Stock Market

Invest in Common Stocks for the Long Term

Variations in the dollar as a measure of real value has an important bearing on the advantageous investment of individual resources. A chain of studies, some presented here based on a comparison of high grade bonds and common stocks over different periods extending from the end of the civil war up to 1922 favors diversified common stocks. Since 1987, with currency depreciating, the diversified common stocks mentioned here are shown to have been by far the superior form of long term investment. When discussing the topic of conservative investment, high grade bonds hold an unassailable position in the minds of most people. The discussion is usually centered on weighing the relative merits of different issues of such bonds or how far it is safe to stray away from the most highly secured bonds so as to obtain a higher income return. Those who suggest preferred stocks sometimes feel they have gone way beyond conservative opinion will support them. It is typical of common stocks being left out of the discussion.

What are common stocks  in the stock market? In general they are regarded as a medium for speculation, not for long term investment. It is bonds that are regarded to be the best medium for long term investment. The basis of an issue of bonds is from a venerable tradition of conservative attached to first mortgages, whether upon real estate or upon corporate property.

Since common stocks are regarded as speculative, they are frequently omitted entirely from the lists of a great many investors. Omission should be based on a thorough study of the relative merits of bonds and stocks but not on prejudice. Well, the truth is stocks fluctuate in price in response to many factors, some related to the industry they represent, some to general business conditions, and some to temporary market position of avowed speculators. A majority of investors should not be influenced against common stocks by speculation associated with them. Such speculation exaggerate in investors’ minds the danger of possible loss to those who buy them for long term investment.

It is possible that the definitive weakness of otherwise perfectly safe bonds is overlooked, that they cannot in any way participate in the growth and increasing activity of the country, that they are defenseless against a depreciating currency. The ultimate difference between stocks and bonds is that bonds represent a promise to pay a certain number of dollars at a future date with a fixed rate of interest each year during the life of the loan. On the other hand, stocks represent ownership of property and processes their own value and income return fluctuating with the earning power of the property.

The value of stocks, valued in dollars, increases with the growth and prosperity of the country and of the industry represented. The value of stocks also increases in proportion as expressed in a higher cost of living. Stocks are prone to temporary hazards of hard times, and may be destroyed in value by a radical change in the arts by poor management.

The reason why the value of high grade bonds, expressed in dollars, changes so fast is because their value represents dollars and nothing more than dollars. Gold is the only commodity whose value does not vary at all, except under extraordinary conditions. The fear of investors is the dollar shrinking in value. We see that the most conservative of our great financial institutions invest so great a proportion of their assets in bonds repayable in dollars.

This chart tracks inflation versus the annual returns of the S&P 500 and long-term government bonds.

Investment in Common Stocks

Source: Standard & Poor’s; Barclays Capital; Bureau of Economic analysis

Large-Cap stocks are represented by the annual returns of the S&P 500. Long Term Government bonds are represented by a composite of the total annual return of the Long Term treasuries (10+ year maturities) and the Barclays U.S Aggregate index.

Investments of savings banks, commercial banks, and trust companies are all made to protect dollar obligations. Their main concern is to transact their business such that they will always have available more dollars than they will be called upon, under their commitments, to pay out, at the same time deriving a profit above operating expenses. The specialists whom they employ to guard them in their financial policies concentrate their attention upon promissory obligations payable in a fixed number of dollars, sufficiently safeguard against the shrinkage in the purchasing power of the dollar itself.

An individual investor should study the possibility of profitable investment in securities which the larger institutional investors are not prohibited by law from considering, and which for that reason may be selling upon a basis of higher income return. Individual investors are unduly influenced by well-deserved reputations of such financial institutions for conservative investment, and overlook the fact that they, as individuals, are investing with the purpose of providing real wealth, not the changing symbol of value for their later years, or the next generation.

There are a wide variety of bonds, but this discussion is confined to the question of conservative long term investment. Thus we are consider those bonds which at the time of purchase, are regarded as well secured by mortgage or prior lien on property which has been authoritatively appraised as worth well in excess of the total amount of bonds issued against it. Such appraisals are mainly based on the cost of construction or reproducing the properties, and that such costs along are not criterion of the real value of the properties at a later date.

It is of great importance, in the choosing of bonds for long term investment, to get all the assurance possible that the revenues, after operating expenses of the debtor company, are and will continue to be , during the whole period that the bonds are to be held, well in excess of all fixed charges, and will provide  sufficient funds for depreciation and possible obsolescence so that the margin over all fixed charges will be sufficient to afford the company the best of credit so that changes in plant or extensions may be financed at least through the sale of stock on favorable terms.

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June 16, 2013 Stock Market