The method of valuing a bond does not differ essentially from that of valuing any other thing which possesses worth. It is simply a question of knowing and applying the right principles. A real estate man applies certain tests or principles in determining the value of a piece of city or suburban property. If he knows his tests and how to apply them, he will be reasonably safe in the valuation which he places upon the property. The valuation of bonds is likewise based upon certain logical and well-established principles. These tests an investor may always apply before purchasing bonds.

Earning Power Of The Corporation

The first and perhaps most fundamental test to apply in valuing a bond is the earning power of the corporation issuing it. The general character of the corporation should be noted, as well as its affiliations and the nature of its business. In fact, if the revenue-producing capacity of the company has once been determined, then all other tests are really subordinate.

Each corporation will have to be judged by the nature of its business. If it is a railroad, what sort of territory does it operate in? What is its competition, actual or potential? It is making money? Is it an independent road or is it a part of a big system, perhaps with its earning power guaranteed?

Should the bonds be issued upon an office building, other tests must be applied. Is the title to the ground site complete? In what city is it located - a growing or a declining city? In what portion of the city? To what class of renters is it apt to appeal? What is the amount of insurance on the building? Such are the questions that need to be considered.

In valuing public utility bonds other tests must be applied, such as the nature of the franchise, the prosperity of the town, the attitude of the people of the town, the political situation, the possibilities for substitution, and special distributing conveniences or difficulties. In judging the value of the securities of any company, therefore, such questions as the nature of a business, the territory, and the people, must be observed in each individual case according to circumstances. A business which cannot answer satisfactorily such fundamental tests will never attract the careful investor, however well secured its bonds may appear to be. The name of the bond issue, therefore, is not so important as the promise of the business from which the interest and principal must be paid.

Security Of The Bond

As already pointed out, the security which is pledged for the redemption of the bond is not the all-important factor. Nevertheless, certain characteristics deserve to be noticed in the security which is pledged. If it is a first mortgage bond, what is the reasonable value of the property on which it is secured as compared with the total amount of the issue? If not a first mortgage bond, then what bonds come ahead of it and how much property value remains lifter prior claims have been satisfied? It is well to look into the junior issues as well, even though they cannot affect the security of the particular issue under condition. If a large issue comes after any particular bond and has been accepted at a fair value by the investing public, evidently the prior issue ought to be good.

When we have disposed of the relative value of the issue under consideration, the next question is how we are to ascertain whether the bonded indebtedness is reasonable or not Take the case of a railroad: Is the bonded indebtedness of $30,000 per mile a safe indebtedness or not? Obviously no arbitrary figure like this can be used. An amount which might be reasonable on the plains might not be adequate in a mountainous region. Likewise the bonded indebtedness of a transcontinental line operating fast trains and carrying heavy loads would be different from that of a jerk-water branch road using lighter rails, a clay-ballast roadbed, etc.

The question whether the amount of bonds per mile is high or low is obviously purely relative. Investors whenever possible should compare the issue of one road with that of a similar road. For example, in considering Chicago and Northwestern bonds, he might compare conditions with the Northern Pacific, the Great Northern, the Chicago, Milwaukee and St. Paul, the Burlington, and similar lines.

Sponsorship Of The Bond

The matter of sponsorship, which is really a question of responsibility, affects two factors - the issuing company and the selling agency. The careful investor will not purchase blindly. Men do not gather grapes from thorns. The responsibility and character of the issuing house often carries more weight than does the nature or standing of the business in which the bonds are to be employed.

The responsibility of the issuing company is, of course, of first importance. A great many bonds have already established their reputation as safe investments and they are bought by investors without any special investigation. Among such may be mentioned certain issues of the Union Pacific or Pennsylvania bonds. There are all sorts of gradations from these safe investment bonds to those which are merely speculative.

Some investors judge the safety of a bond by the banking or bond house which attempts to dispose of them. Most of the great banking and bond houses of international reputation do not attempt to float an issue which is entirely speculative, and most of the bonds which are sold through reliable houses may be accepted without much further investigation. However, anyone who purchases blindly takes the risk of his own act. The purchaser should not forget that a bank has a direct financial interest in the sale of the security.