The Factor of Safety
“There remains but one point to which, in view of the conditions roughly sketched above, the writer would call especial attention. That is, that the investor should look well, always, to the factor of safety. Before he puts his money into any road, no matter if it be on the recommendation of the greatest banker in the United States, let him consider how far that company is prepared to weather a storm. Few roads ever prospered under receivership, no matter how honest or how able. The receivership itself is a handicap. No matter how high the yield, no investor whose primary regard should be the safety of his money will put it into a road whose fixed charges, after ample charges for maintenance, consume much more than 50% of the total net income available for interest, dividends and improvements—that is, save in exceptional cases like the New York Central—and until he has satisfied himself thoroughly that the property is sound.
“For the convenience of those not well acquainted, the following list of the principal roads is given, with the percentage of total net income consumed by fixed charges in the highly prosperous fiscal year of 1905:
TABLE OF FIXED CHARGES.
| Atch., Top. & S. Fe | 42% | Chi. & East. Illinois | 68% |
| Atlantic Coast Line | 57% | Chi. & N’western | 39% |
| Baltimore & Ohio | 39% | Chi., Bur. & Quincy | 45% |
| Boston & Maine | 78% | Chicago Gt. Western | 67% |
| Canadian Pacific | 33% | Chi., Mil. & St. Paul | 32% |
| Central of Georgia | 47% | C., St. P., M. & O. | 42% |
| Cen. R. R. of N. J. | 50% | C., C., C. & St. Louis | 69% |
| Chesapeake & Ohio | 53% | Col. & Southern | 55% |
| Chicago & Alton | 73% | Delaware & Hudson | 40% |
| Del., Lack. & West | 38% | N. Y., Chi. & St. L. | 41% |
| Denver & Rio Grande | 52% | N. Y., N. H. & H. | 48% |
| Det., Tol. & Ironton | 87% | N. Y., O. & Western | 53% |
| Du., S. S. & Atlantic | 115% | Norfolk & Western | 37% |
| Erie | 66% | Northern Central | 28% |
| Gr. Rap. & Indiana | 76% | Northern Pacific | 29% |
| Grand Trunk | 65% | Pennsylvania | 38% |
| Great Northern | 26% | Pitts. & Lake Erie | 11% |
| Hocking Valley | 31% | P., C., C. & St. L. | 54% |
| Illinois Central | 47% | Reading | 45% |
| Iowa Central | 79% | Rock Island | 83% |
| Kansas City South’n | 54% | Rutland | 69% |
| L. Erie & Western | 69% | St. L. & S. Fran. | 82% |
| Lehigh Valley | 46% | St. L. & S’western | 76% |
| Long Island | 101% | Seaboard Air Line | 78% |
| L. S. & M. S. | 38% | Sou. Pacific | 49% |
| Louis. & Nash. | 54% | Southern | 69% |
| Maine Central | 46% | Texas & Pacific | 40% |
| Michigan Central | 57% | Tol., St. L. & S’w’n | 61% |
| Minn. & St. Louis | 77% | Union Pacific | 31% |
| M., St. P. & S. S. M. | 44% | Vandalia | 54% |
| M., K. & T. | 75% | Wabash | 80% |
| Missouri Pacific | 60% | Wheel. & Lake Erie | 90% |
| N. Y. C. & H. R. | 64% | Wisconsin Central | 69% |
Importance of Fixed Charges
to the Investor.
“The high degree of stability imparted to interest payments and dividends by a low percentage of fixed charges, and the high degree of instability imparted by a large percentage, is so elementary that it would seem to need no emphasis. And yet this item is habitually disregarded by perhaps 90% of bond and stock buyers. On this account it may be worth while to illustrate by simple comparison the effect of a 20% decline in gross or net earnings. We will compare the conditions of two roads whose fixed charges are respectively 75% and 25% of the total net income. The operation would be as follows:
| Suppose a 20% Decline | |||
| Say Earnings | $1,000,000 | $800,000 | |
| Exp. (70%) | 700,000 | 560,000 | |
| Net | $300,000 | $240,000 | |
| If F. C. 75% = | 225,000 | 225,000 | |
| Surplus for div. | $75,000 | $15,000 | (Case I) |
| Decrease | 80% | ||
| If F. C. 25% = | 75,000 | 75,000 | |
| Surplus | $225,000 | $165,000 | |
| Decrease | 26% | (Case II) | |
“It will be seen from the above that a 20% decline in the net earnings would, in the first instance, mean a decrease of 80% in the surplus; while in the second case, the same decline would mean a decrease of only 26% in the surplus—figures which sufficiently indicate what a high percentage of fixed charges means.
“In this connection it may be further noted that in the large holding companies, like the Pennsylvania, the New York Central, the Union Pacific, and others, the factor of safety and the surplus shown tends to be relatively more stable than in companies largely or exclusively dependent upon the earnings of their own roads. This is due to the general custom of American Railways of paying out in dividends only a part of the actual surplus earned. From this it results that dividends are much more stable than earnings, and that the income of the holding companies from this source will correspondingly show smaller fluctuations than earnings. When, therefore, as in the case of some of the large holding companies named, the income from investments represents a considerable portion of the total net income shown, the surplus, other things being equal, will be much more stable than in other companies.
“It is needless to add that this stability is still further heightened when, as in the case of the Pennsylvania, Union Pacific and some other roads, the percentage of fixed charges is at the same time low.”—From “American Railways as Investments,” by Carl Snyder.