Vinod's Finance Page

Chapter 12: Special Factors in the Analysis of Railroad and Public Utility Bonds

Graham shows the factors that should be considered in a thorough study of bonds but notes that this is not consistent with a high grade bond investment. The selection of fixed value investments should be a relatively simple approach.

The investor must make certain by quantitative tests that the income has been amply above the interest charges and that the current value of the business is well in excess of its debts. In addition, he must be satisfied in his own judgment that the character of the enterprise is such as to promise continued success in the future, or more accurately speaking, to make failure a highly unlikely occurrence. These tests and this expression of judgment should not require a highly elaborate technique of analysis.

If the investor in railroad bonds must weigh such factors as a favorable trainload trend as against a poor diversification of traffic handled, he is called upon to exercise penetration and skill out of all proportion to the reward offered, viz., a fixed income return of from 2.75% to 4.5%. He would certainly be better advised to buy United States government securities, which yield a lower return but are safe beyond question, or else to let one of the large savings banks invest his money for him with the aid of its extensive statistical staff.

Recommended Procedure: The complexities associated with railroad bond analysis have arisen naturally—but in our view, rather illogically — from the wealth of data available for study. The fact that a mass of figures is obtainable does not mean that it is necessary, or even advantageous, to dissect them. We recommend that the buyer of high-grade railroad bonds confine his quantitative study to the coverage of fixed charges (with due attention to the trend of earnings and the adequacy of maintenance expenditures) and to the amount of the stock equity. If he desires to be particularly careful, he will probably be better advised to increase his minimum requirements on these two points, rather than to extend his statistical tests to numerous other features of the annual reports.

Graham adds that such elaborate analyses may at times be of real value to the purchaser of speculative railroad bonds or stocks, as aids to his judgment of what the future will bring. But the whole raison d’être of fixed-value investment is opposed to any primary reliance upon surmises as to the future, since the field for exercising such judgment must logically be among those issues which offer possibilities of gain as a reward for being right, commensurate with the penalties attached to being wrong.

<< Previous Chapter           TOC         Next Chapter >>