of finance that you should never borrow short and lend long. Some companies have broken this rule, and paid the penalty. The shareholders’ equity in a company which is soliciting funds for investment

should be closely looked at' by an intending investor. There are certain basic ratios of shareholders’ involvement to investors’ funds which are designed to protect the investing public. These ratios are normally set out in trust deeds whereby the borrowing com-1 pany covenants that it will I maintain certain standards.! and appoints an independent trustee to act as a watchdog in the interests of the in-i vesting public. The ratios vary according! to the nature of the business. At the high end of the] scale there are banks and short term money market! companies and at the other] end are industrial companies] which by their very nature] are less liquid. In Broadlands’ case, for example, the company’s debenture trust deed limits secured borrowings to either a maximum ratio of $6 of secured borrowings for every $1 that shareholders have invested, or 80 per cent of tangible assets, whichever to repay. Maintaining a prudent ratio of investment funds to shareholders’ funds is really a question of putting your money where your mouth is] — that all the things you] say you can do are backed) up by shareholders’ money. | In addition to the ratio] which has been set, share-] holders’ funds should be) publicly stated. Profitability in past years provides a sound guide to | the future prospects of ani organisation. A golden rule for an intending investor is to look for a company with a history of profitability. This

indicates success in its activities, sound management and a high probability that it will continue to be profitable in the future. Profitability is important to shareholders and investors alike. Some of these profits may well be set aside in cash reserves to meet future commitments. The intending investor

[will need to make certain! that the company he selects] enjoys a strong cash flow! from the funds that it [ employs in its business. Fin-1 1 ance companies regard cash; as their stock and employ! this in making loans to the! i many thousands of people] 1 who meet its criteria by: I way of security and ability] Ito replay. An investor should exam-1 ;'ine the cash flow of .he •company under review to) ]make certain that its com- [ interest on his investment] • public can be fully met from; !|the returns of cash from the] I! various avenues in which! these funds are employed. •I It is important in the in-1 vestor’s mind that he can; : see that funds will be avail-] able not only to pay the • interest on his investment [ but to redeem the in-1 vestment upon maturity.] . This cash flow is even morel important than the technical' security offered. Company management provides the vital link between . shareholders, in-, vestors and the market. The wise investor will] seek to find out about those: people who manage a company, making certain there I is a good proportion of full- • (time competent directors) /and executives exercising (control and pursuing; | a course of profitabil-l )ity and mangement which; will meet competition and ) adapt to changing circum-; stances. A well-managed] [company will adopt the cor-| ;rect principles to ensure its 1 continuity. In reaching a decision an investor will have satisfied himself that the similarities or differences between cer-

tain organisations provide a clear picture of where an investment should be made. If he can add to that a series of satisfactory conclusions based on the points discussed here, plus the statutory recognition of a company’s standing, then the risks are minimised and he should be in a position to make a sound investment.

Specially written for “The Press” by Mr D. A. Clark, chairman of the N.Z. Finance Houses Association, and managing director of Broadlands Dominion Group, Ltd.