Railroad bonds cover a wide range of income return. They yield all the way from 3¾ per cent to 9 per cent, the general average being from 4 per cent to 6 per cent. As a class they yield more than government or municipal bonds, and less than public-utility or industrial bonds. With equal security they probably yield less than real-estate mortgages. Compared with stocks they return more than bank stocks, average about the same as railroad stocks, and yield less than public-utility, industrial, or mining stocks. These comparisons are intended to apply to the classes as a whole, and remain generally true in spite of specific cases to the contrary.
Convertibility is the distinguishing mark of railroad bonds. Generally speaking they may be more easily marketed than any other class of bonds. Compared with stocks they exceed public-utility, mining, and bank stocks in point of convertibility, and yield only to railroad stocks. It is hard to say whether or not they possess greater convertibility than industrial stocks, but it is probable that they do, allowing for the fact that an undue impression is created by the activity of certain prominent shares.
Railroad bonds as a class possess great promise of appreciation in value. American railroads, generally speaking, have adopted the conservative policy of putting a considerable part of their annual earnings back into the property in the form of improvements. To the extent to which this policy is followed, an equity is created back of the bonds which raises their intrinsic value. This policy contrasts favorably with the general practise of English roads to pay out all their earnings in dividends, and to capitalize their improvements. In addition, new capital for American railroads is largely raised by stock issues, which further increases the margin of security for the bondholders. Taken together these facts insure a steady enhancement in the intrinsic value of railroad bonds, which is bound to be reflected, other things being equal, in higher prices.
We shall not attempt to discuss at this time the degree of stability of market price which railroad bonds enjoy. As explained in the first chapter, stability of market price is dependent upon general financial and business conditions. It is sufficient to point out here that the maintenance intact of the principal sum invested can only be rendered certain by the purchase of short-time securities whose near approach to maturity will keep their price close to par. In a later chapter the general principles which determine this question will be elucidated.
The ideal investment may be defined as one combining ample security of principal and interest, a good rate of income, ready convertibility into cash, and reasonable promise of appreciation in value. Measured by the requirements of this definition, the conclusion seems justified that well-selected railroad bonds, if purchased under favorable money-market conditions, afford a highly desirable form of investment.
III
RAILROAD EQUIPMENT BONDS
As its name implies, an equipment bond is one issued by a railroad to provide funds with which to pay for new rolling stock—cars and locomotives. The issues are variously described as car trust certificates, equipment bonds, or equipment notes. They conform in general to one of two standard forms: (1) The conditional sale plan: In accordance with specifications furnished by the railroad, the trustee selected (usually a trust company) contracts with the builders for the purchase of the equipment. From 10 to 20 per cent of the cost of the equipment is paid in cash by the railroad and the rest is represented by the equipment bonds. The bonds are the direct obligation of the railroad company. They are secured by a first lien upon the entire equipment purchased. The title to the equipment remains in the trustee for the benefit of the bondholders until the last bond has been paid, so that under no circumstances can the general mortgages of the railroad attach as a first lien on the equipment ahead of the car trust obligations. After the final payment, the trustee assigns title to the railroad company, which thereupon becomes the owner in fee of the equipment. Under the terms of the deed of trust the railroad is always obliged to keep the equipment fully insured, in good order and complete repair, and to replace any equipment which may become worn out, lost, or destroyed. The bonds are usually issued in coupon form, $1,000 each, bearing semiannual interest, with provision for registration. They are generally paid off in semiannual or annual instalments of substantially equal amounts, the last instalment usually falling due in ten years, a period well within the life of the equipment as estimated under the master car builder's rules. Occasionally this method of payment is altered by the substitution of a sinking fund, the bonds having a uniform fixt maturity, but subject to the operation of a sinking fund which is sufficient to retire the entire issue well within the life of the equipment. In either case the security, ample at the outset, increases proportionally with the reduction in obligations outstanding against it.