In what has been said in the preceding section as to adapting capitalization to earning power, it has been assumed that there will be no difficulty in determining earnings. If a company has been doing business successfully over a period of years and has had reasonably stable earnings, it would seem that there ought to be little difficulty in estimating the probabilities for the future; yet the experience gained during the last 15 or 20 years in forming combinations of industrial companies indicates quite clearly that even expert estimates are an unsafe guide.

At the time the American Malting Corporation was formed in 1897, a preliminary examination of the 22 plants concerned was made by an accountant of high standing, who reported that these concerns had earned about $1,300,000 per annum during five years of depression, and that the net earnings under a combination should be at least $2,000,000 without raising the price of the product to the consumers. Unfortunately, in making this estimate one important factor was overlooked. The business of furnishing malt to brewers had been an affair largely of financial connections and personal friendships. The brewers preferred to deal direct with the heads of the concerns from whom they bought their malt and refused to take kindly to the more businesslike methods of the "trust." As a result, the combination, instead of gaining through the greater efficiency of its sales methods, actually lost ground. The whole transaction, it has been remarked, is "a startling illustration of the fallacy of basing an estimate of the future earnings of a consolidated company upon the aggregate earnings of the constituent plants prior to their combination."*

In his excellent study, which is frequently referred to in this volume, Mr. Dewing includes a list of important industrial combinations showing the ratio between the earnings actually realized after the consolidation, and the aggregate earnings of the subsidiary companies before the combination. The following are his percentages:

Mount Vernon-Woodberry Cotton Duck Company............

166%

National Salt Company..........

134%

New England Cotton Yarn Company...........

98%

International Cotton Mills Corporation...........

56%

United States Ship Building Company..........

56%

United States Realty & Construction Co.............

50%

Asphalt Company of America..............

40%

American Malting Company...............

31%

American Bicycle Company..........

24%

Some of the discrepancies above shown may have been due in part to padded statements of earnings on the part of the companies which just prior to the combination were trying to make the best possible terms for themselves, and some are due, doubtless, to the fact that combinations are generally organized at the height of a period of prosperity. In general, however, they seem to represent a tendency toward actual decline in efficiency under the new form of organization.

Wherever the personal element in management is strong, estimates of future earnings are particularly uncertain. After a strong, going organization has been formed and methods have become standardized, this element of uncertainty due to the personal factor becomes less and less prominent. Nevertheless, in some lines of business it is especially strong. For example, it is reported that bankers are not willing to make large advances to companies engaged in operating chain stores. They believe that these stores depend to an especial degree upon the human equation. A single mistake in buying on a large scale might result in serious loss, for these stores generally sell on a close margin of profit. The death of the executive who had built it up and had formed his personal connections might be a fatal blow.

* Dewing's "Corporate Promotions and Reorganizations," p. 273.

Another source of uncertainty in lines of business where earnings would otherwise be remarkably stable, consists in the legislating power of governmental bodies. The legislatures of several states have in recent years passed laws fixing rates of transportation and of public utility services on arbitrary bases which have introduced a sudden and wholly unforeseeable change in the earnings of the corporations affected. There is probably no reasonable ground for doubting that this is a wrong principle. Wherever profits require regulation, it should certainly be carried on by some systematic and continuous method. In Great Britain there is no such thing as public rate regulation as understood in America. The two methods of regulation are the maximum dividend method and the sliding scale method, both of which operate continuously and automatically.

There is, perhaps, no safe practical rule to follow in making or in reviewing estimates of future earnings, except to follow the rule of skepticism. Sometimes the skepticism may be undeserved, but at any rate the banker or investor can make no mistake in demanding full and satisfactory evidence of the correctness of the estimates. This remark applies especially to promoters' estimates of the future profits of their concerns. "When you are capitalizing a perhaps which you believe to be infinite," says Hartley Withers in one of his incisive epigrams, "the number of noughts that you add on to the market value of the company's capital is a matter that does not concern you as long as you are wrought up to the right pitch of excitement."*