Discounts and the Use of Company Assets

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Perhaps oddly, general "feelings" surrounding the stock market, such as optimism and pessimism, tend to have a mensurable effect on the value of stocks. Also, major world events, such as a war or a national tragedy, tend to effect stocks to a large degree.

Investors are willing to pay more than the net asset or liquidating value on the grounds that, if the stock market advances substantially, the common stock will acquire a value through the operation of the leverage principle. As an illustration, consider the common stock of Tri-Continental Corporation. This stock had an asset value of seven cents per share at the end of 1941; yet during the year the price of the stock was never less than 62.5 cents and it sold as high as $2 per share. On the other hand, at the end of 1950, the asset value amounted to $17.08 per share, but at that time the stock sold for $10,875 per share.

A general peculiarity is that, in the past, the discount at which closed-end-company shares sold has generally been larger at low levels of the stock market. The discount tended to shrink as stock prices rose and greater optimism prevailed. This seems inconsistent. But the market often is inconsistent. Actually, other things being equal, the risk in the stock of an investment company with a diversified portfolio would be less when stock prices were depressed than after a substantial advance had occurred.

In several years past, a few closed-end investment company stocks (other than those with little or no asset value) have been selling at a premium or close to net asset value. Among these are stocks of investment companies, which have had a conspicuously favorable record. The discount generally has tended to narrow in the last decade.

The tendency of closed-end investment company shares to sell at some discount may be interpreted in a number of ways. Since security prices reflect investor choices, a substantial discount (more than 10 percent) as much as says that the investor prefers other securities. The importance of the redemption feature is indicated by the fact that investors buy large amounts of open-end-company shares at a fairly substantial premium.

Careful investors know, too, that attractive though a 15 to 20 percent discount may be, they have no assurance that the discount may not be even larger within six months or a year, and this although the underlying net asset value has not changed. Finally, after the original offering has been made, less effort is put into selling closed-end shares than into selling open-end shares.

When the stock of an investment company is permitted to sell at a discount of 25 percent and more and the common stock is the sole capitalization (complex problems arise if there are senior securities), there is good reason for repurchasing stock in the open market or asking for tenders. This practice would lead to the elimination of the discount or would reduce it to nominal proportions. It is hard to envision a more desirable or advantageous use of a company's assets.

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