You are now at the most exciting point of investment: select­ing a stock to buy. Behind you is a careful determination of your fitness as an investor. You have set your objectives. You have made contact with the man who win be your agent and confidante in all transactions. You know the market place in which you and he will be operating, and you have fundamental knowledge of the types of securities available to you.

All right, what do you buy?

Whether you want income, growth, or safety, your chal­lenge now is to survey the field and narrow it down to the stock that seems best to meet your requirements. This means research.

You will feel like the amateur you are—at first. There are experts of every description who have a big lead on you in wisdom and experience. There are sober scholars who have made a lifetime specialty of rails, oils, utilities, or steels. There are bushy-tailed tipsters offering tempting morsels that, in all truth, turn out well enough just often enough to be most disconcerting. And there is information and advice—millions of words of it—streaming from hundreds of sources and ranging in substance from half-sheet flimsies to Graham and Dodd's great keystone volume, "Security Analysis."

It is perfectly acceptable procedure to let these sources (except the tipster) help guide your selections. Unless you expect, first crack out of the box, to uncover a bonanza overlooked by the professionals, you probably will end up buying a pretty well-known and predictable issue, anyway.

Still, there is virtue in going as far as you can in marshal­ing your own facts and reaching your own conclusions. To be on the safe side, you may wish to check the results of your research with your broker. But conducting your own selec­tion process will give you valuable insight into the technique and discipline of security analysis.

Discipline need not eliminate the fun, and it can be a healthy balance to an overly romantic view of stocks. You may love airplanes, movies, and bourbon, but that doesn't necessarily mean that aircraft, entertainment, and distillery stocks are a good buy at the moment.

At the outset, let it be said that a full-fledged security analysis is a painstaking, highly specialized bit of business. Essentially, it is an effort to predict a company's potential earning power and, hence, the present value of its stock as an investment.

The analyst's raw materials are statistics. He studies earn­ings reports, balance sheets, stock-market records, and the various ratios that can be derived from them. He considers the company's long-term debt schedule, its expansion plans— contemplated or under way—and its tax position. He com­pares the company with its competitors, and checks the performance of its industry group against that of other groups or of the economy as a whole. All of this data, of course, is history. But if the analyst is diligent, his study will turn up statistical patterns and trends that reveal a great deal about the company's consistency, stability, and vigor, and suggest more than a little about its basic quality.

To this he adds what he can learn about such largely un-measurable values as the skill and enterprise of the company's management, the possible sales appeal of an upcoming new product, and the growth factors evident in the industry.

In due time, he reaches several conclusions, each bearing on the others. The first is a statement of what the facts—and the surmises—suggest as to the general quality of the com­pany. The second predicts the per-share earnings which might be expected in the next year. The third—the most difficult feature of security analysis—relates the stock's quality and potential to its current price and attempts to say whether, at this level, it is a good investment.

A little reflection, of course, will show how delicate is the balance of these three factors. On a quality basis, for instance, a bright, young electronics company would almost certainly be considered inferior, say, to Westinghouse. Yet if its ini­tial plant-expansion program had been largely depreciated and written off, and the products in which it specialized were in great demand, the earnings prospect could be most attractive and, over the short term, relatively safe. Handsome earnings, however, might have to be discounted if speculative buying of the stock had already shot the price up.

On the other hand, if the company had been largely over­looked, and rested comfortably at a low price level, anticipa­tion of even a modest increase in earnings could make the stock a worthwhile investment.

Most analyses are confined to the short term. There may be factors enabling the analyst to take a longer view. It has been clear since 1945, for instance, that industrial emphasis on electronics and automation virtually guaranteed a glowing future for these fields, whereas full development of peace­time uses for atomic energy may still be a decade off. Such generalities, however, do not say very much about the pros­pects of individual companies, and any analyst will admit that the farther ahead he looks, the greater the chance for error.

To be frank about it, any analysis will contain many im­ponderables. Even an experienced analyst inevitably must include informed guesses, inspired hunches, and the "feel" of a situation in arriving at a conclusion. For, excepting the hard figures of a company's financial statements, there are no numerical values to be gleaned from such items as managerial efficiency or sales potential. All the analyst can do is to establish relativities: if Company X's management, on the basis of observable performance, rates 90, then Company Y's officials can be graded no higher than 80. And if there is validity in this relationship, then a weight must be assigned to the importance of the management factor in the total company performance. The ramifications, of course, are soon beyond calculation. It may be, for instance, that Company Y is an old-line corporation whose stability and earning power is beyond question. A rating of 80 for its management may imply a certain stodginess, a certain conventional attitude toward new conditions; and yet who is to say that the response of such an important company does

not go a long way toward deciding what the new conditions might be? Company X, high-rated at 90, on the other hand may be a rising young company whose brilliant direction promises much for the future, but whose capacity to over­take Company Y is limited by the availability of capital and the rate at which markets can be developed and expanded. How now, analyst? What is the significance of 80- or 90-degree management in this picture?

These considerations are not raised to demean the analytic process. If anything, they show just how competent the top­flight professional has to be. For, despite complications, a good analyst can forecast a company's prospects with amaz­ing precision.

You won't—nor is it essential that you do so in selecting your initial investment. But attempting to thread your way through the activities and affairs of several companies, as an analyst would, will give you a firm and fascinating ground­work in the true meaning of investment.

Selecting an Industry

How do you begin? Since your analysis is not going to be highly formalized, you can begin just about anywhere. To give the process point and order, however, let's begin with an industrial grouping. In spite of the trend toward diversity, most of the hundreds of stocks on the Big Board can be grouped into one product or service category or another.

Which group is for you? Well, there are about fifty clearly defined industries in this country, even more if you are par­ticular enough to separate aircraft manufacturers from air­line operators, or natural gas from oils, or Class 1 railroads from lesser lines.

Typical Stocks in Standard Industrial Groups

Agricultural Machinery: Allis Chalmers, Deere, Inter­national Harvester.
Aircraft Manufacturers: Boeing, Douglas, General Dy­namics, Lockheed.
Airlines: American, Eastern, Pan American World Air­ways, United.
Amusement Industry: Paramount Pictures, Twentieth Century Fox, Warner Brothers.
Automobiles:  Chrysler, Ford, General Motors.
Auto Accessories: Bendix Aviation, Borg-Warner, Clark Equipment, Electric Auto-Lite.
Beverages & Confections: American Chicle, Coca-Cola, National Distillers, Wm. Wrigley.
Building Trades: Carrier Corp., Johns Manville, Lone Star Cement, Minneapolis Honeywell, U. S. Gypsum.
Chemicals: Allied Chemical & Dye, Dow, Eastman Kodak,   duPont,   Union   Carbide,   Monsanto.
Drugs: American Home Products, Merck, Chas. Pfizer, Smith Kline & French.
Electrical Equipment: General Electric, Sylvania Prod­ucts, Westinghouse.
Finance: Beneficial Finance, C. I. T. Financial, House­hold Finance.
Food Products: Borden, Corn Products, General Foods, General  Mills,  National  Biscuit.
Machinery: Babcock & Wilcox, Cincinnati Milling, Ingersoll Rand.
Metals and Mining: Aluminium Ltd., ALCOA, Inter­national Nickel, Kennecott Copper, Reynolds Metals.
Natural Gas: American Natural Gas, El Paso Natural Gas, Pacific Lighting.
Office Equipment: IBM, National Cash Register, Pit-ney-Bowes.
Paper & Publishing: Crown Zellerbach, Curtis Publish­ing,   International   Paper,   Scott   Paper.
Petroleum: Gulf Oil, Phillips Petroleum, Standard Oil (N.J.), Standard Oil (Ind.), Standard Oil (Cal.), Texas Co.
Railroads & Railroad Equipment: Atchison, Chicago Rock Island & Pacific, Union Pacific, Westinghouse Air Brake.
Retail Trade: Grand Union, May Dept. Stores, Safeway, Sears Roebuck.
Rubber: Firestone, Goodrich, Goodyear, U. S. Rubber.
Steel: Bethlehem, Inland, National, U.S.Steel, Youngs-town Sheet&Tube.
Tobacco: American Tobacco, Liggett & Myers, R. J. Reynolds.
Utilities: American Tel & Tel, Consolidated Edison, Pacific Gas & Electric, West Perm Electric.

Even these groupings are by no means complete. The list could be fleshed out with banks, insurance companies, leather-products companies, glass and container manufac­turers, shipbuilders and fleet operators, textile millers, sugar growers, and radio and television manufacturers and broad­casters.

All of this reflects the wonderful and confusing diversity of American industry. Among it all there should be a few good stocks to buy. Indeed, there are. But it will not take much investigation to learn that each of these industrial groupings has a reputation, and that even the best reputations may be subject to cyclical slumps. These reputations are variously described, but roughly they can be said to follow the gradations given to stocks. There are Blue Chip industries, there are "businessmen's risks," there are out-and-out specu­lations. Or, you might say, there are industries of investment caliber, those of good quality, those responsive to abrupt up-and downswings, or, again, those which are speculative. Some are growth industries, some have hit then: peak and leveled off on a comfortable plateau, some are on their way down and out.

As always, generalities must be taken with a grain of salt. Within a group, one stock or another may run entirely counter to the general trend, either up or down. (And it is precisely this sort of contrary action that occasionally enables shrewd traders to buck the trend and come up with a winner.)

Among the industries of solid reputations, you would have to put the utilities first. This has not always been so. Manipu­lation with public-utility holding companies was one of the skyrocketing scandals of the days before the Crash. In the 30 years since then, however, utilities have regained status among the solid rocks of the securities markets. They are rarely spectacular performers. Rate regulation by state power commissions permits—and even maintains—a reason­able return on utility operations, but curbs all chance of runaway profits. All estimates of future power needs and consumption point upward. Many utilities are in the fore­front of atomic-energy development. Conservative manage­ment, steady expansion of plant and generating capacity, and temperate market action maintaining yields at 4 to 5 per cent are factors which currently give the better utilities a Blue Chip rating.

Food production and packaging is  another sound and basic industry. Processors of grain—the flour millers, cereal producers, and syrup manufacturers—dairymen, and frozen-food packagers are all steady performers and likely to remain so, as the population increases and the nation's diet continues to improve. Strangely, despite America's passion for beef and pork and lamb, the meat packers do not enjoy the same level of prosperity.

The drug manufacturers generally are a conservative group with an impeccable reputation and an enviable profit record. (You will see them classified as producers of "ethical" or "proprietary" drugs. The former are the medicines or medical ingredients that can be dispensed only by a doctor's prescrip­tion. The latter are the drugstore items—cough syrups, cold tablets, vitamins, ointments, and pills—that health-conscious America doses itself with to the tune of more than three billion dollars a year.) Competition among the drug com­panies is fairly fierce. The company that comes up with a new antibiotic or tranquilizer enjoys a keen competitive edge. And so does the one whose trade name for a standardized product becomes more popular than the rest. As suppliers of a basic American necessity, however, the drug group ranks with the food and power producers.

Chemicals must also be near the top of any quality list. Certainly, few industrial groups have such a high percentage of truly outstanding companies or such a basic and vital economic function to perform. Interestingly enough, as this is written, they are just beginning to come back into favor. Several years ago they were among the bluest of Blues. Then overexpansion, overproduction, and similar corporate im­balances began to plague them, and took the bloom off the rose. Earnings fell off. The performance of chemical stocks as a group lagged behind that of other industries. Now they are picking up again, and brokers' letters are rediscovering opportunities in chemicals. Such short-term reactions are not serious enough to weaken the fundamental stability of the chemical group. But one of the points to be made about the reputation of any category of stocks is that it is never invincible.

The oils have likewise suffered recent interruptions of the serene prosperity that has made them a premier item. Inter­national confusions and uncertainties in the Middle East and a changing tax structure in Venezuela have raised the un­pleasant prospect of lost resources and revenues. The stocks have reacted nervously, as timorous investors ducked for cover. Should political ructions in the oil centers of the world continue to intensify, some of the high-toned Blue might rub off the big oil stocks. So far, however, general interest in them seems undiminished, perhaps in part be­cause the operations of so many of them are spread widely enough to cushion losses in any one area.

Also of first rank is the electrical-equipment industry, a category which probably should be broadened to include the electronics and business-machine people as well. Always a basic element of the machine-operated civilization of Amer­ica, the electrical industry has mushroomed tremendously in the years since World War II. Virtually every province of the nation's life has been invaded by the power-driven appli­ance, mechanism, and tool. The home whirrs from morning until night with the vibrations of electric shavers and clothes driers, with TV and hi-fi, with toasters, ranges, mixers, freezers, heaters, and blankets. Office procedures are domi­nated by electric machines for billing, accounting, sorting, computing, and typewriting. Drills, saws, and sanders are now electrified. The automobile has power steering and electrically operated windows. Atomic submarines, bevatron atom-smashers, rockets and missiles would be nowhere with­out their electrical components. There is no indication that this pervasive activity is slackening; the stocks of the com­panies involved are performing well. Not every stock within these groups is top drawer, naturally. But a top stock in any of them may be considered to have an edge on most stocks in less-stable groups.

What are "less-stable" groups? And why? In a boom such as the present one, which has shot many stocks to all-time highs, it is difficult—and possibly misleading—to stigmatize any particular stock category. Still, some fairly acceptable generalizations can be made. Railroads, most machine-tool and agricultural-equipment manufacturers, autos, aircraft, building-trades suppliers, many metals—all these would have to be graded below the best. These are not necessarily un­stable industries, but they may be subject to seasonal cycles, limited to a somewhat narrowly based market, or prone to special problems that are in the nature of the business.

Everyone knows, for instance, that the future of the rail­roads is cloudy. High tax burdens, the costs of labor, maintenance, and new equipment, unprofitable commuter lines, and the inroads of truckers and airlines on freight business have many rails in deep trouble and make their stocks some­what chancy investments.

The weakness of a generalization, of course, is that it is so general. It is quite conceivable that many investors would prefer to have a piece of a well-managed, steadily productive railroad such as Atchison, Union Pacific, or Chesapeake & Ohio than of a B-rated utility. Perhaps the way to make the point is to say that while there may be exceptions, the likeli­hood is that more good stocks will be found among utilities than among rails.

Agricultural-machinery manufacturers are necessarily tied to farm prosperity. Reapers, binders, harrows, and tractors move slowly when the prices of wheat and corn are down. Machine tools—the great cutting, drilling, stamping, and rolling rigs that shape and form Alcoa's aluminum sheets, Ford's fenders, and Inland's I-beams, as well as every other patterned metal part in industry—are, for all their importance, cyclical items. And so are the raw metals they work. Copper, aluminum, steel, and the rest all are stockpile items, subject to the ebb and flow of business.

Steel companies historically are among the first to feel the pinch of recession. Steel users are inclined to rest on their inventories at the first signs of trouble, and, certainly in years past, the automatic reaction of the steelmakers has been to bank their furnaces. Steel, of course, is a prime material. It is employed essentially to make new things. A poor year in automobiles will hurt the steelmakers, while the petroleum industry, for instance, can make a profit selling gasoline for cars in being. Steel has also lost some ground to plastics, particularly in the toy field and in sheathings for various products. On the other hand, it is acquiring new business through the rising demand for specialized alloy steels to withstand the high temperatures and stresses of the rocket and missile age. On balance, the prospects for income in steel are somewhat less sure than in a number of other industries and this is reflected in the record of consecutive dividends. Except for National and Inland, the steel com­panies do not have an impressive record for consistent, long-term payments and cannot be considered unfailingly top-grade investments. Their attraction lies in the fact that when they hit, they frequently hit big.

Automobiles are a necessity subject to cyclical swings. Since much buying is artificially induced (it is not based on absolute need), any stringency in the economy—as we saw in 1957—or any shift in buying mood—as, for example, away from big cars—may tempt the public to go another year with the old bus, or buy a Volkswagen, and thereby put a serious crimp in automakers' profits. And as go the automakers, so go the manufacturers of sub-assemblies and accessories.

Aircraft manufacturers are dependent on Government contracts, and airlines on subsidization. The air industry is absolutely essential and cannot be permitted to fail, but, with rare exceptions, it has not found the way to put its fabulously costly enterprise on a paying basis.

Building-trades industries are very responsive to economic tremors. Office buildings and family dwellings are almost always too big an expenditure to be met without help. Build­ing starts, therefore, depend heavily on the availability of mortgage money and the level of interest rates.

Below the "less-stable" groups are the out-and-out specula­tions. Few entire industries can be so classified, although high-overhead, unessential products, subject to public whim and taste, such as movies and publications, and industries whose staple products are under severe pressure from other sources, such as coal, leather, textiles, and carpets, are difficult to justify as of investment caliber. Generally speaking, how­ever, there are more speculative issues than industries. And, make no mistake, speculations lurk among even the soundest of industrial groups.

At this point you have a sampling of industry categories and some rough evaluations of them. You still do not know enough, however, to choose among them. Let's refine the selection process. Here are 10 questions which should be asked about any stock group you are studying. Some of the answers will be contradictory; the significance of all of them will be relative. But each will contribute a plus or minus factor to your thinking about the industry.

1. Does the industry deal in necessities or "postponables"? Does it produce things people have to have in good times or bad—food, drugs, power, or heating supplies? Or can people put off buying its products to another year? There is one investor who holds meat-packing and distillery stocks, not notably high-grade issues, because of his conviction that, come hell or high water, beef and bourbon will be staples of the American diet.

The same question on a different level: Is the industry in­volved in durable or capital goods, such as locomotives, trucks, freight cars, ships, large buildings? These are ex­pensive items with a long life, and are usually financed with long-term, fixed obligations. In a pinch, they are among the first things customers are prepared to do without.

2. Is the industry depression-resistant? Retail stores, to­ bacco, metal containers, and, again, food products have a reputation for  stability,  not  only  in  terms  of  continuing consumer demand, but in terms of production costs and price structures which make them attractive as so-called defensive issues.
3. Is it an extractive industry? Does it deal in natural raw materials, such as oil, lumber, asbestos, metals? Stocks of these companies are considered good hedges against inflation because they represent a primary material, an asset already owned. The acquisition cost of oil underground, for instance, may already have been rationalized; henceforth all that can be inflated are the extraction and distribution costs.
4. How keen is competition within the industry? Usually competition is keenest where the differences are least. Auto­mobiles, soaps and detergents, drugs, tobaccos, gasolines and motor oils—within these categories the companies all offer the consumer pretty much the same thing. The local power and light company, the telephone company, and the natural gas companies (except for the scramble to run pipelines here or there)  are virtually without competition.

Cross-competition between industries is also a factor. This is not the struggle of Coke vs. Pepsi, or Tide vs. All, but whether new office buildings are going to have a skin of brick and mortar, aluminum sheets, or glass panels.

The container and packaging people are a lovely example of round-robin competition, as is perfectly evident from five minutes' inspection of your supermarket's shelves. Plastic squeeze-bottles of one sort or another have cut into glass as far as the packaging of cosmetics is concerned. On the other hand, the appearance of liquid soaps has given glass an opportunity in a field that was exclusively the paper-carton supplier's. The paper-carton manufacturer, meanwhile, has benefited from frozen foods at the expense of the tin-can producer. But the tin-can man has a new area in the pressure containers now used to dispense shaving cream, toothpaste, DDT compounds, hair lotions, and anything else that can be squirted or sprayed—and that isn't already in a plastic squeeze-bottle.

5. Are wages a big item in the industry? How large a percentage of total sales are they? This, of course, can bear heavily on net earnings and, consequently, dividends. In the chemical industry, the ratio of wages to sales is quite small. In steel and railroading, which have vast numbers of em­ployees and huge payrolls, it is quite large.
6. Do raw materials come from domestic sources or from abroad? Are their prices traditionally stable or volatile? This, of course, applies to the oil, rubber, and sugar companies, to some of the mining and metals companies, and to a few of the chemicals. This is, possibly, not so important as it once was, considering that few industries are totally dependent on foreign resources, and that political upheavals or wars are
   so far-reaching these days that almost everyone is affected to some degree, at home and abroad.

The question should also be broadened to include foreign markets: What percentage of income derives from sales abroad? This would affect air and shipping lines, distributors like W. R. Grace and U. S. Industries, and the export trade of the auto, machinery, movie, and electrical-equipment industries.

The investor will have to decide, too, whether he considers foreign trade a positive or negative item. Overseas markets may be uncertain or undependable, but they are also frontier areas of tremendous potentiality for an economy like that of the United States, which has lived so largely off its own people.

7. Is the industry heavily dependent on Government con­tracts? Is it subject to seasonal or other cycles? There is noth­ing wrong with Government contracts except that they can be cancelled. The manufacturer of a proved item, like the Nautilus,  the  Atlas   rocket,   or  the  B-36  intercontinental bomber is in fine shape, but Chance-Vought, manufacturer of the Navy's recently dropped Regulus missiles, is probably less happy.

As for seasons, it is a fact that cement and building sup­plies do best in warm weather, and that power companies sell more fuel when it is cold. Freight-car loadings are highest at harvest time. This, of course, may mean an uneven profit picture, but it need not mean a disastrous one.

8. How profitable is the industry? Either because the cost of production is high or because the mark-up is measured in pennies, many industries work on very narrow margins of profit. Meat packers and grocery chains, for instance, usually net 1 or 2 per cent of sales after taxes. Chemicals and oils, on the other hand, enjoy far more handsome margins.
9. What is the industry's investment per dollar of sales? To earn a dollar  in chemicals, oil, steel, cement, and paper there must be a huge investment in plant and equipment, which is usually long-term debt riding on top of the common stock. Drug and tobacco companies, retail stores, and finan­cial institutions, on the other hand, require relatively little
   investment.
10. How diversified are the companies within the in­dustry?  Diversification has been one of the major facts of our postwar economic life, and forces the analyst to be more cautious than ever in characterizing industrial groups. General Dynamics has been classified among the airplane manufacturers ever since taking over Consolidated Aircraft, and planes are undoubtedly a big piece of its business. Yet it is also a producer of atomic submarines, the Atlas rocket, electric motors, and radio and TV equipment. Olin Mathieson, aside from a long line of industrial and agricultural chemicals, makes Winchester firearms and ammunition, industrial explosives, Squibb Pharmaceuticals, specialty papers, cellophane, dry-cell batteries, and various copper, brass, and
    aluminum products. American Home Products is included among drug manufacturers, and indeed nearly half its sales are in ethical drugs. But it also makes and sells foods, coffee, cosmetics,   deodorizers,   insecticides,   waxes,   cleaners,   and lubricants.

Bendix Aviation, General Mills, National Lead, Westing-house Electric, and Goodrich are turning out a vast number of items having nothing particular to do with aviation, mill­ing, lead, electricity, or rubber.

What this means is simply that it may be unrealistic for comparative purposes to place a highly diversified company among specialized ones, or to consider the prospects for General Dynamics by looking at the performance of "a dozen aircraft manufacturers" against the performance of the market as a whole.

Finding solid answers to your ten questions will give you a pretty fair degree of familiarity with the industrial structure of the United States. You will not have a specialist's knowledge, but you will have begun to catch up on the body of information that forms the background for judgment in investment matters. You will have a sense of relationships and differences between industries, of the conditions under which they operate, and of the objectives they might reasonably be expected to achieve. You will have a feeling for sizes and shapes and rates of speed, which is to say, who is getting bigger and who is moving faster, and you will get a glimmer­ing of why. Most of all, you will see that nothing is fixed, rigid, or permanent; everything is included in the process of change.

With an idea of general dimensions, you will be in a posi­tion to begin to consider individual companies as possible investments.

Selecting a Company

Much of what you should know about a company is similar to what you have discovered about the industry. Your study will be closer and more comprehensive, however, and you will be working specifically with the trained analyst's materials.

Here, again, there are ten basic elements to investigate.

1. Look first at the history of the company under study. What is its record of sales, earnings, and dividends? Sales—or rev­enues—peg the volume of business done, and are one meas­urement of a company's size. The elite of American industry are the 46 "billionaires"—companies whose sales or revenue totaled a billion dollars or more in 1958. Topping the list is General Motors, the most tremendous corporate entity in the world, whose sales were over $9.5 billion. Standard Oil of New Jersey is second with $7.7, and American Tel & Tel third with $6.7. Twelve of the 46 are oil companies.

Sales, of course, tell only part of the story. Net earnings, or profit, are of even greater importance to the investor, for these determine his dividend. On the basis of 1957 results, for instance, an interesting contrast could have been made between Swift & Co., the meat packers, and the Texas Co., an integrated oil company, which stood fourteenth and fifteenth on the billionaire list. In 1957, Swift paid a dividend of $2.25 and Texas Co. $2.30, or only a nickel more. Yet look at the derivations of those dividends. Swift's revenues were $2.54 billion, as against $2.34 billion for Texas Co. Swift's net profit, however, was only $13.5 million, less than $.005 per dollar of sales, whereas Texas Co. reaped $332 million, or more than $.13 per dollar of sales.*

Texas Co. has about ten times as many shares outstanding as Swift—54.8 million as against 5.9 million—and, therefore, declared some $126 million in dividends, a 38-per cent pay­out. Swift declared about $13.3 million, or almost a 100-per cent payout.

46 Companies Whose Sales or Revenues Totaled More Than $1 Billion in 1958

Company	Sales or Revenues in millions
General Motors Corp	$9,522.0
Standard Oil Co.  (N. J.)	7,712.3
Amer. Tel. & Tel. Co	6,771.4
The Great A. & P. Tea Co	4,769.2
Royal Dutch Petroleum Co	4,279.0
Ford Motor Co	4,130.3
General Electric Co	4,120.8
Sears, Roebuck & Co	3,721.3
U.S.   Steel  Corp	3,472.2
Socony Mobil Oil Co	2,932.8
Shell Transport & Trading	2,852.6
Gulf  Oil  Corp	2,769.4
Swift  &  Co	2,645.4
Texas Co	1,864.0
Safeway Stores, Inc	2,327.9
Chrysler Corp	2,225.4
Bethlehem Steel Corp	2,165.4
Westinghouse Electric Corp	2,005.9
Standard Oil Co. (Ind.)	1,895.7
Armour & Co	1,850.4
DuPont de Nemours (E. I.)	1,829.2

* Swift's 1959 net income improved to more than $19 million, or $3.20 per share

Company	Sales or Revenues in millions
Kroger Co	1,776.2
Boeing Airplane	1,711.9
Shell Oil Co	1,666.0
Standard Oil of Cal	1,559.2
General Dynamics Corp	1,511.5
National Dairy  Products	1,451.2
Goodyear Tire & Rubber Co	1,367.6
Penney   (J.   C.)   Co	1,325.6
Union Carbide Corp	1,296.5
Proctor & Gamble Co	1,295.2
Douglas Aircraft	1,209.9
United Aircraft	1,200.4
Sinclair Oil Corp	1,190.4
Radio Corp. of Amer	1,176.1
International Bus.  Mach	1,171.8
Reynolds Tobacco Co	1,146.6
American Tobacco Co	1,103.0
Montgomery Ward & Co	1,099.1
International Harvester Co	1,098.4
Continental   Can   Co	1,080.4
Phillips  Petroleum Co	1,066.6
Firestone Tire & Rubber	1,061.6
American Can Co	1,037.0
Cities Service Co	1,015.3
General  Foods	1,008.9

The Exchange, May 1959

Swift obviously operated on a much narrower margin, and does not enjoy the 37½-per cent depletion allowance that eases the oil companies' tax burden. On the other hand, it does not have the huge capital investment, and exploratory and research expenses that Texas Co. must bear.

In checking history, do not be content with two-year, or even 10-year, comparisons. Go back to the 1920's if you can. Dollar values were different in those days, of course. But a 35- or 40-year span will take you through a major depression and a couple of wars, and reflect the company's strength more honestly than a quick sweep through the recent boom years.

What you look for, of course, is evidence of growth. Hope­fully, the company has expanded its sales, increased its net, and occasionally raised its dividend. At the least, it should show good rebounding strength after setbacks or slumps.

2. Familiarize yourself with the company's product or products. This is especially important in the case of diver­sified corporations with a number of sources of income. How much does each division or product contribute to the whole? Will a slump in autos hurt Borg-Warner? Possibly. Some 33

per cent of its business is in automatic transmissions, clutches, carburetors, and radiators. But remember that more than 35 per cent is in Norge home appliances and in air conditioning and building equipment, and that almost a third is in industrial machinery, equipment for agriculture and the oil industry, electronic and aviation items, steel products, chemicals, and national defense products.

Be aware of who does what. Do you know that Prestone antifreeze is Union Carbide's and that Zerone is duPont's? Who produces Chase & Sanborn coffee? (Standard Brands). Maxwell House? (General Foods).

This not only gives you a sense of a company's interests and activities, but avoids duplication in investment. Holdings in IBM (business machines), Thompson Products (auto parts), Minneapolis-Honeywell (heating gauges and regulators), North American (aviation), and RCA (radio, TV, phonographs) would seem to make a nicely diversified portfolio. Yet every one of these companies is a major figure in electronics, and as a group they would constitute undue concentration for the average investor.

3. Whom does the company sell to? The markets a company serves are a significant indicator of its stability. Does it supply raw materials or semifinished goods to industry, or does it supply retail items directly to the consumer? Or does it supply services rather than products? What is the retail price-range? Do the products reach a mass market (permanentwave lotions), a specialty group (hi-fi), or a high-income elite (yachts)? How big a customer is the Government? If the com­pany is a utility, what is the split in power sales among res­idential areas, industry, and agriculture? How much income is earned abroad, how much in the United States?
4. What raw materials does the company use? Where do they come from, and are they in ample supply? Or, to put it another way, is the company integrated? Does it control its raw-material sources? These questions are not always easy to answer, but they bear on the continuity of the  company's production. It is good to know that a prime product does not
   depend utterly on a scarce extract obtainable only in Com­munist China.

Glass is very simple to make, requiring only silica, soda, and lime. Many chemical and drug compounds are consider­ably more difficult to come by. Thinly concentrated ores, like titanium, can be located readily enough, but are devilish to extract. And rare earths, like thorium and germanium, are, indeed, rare.

5. How are the company's finances? This is the first of several questions you must ask about the company's admini­stration. Finances will be taken up in more detail in Chapter 16, "Understanding Financial Reports," but it will not hurt to start examining them here. For perhaps no aspect of a com­pany is more significant than the way it rigs its financial sails. The way a company handles its money is an accurate reflection of the business enterprise of the men who run it. A soundly structured company can weather a great deal of trouble, and, even in boom times like the present when everyone is doing pretty well, it is comforting to know that a company you are considering for investment is smart with its resources.

This does not necessarily mean conservatism, if conserv­atism means rigid use of funds. One of the classic examples of rigidity was the $293 million reserve in cash and Govern­ment bonds that Montgomery Ward piled up after World War II. It gave the company undoubted strength, and gave its stock a book value some 50 per cent higher than its market price! But, essentially, the money was useless, or at least unused. Sears Roebuck, meanwhile, expanded force­fully, to take advantage of the postwar boom it anticipated, and now stands as the world's largest mail-order and depart­ment-store retailer and the eighth largest of the nation's bil­lionaire corporations. In 1958, its revenues were a staggering $3.7 billion, while Montgomery Ward, although still a giant, was thirty-ninth on the list. Its revenues of $1.09 billion were simply keeping pace with its operations of the last decade, or perhaps not quite, considering the cheapening of the dollar.

To repeat, strong finances are dollars strongly used. Large debt should be looked into to see what it consists of, the rate at which it is being paid off, and its effect on net earnings for distribution. The capital structure should be studied to see what obligations have priority positions over the common stock. The working capital—cash, receivables, and inventory, minus taxes, accounts payable, and short-term loans—should be examined to see if it is sufficient for the company to meet the normal stresses of a business year.

Do not be horrified if debt seems enormous, or if a fat clump of bonds and preferreds stand ahead of the common. These may be signs of overextension, or they may be normal for the company or the industry. Public utilities, you will find, are frequently more heavily capitalized than industrial firms. Or it may be that a company's obligations represent the cost of expanding production and, thereby, earnings.

Note, too, whether the company has investments in other corporations. This can be a nice source of income, but, of course, does not represent earnings of the company by its own efforts. Allied Chemical & Dye, for instance, has considerable holdings in Owens-Illinois Glass, U.S. Steel, and Libby-Owens-Ford. Kennecott Copper has a good piece of Kaiser Aluminum & Chemical and of Molybdenum Corp.

6. What is the investment in research? For many industries —railroads, public utilities, retail stores—research is of little or no importance. For the chemicals, oils, rubbers, metals, aircrafts, and electricals it means survival. Be sure to deter­ mine the ratio of research dollars to sales dollars in any company in these fields. It will not tell you how good the research is, but it will indicate the kind of effort being made. Perhaps the most important question to be asked is whether any money is being spent for "pure" research, as opposed to "applied." Some scientists will argue that there isn't much difference, or that you can't do one without the other. Maybe so. An emphasis on gimmicking products in being, however, is less enterprising for the long run than finding a scientific prin­ciple that may require an entire new industry to exploit it.
7. What is the caliber of the company management? At no time in American business history has there been such fierce concentration on management skill as now. The business schools of American universities are top-heavy with aspirants to the seats of corporate power. The organization man-outer-directed—is riding high. The necromancy of business psychol­ogy is being successfully practiced by an increasing number of management consultant firms, by merchandising experts, by restless probers of the public psyche, armed with Ph.D.'s in the social sciences and seeking the underlying motivation of your buying habits  and mine.  Business publications, like Fortune, are endlessly fascinated by the largely intangible fac­tors that combine to make the good boss, the satisfied worker, the broad-gauge leader, the entrepreneur, the millionaire. A pantheon of business heroes is emerging, invested with a kind of stodgy glamour that places them several levels below ball­ players and actors but a cut above jockeys and Congressmen.

Beneath this froth is sober recognition that the impersonal business entity is nonetheless the creature and creation of men, and that the scope of their wisdom and daring has painfully immediate effects on its welfare.

Proof is sometimes hard to find, an accurate measurement of responsibility difficult to assign. But certainly the dramatic resurgence of Ford Motor Co., on the edge of failure under the superannuated management of old Mr. Ford, was a triumph of bold and imaginative managerial tactics. General Electric, Owens-Corning Fiberglas, Union Carbide, Douglas Aircraft, IBM, Gulf Oil, Minnesota Mining & Manufacturing are only a few among many corporations which glow with the extra brightness that emanates from great management. Jones & Laughlin, an old-line steel company somewhat in the dol­drums, has attracted new interest—and an improvement in its stock price—with the venturesomeness and vigor of its new management. Fairchild Camera (American Stock Exchange) recently enjoyed a 250-point rise, completely undeserved on the basis of past earnings performance, based in large part on the potential of its forceful and promising new executive talent.

Management, of course, is a comprehensive term covering everyone from the board chairman to shop foreman. For analytical purposes, however, it can be considered to mean essentially the top echelon, the key-officer level that makes and implements policy. There are no absolute criteria for ex­cellence at this level, but enlightened leadership as a cor­porate characteristic is discernible, and investors are giving this factor important weight in investment decisions.

8. What is the company's labor record? This is an aspect of management policy, yet important enough to be considered separately. Labor-management relations are still in evolution and, again, there are few absolutes on which to base value judgments. They are of vital concern to the stockholder, how­ ever, as far as the smooth functioning of his corporation is concerned. Good labor relations pay off in production, ef­ficiency, reduction of shop accidents, absenteeism, and tran­siency, and fewer work stoppages.
9. What is the company's rank in its industry? Ranking and rating are one of the analyst's favorite indoor sports, and you will not have to look far to find reliable estimates of company standings in terms of business volume, profit margins, and so forth. Ratings, remember, are simply one more yardstick. The Number One company is not automatically the best buy.
10. What has been the performance of the company's stock? This is the final element of your analysis and is suf­ficiently involved to be treated as a separate study.

Features of a Company's Stock

The deeper you dig, the more you will discover there is to know about stock and ways to appraise it. Yet in the end, as had been said before, it must be recognized that evaluations are efforts to penetrate an unpredictable future, and that the best that can be done is to approximate probability. You can never be certain beforehand that you have selected the best industry or that your survey of its members has turned up the best company. But conscientious effort will land you fairly close to the mark. As close as most people ever get.

And now you face the crucial point of the whole exercise: deciding whether the potential of the company you are con­sidering justifies its current price in the market. Don't be greedy. You don't have to buy at a giveaway price to have done well. Bargains are fine, but somewhat difficult to locate. A quite satisfactory price is one that your study indicates can be topped in the course of a year or two of healthy earnings, or that will produce a good yield in terms of the dividends that can be expected from those earnings.

Negatively, a too-high price is one that has shot extrava­gantly ahead of indicated earnings or that suggests a meager yield.

There are many proportional words in these paragraphs— "giveaway price," "healthy earnings," "meager yield"—that can be pinned down only in relation to a specific stock.

Accordingly, the first of five basic steps to be taken in stock analysis is an examination of the price trend. Is the current price near the year's high or low? What was the range last year? What is the post-war, boom-time spread between high and low? What has been the course of the price movement of the past decade? Gradual or steep rise or decline, or erratic shifts both ways? Just for fun, chart several varied stocks chosen at random and see what kind of pattern you get.

Stocks selling at or near their highs—and many today are at all-time highs—must be regarded cautiously. The upward swoop of recent years has tempted people to believe that there is still unlimited growing room ahead—and this may be. Pessimists have had a hard time earning a living for some years now. Nonetheless, there is much to be lost by getting in at the top. There is a long way to slide down, and no assur­ance that the upward movement will be sustained. Watch the stocks you're interested in for a week or two. How fast is the rise and how steady? Four and 5 point leaps totaling per­haps 25 or 30 points in two weeks' time almost certainly in­vite a reverse of greater or lesser severity somewhere along the way. Steady gains of a point here and a point there may not carry any guarantees, either. But they suggest that some­thing more than speculative excitement is behind the rise.

Stocks selling near their low generally do so for a reason, particularly when all the pressure is upwards, as it has been. This does not mean they are bad stocks, but it is worth a look around to see why they are sloshing in the trough when pre­sumably comparable stocks are on the crest. Often the trou­ble is temporary. As indicated earlier, the chemicals and aluminums fell from favor a year or so ago; the chemicals have climbed back into the sunlight, and it will be interesting to see if the aluminums do so too. Inland Steel could have been picked up in 1958 in the 70's, where it had rested for some months. Since then it has been rising like a bride's biscuits and hit the 140's prior to a 3-to-l split.

The question here is one of timing. Unless you simply want to put your stock in the bottom of the box and forget it, you must do some figuring on when to commit your funds. In short, buying low can involve a long wait for the rise.

Price, as must be said again and again, is a reflection of value, and value derives from dollars earned. Much of the reason for price trends can be found in earnings records and—your second analytical step—the price-earnings ratio. This is arrived at by dividing the stock's price by the past year's per-share earnings. A stock priced at 60 on 1959 earnings of $5 a share has a 12-to-l price-earnings ratio, or is selling at 12 times earnings. At each quarter of 1960 it will be possible to project a somewhat more current, though less reliable, ratio by dividing price by estimated earnings. For past years, the ratio can be obtained by taking an average of the high and low prices and dividing.)

There is a popular free lecture you can get from any Wall Street optimist these days on the meaninglessness of p-e ratios. In the old days, even 10 years ago, "10 times" was par for the course, and conservatives began to look for reasons when stocks sold at 12 times earnings. Twenty times was the absolute limit. There was certain basic sense to this. On $5 earnings, 20 times means a market price of 100. The investor-for-income knew that he couldn't expect much more than a 50-per cent payout, or a dividend of $2.50, which means a yield of 2.5 per cent. Investors-for-income expect to do considerably better than that.

The capital-gains man is not concerned with dividends, although it is earnings and, consequently, dividends that must rise to justify a rise—and thus a capital gain—in market price. To put it another way, a capital gain is a profit realized on an anticipatory rise in a market price. But it must be an intermediate transaction, for unless there is a proportional rise in earnings and, thereby, dividends, a point will be reached beyond which no investor will anticipate, a point at which the price will, therefore, rise no more, and a point at which no more capital gains can be made* For a price to reach 20 times earnings, therefore, meant that many of the hopes of the future already were built into it. As little as five years ago, when yields of 6 per cent were not uncommon, a stock selling at 100 would be paying $6 in dividends, which infers at least $8 in earnings and very possibly $12. An in­crease in earnings from $5 to $8 or $12—up 160 to 240 per cent—is the work of several very fat, if not phenomenal, years. The assumption was, therefore, that at 100, or 20 times earnings, the stock was getting ahead of itself and was no longer a reasonable value.

Today, in 1960, IBM is selling at 53 times earnings and many, many sturdy, respectable stocks at above 20 times. There are several reasons for this, principally an unparalleled optimism about the Utopian future of our capitalist economy, and slightly apprehensive hedging against further inflation. As concerns what we are discussing here, however, it is evident that some adjustment of sights is necessary. Unfortunately, no one knows where to set them now. Twelve times earn­ings is, indeed, an unrealistic standard in today's market, but 30 and 35 are probably implausible as well, if the investor at these prices is going to have to wait interminably for earn­ings and returns to catch up.

With unexampled prosperity and inflated dollars, it is undoubtedly possible for corporations to boost earnings higher and faster than before; a jump from $5 to $8 could probably occur in a year. And to this extent, the arbitrary figures "12 times" or even "20 times" might well be thrown out the window. Even when people heeded them religiously, they were, like so many stock-market statistics, only ap­proximate reflections of processes or conditions. If process­es and conditions are to be fixed in new patterns, perhaps 30 or 35 or 47 will become the rubric. This is all right, as long as you know what the p-e ratio at this level means.

For however enchanting it is to keep one's eyes on the heights, it is also good to know that one is checked against a fall. In reverse, the situation can be truly shocking. If, for instance, the $5 earnings on which the price of 100 was predicated should shrink to $3, and the dividend to $1.50— and don't bet it's never happened—the market price would have to drop to 60—a sickening 40 points—to maintain the miserable 2.5 per cent return. Buoyed by general market optimism, the stock might slip only to 80, but at that point the yield would be a microscopic 1.9 per cent, small com­pensation for a $20 capital loss.

You can disregard price-earnings ratios if you wish, but never buy without knowing what they are.

The third factor is dividends. Even if you fancy yourself a capital-gains investor, know the dividend structure of any stock you buy. Dividends may be slow piling up, as has been suggested earlier, but essentially they are what all the shoot­ing is about, and there are few reputations for solidity better than those of the companies that have upped their dividends six, seven, and even 10 tunes in the past 10 years.

Yields (dividend per share divided by market price) are very low these days. Almost no leading stocks pay 5 per cent; most of them pay less than 3; some even less than 1. Traditionally, the growth stock, much of whose current earn­ings are plowed back and whose peak earnings are still ahead, has always yielded a return of around 2 or 3 per cent. High-quality investment stocks—bid up because they are high quality—often pay around 4. But many other sound stocks have yielded 5 and more until the fast climb of the past year or so.

Low yields are discouraging to the investor who seeks in­come. His best chance these days is to find a stock at what seems to be a reasonable price, and one he is content to ride with until its earnings catch up with its cost. If, while he is waiting for better dividends, the market price rises, he has a gain there, too. There is, frankly, little use searching for a big payer at current levels. Anything returning 6 or 7 per cent would have to be looked at with a hard eye, for, as usual, a statistic out of line with the prevailing market means a special situation that requires investigation. A high-yield stock today is very likely (though not inevitably) undervalued.

Dividends should also be considered in terms of the per­centage payout they represent. A 2-per cent return is some­what less disturbing if you know that it is only 50 per cent of earnings, rather than 80 or 90. At 50 per cent, potential dividend dollars are already being earned (unless fixed obliga­tions or senior securities are absorbing them), whereas on an 80-or 90-per cent payout, new dollars would very likely have to be earned before there could be much improvement in the dividend.

Fifty per cent is about the average cut. Growth companies needing development money will hold dividends to> 25 or 30 per cent, but anyone else who does so may well have some troubles and be attempting to conserve cash for a rough road ahead. You can count on this for sure if dividends are reduced or passed.

A fourth element is the profit-margin trend. You can calculate this by dividing net profits by sales volume. This is a measure of the company's efficiency. By establishing a ratio between dollars and profit earned, you can see how much the company has had to pay to manufacture, sell, and distribute its products—in other words, the expense involved in acquiring a dollar of sales. If production and sales costs are high, and the sales price is presumably competitive, then profit margins will have to be squeezed.

You can plot this over a period of years to see whether the company is increasing its efficiency, but usually it is calculated for the current or past year (depending on the statistics available) in relation to the performance of com­peting companies or the industry as a whole.

Texas Co., referred to earlier, had a net of $310 million in 1958 on sales—or revenues—of $2.32 billion. This, as we saw, worked out to something more than $.13 profit per dollar of sales. In comparison with half a dozen other big oil companies picked at random, this was a fine performance indeed. Standard Oil of New Jersey, Royal Dutch Petroleum, and Gulf Oil, all of which had higher earnings, had lower profit margins. Gulf's was almost $.12, Esso's a fraction over $.07, and Royal Dutch was $.06. Phillips Petroleum was nearly $.08, and Sinclair $.04. Standard Oil of California did less business than these others ($1.56 bil­lion), but its profit of $257 million meant a striking $.16 profit margin.

Finally, there are earnings prospects to consider. This fifth step means marshaling all you have discovered about the company in question and seeing whether it tells you something about the future. The statistical record of the past may suggest a steady upward trend in earnings. The dividend record may show steadiness as well, or, ideally, a consistent pattern of increases. The stock-price record is unlikely to be so stable. It will have ups and downs, but if the other factors are encouraging, the general price trend will reflect it. The price-earnings ratio is reasonable, we'll say. The profit-margin trend is good. Statistically, then, the momentum is onward and upward.

Now, what do you know about the company? Its debt is under control. As far as you can learn, its last big borrow­ings have been put to use, and increased production should result this year or next. In fact, you have read something somewhere—if you're a real bear-cat you'll have clipped and saved it—about the company being ready to plunge into a new product area. Advertising or merchandising news may have informed you about the product a little bit more. Pre-sale market tests are very encouraging. Fortune may have done a bio—and accompanying four-color portrait—of the company's new president; "Mr. Energy" they call him. Per­sonnel news may have announced some first-of-the-year vice presidential appointments. This is all very promising.

But let's be realistic. It's never all this clear-cut. Govern­ment economists are glooming about prospects for the in­dustry this year. Indexes are off 13 points, as compared to median figures over the last 17 years, with 1936 representing 100, whatever that means. Furthermore, with steel up $2 a ton and 27 craft unions making noise about a new four-year contract with fringe benefits, the whole production and earnings picture is clouded. You can go on and on: the competition is coming up with a different new product, also successfully pretested, which is going to beat the pants off Mr. Energy's; last year's earnings included $1.13 in non­recurring depreciation factors, and, of course, it was a con­solidated earnings report, anyway, which makes it difficult to say whether profits from raw-material sales to industry will compensate for losses when the new consumer product turns out to be a bad dream.

Hold tight. You aren't the only one confused by conflicting and contradictory information. It was ever thus. The past years, now so tidily summed up in a few figures, were also surging with confusion, shifts, competition, Government econ­omists, and men, now rusticating on the board of directors, who were once as young, vital, and promising as Mr. Energy.

You must remember first that you are dealing with symbols that are men's poor best efforts to state relationships, and that" there are no index numbers for momentum, on the one hand, and resilience and adaptability on the other. As time unravels, Energy and his vice presidents will brain-storm their way around the $2 increase in steel (perhaps aided by a smart suggestion from a foundry foreman). The labor contract will get settled without a work stoppage and on terms that, surprisingly, do not bankrupt the corporation. And there turns out to be room for both the new product and the competitor's. In fact, research—prompted by a field salesman's report that floated through channels to the v.p. for sales—has an even better notion for the new product next year, if engineering can figure a way to produce it without replacing every machine in the plant. (You haven't heard about this yet. This is part of next year's confusion that will begin appearing in brokers' letters in another few months.)

The combination of possibilities is endless, but everyone recognizes that. The point is to come as close as you can to probability. And, in time, as you become used to sifting and hefting the facts of business, a certain sense of better and worse, relevant and irrelevant, now and later, will be yours. On this basis, you select a stock to buy.