Front Matter

CFA Institute

Front MatterSource: Financial Analysts Journal, Vol. 35, No. 4 (Jul. - Aug., 1979), pp. 1-28Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478244 .

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FINANCIAL ANALYSTS

JOURNAL Editor / Jack L. Treynor Associate Editors FISCHER BLACK Sloan School of Management, M.I.T. Cambridge RICHARD A. BREALEY Graduate School of Business London GLENELG P. CATERER, C.F.A. New York JAMES F. COLE Guardian Capital Group Limited Toronto ROBERT I. CUMMIN Lloyd Investments, Inc. Philadelphia M. HARVEY EARP, C.F.A. Brittany Capital Corporation Dallas, Texas CHARLES D. ELLIS, C.F.A. Greenwich Research Associates Greenwich ROBERT FERGUSON College Ret. Equities Fund New York WILLIAM L. FOUSE, C.F.A. Wells Fargo Invst. Advisors San Francisco WALTER R. GOOD, C.F.A. Lionel D. Edie & Co. New York WILLIAM S. GRAY, C.F.A. Harris Trust and Savings Bank Chicago DAVID L. GROVE Int. Chamber of Commerce U.S. Council New York GODFREY G. HOWARD North Carolina National Bank Charlotte, N.C. IRVING KAHN, C.F.A. Kahn Brothers & Co. Inc. New York MARTIN L. LEIBOWITZ Salomon Brothers New York JAY 0. LIGHT Ford Foundation New York EDMUND A. MENNIS, C.F.A. Security Pacific Investment Managers, Inc. Los Angeles ANTHONY H. MEYER Drexel Burnham Lambert Inc. New York ROBERT D. MILNE, C.F.A. Boyd, Watterson & Co. Cleveland RUSSELL J. MORRISON, C.F.A. Investment Counsel Toronto STANLEY A. NABI, C.F.A. Lazard Freres & Co. New York GORDON PYE Irving Trust Company New York

FINANCIAL ANALYSTS

FEDERATI ON The Financial Analysts Federation, founded in 1947, is a non-profit professional organization consisting of 48 Financial Analysts Societies located in the major cities of the United States and Canada. These Societies have an aggregate of about 14,500 members who are engaged in security analysis, portfolio management, and executive direction of the investment function. The affiliated Institute of Chartered Financial Analysts awards the professional designation of "Chartered Financial Analyst" to qualified members upon successful completion of three examinations.

Officers: 1979-80 Chairman / Marion Van Dyke, C.F.A. President / Theodore R. Lilley, C.F.A. Vice Chairman / Erwin H. Will, Jr., C.F.A. Vice-President / Frank A. Cappiello, Jr.

Board of Directors: 1979-80 H. Kent Atkins, CF.A. / Bankers Trust Co., New York Dennis R. Bouwer, C.F.A. / Capital Research Co., Los Angeles J. Gary Burkhead, C.F.A. / Equitable Life Assurance Society

of the U.S., New York Frank A. Cappiello, Jr. / Monumental Capital Management, Inc., Baltimore John S. Chalsty / Donaldson, Lufkin & Jenrette Securities Corp., New York William A. Cornish, C.F.A. / Duff and Phelps, Inc., Chicago Edward B. Dillmann, C.F.A. / Harris Trust and Savings Bank, Chicago Dennis E. Evans, C. F.A. / First National Bank of Minneapolis, Twin Cities Benjamin C. Korschot, C.F.A. / Waddell & Reed, Inc., Kansas City Theodore R. Lilley, C.F.A. / The Financial Analysts Federation, New York Brian E. McManus, C.F.A. / Oppenheimer Asset Management

Corporation, Denver John D. McStay, C.F.A. / Mercantile National Bank at Dallas, Dallas Matthias Plum, Jr. / Massachusetts Financial Services Company, Boston Michael M. Ryan / Pemberton Securities Limited, Vancouver Marion Van Dyke, C.F.A. / Bell Canada Pension Fund, Montreal Ernest R. Widmann, C.F.A. / Widmann, Blee & Co., Inc., Philadelphia Erwin H. Will, Jr., C.F.A. / Capitoline Investment Services Inc., Richmond James L. Woods / American Republic Insurance Company, Des Moines

Staff

Secretary / Mildred M. Hermann Director, Education and Programs / Russell K. Mason

BERYL W. SPRINKEL, C.E.A. JolUg Staff Harris Trust and Savings Bank Production Manager / Irving Stachel Chicago ADOLPHE J. WARNER, C.F.A. Assistant Editor / Judith F. Kimball Salomon Brothers Advertising Coordinator / Rita Nederman New York FRANK T. WESTON Advertising Representative Rancho Santa Fe James R. Stack & Associates, Inc. California 50 East 42nd Street ARTHUR ZEIKEL New York, N.Y. 10017 / (212) 867-9690 Merrill Lynch Asset Management Ne ok ..107I(1)8799 New York James R. Stack / Marketing Manager

For Change of Address: Send old label and new address with Zip Code, six weeks before moving.

Headquarters Office: 219 East 42nd Street, New York, N.Y. 10017 / (212) 557-0055



Journal at a glance JULY/AUGUST 1979

THE FRENCH ECONOMIC MIRACLE Rolf E. Wubbels 23

French President Valery Giscard d'Estaing and Prime Minister Raymond Barre are showing the world that intelligent leadership is a country's most valuable asset. In contrast to 1977, when France suffered a trade deficit of over 10 billion francs, it had achieved a trade surplus for six consecutive months by the middle of 1978. Inflation, which began 1977 at an annual rate of 13 per cent, had receded to 9.5 per cent by the end of 1978, and the official forecast for 1979 is 7.9 per cent.

LONG-TERM OUTLOOK FOR THE STOCK MARKET William S. Gray, III 29 If U.S. corporations continue their great strides in adjusting to inflation, corporate profits could expand at an average rate of nine to 11 per cent during the next 10 years. Coupled with higher dividend payout ratios, this rate of growth could bring the Dow to 2400 by 1988 - and provide an average rate of return for the intervening 10 years of 17 per cent.

STOCKS, BONDS, BILLS AND INFLATION: UPDATES R. G. Ibbotson and R. A. Sinquefield 40 In this summary of a forthcoming update of their book Stocks, Bonds, Bills and Inflation, the authors present both annual index levels and rates of return for common stocks, long-term government bonds, long-term corporate bonds, Treasury bills and the Consumer Price Index. They also provide historical returns for the riskless real rate of interest, the equity risk premium, the bond default premium and the maturity premium between long-term government bonds and Treasury bills.

ANALYZING EFFECTIVE CORPORATE TAX RATES Clyde P. Stickney 45

ASR No. 149 requires companies to publish a reconciliation between reported income tax expense and an amount equal to the statutory federal tax rate of 48 per cent multiplied by income before taxes. Properly analyzed, the reconciliation data can reveal whether observed differences between firms' effective rates reflect real competitive advantages or mere differences in accounting and reporting.

A COUNTER EXAMPLE TO THE RANDOM WALK Edward M. Miller 55

Theoreticians have long argued that the transactions of speculators will eliminate any price inefficiencies, producing the well-known random walk. Under New York Stock Exchange rules, however, short sellers do not receive prompt use of the proceeds of the sale. This discourages them from transacting in cases where the expected return is more than zero but less than the competitive rate of return.

2 Ol FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1979



CHOOSING BETWEEN GROWTH AND YIELD Lee N. Price 57

Investment decisions between yield and growth stocks should be based, not merely on a stock's appreciation rate, but on the spread between the appreciation rate and the company's expected growth rate on the rate of change, in other words, in P/E multiple. Charts based on a 10-year holding period (the apparent average for individual investors) permit an investor to use his own assumptions about dividend growth and multiple risk under differing tax rates.

THE EFFECT OF COUPON ON YIELD SPREADS William H. Gross 68

Comparing the yields of bonds with different coupon rates on the basis of their historical spreads can be dangerous unless it takes into account changes in the general level of interest rates. When interest rates fall, for example, higher coupon bonds begin to trade on the basis of their yield to call, rather than their yield to maturity. The author describes an approach to yield comparisons that avoids the pitfalls.

THE CONCEPT OF EARNINGS QUALITY Leopold A. Bernstein and Joel G. Siegel 72

Earnings quality is affected by business, as well as accounting, decisions. A company can increase current reported income by deferring maintenance, advertising or development expenditures. Since such expenditures often represent the key to the company's future success or failure, their deferment degrades earnings quality.

PENSION FUND PERSPECTIVE Emily L. Meschter 10 SECURITIES LAW AND REGULATION John G. Gillis 12 ACCOUNTING FOR FINANCIAL ANALYSIS William C. Norby 16

Editor's Comment J.L.T. 4

Editorial Viewpoint J.L.T. 20

Letters 6

Book Reviews Robert 1. Cummin 79

Reprints of articles published in the Journal are available at a nominal cost. Payment must accompany orders of $10 or less. Address your requests to Reprint Dept., Financial Analysts Journal, 219 East 42nd Street, New York, N. Y. 10017 / (212) 557-0065.

FINANCIAL ANALYSTS JOURNAL / JULY-AUGUST 1979 Ol 3



We're growing bybeeso andr sounds.

XATe're United Telecom, and we operate (whirr,

click, click, beep) the United Telephone System. Aside from being the third largest telephone system in America, we're also one of the fastest growing.

But we're more than a telephone company-far more.

We also operate two other fast-growing telecommunications companies. One is United Computing Systems, a computer services company. From 1972 through 1978, our revenues from this computer service jumped from about $8.2 million to over $75 million.

And there's North Supply Company, which distributes the telecommunications products of more than 300 manufacturers. Since 1972 North, too, has grown rather spectacularly, we think-from $86.7 million in sales to more than $270 million.

All of which helps add up to our astonishing overall growth-from $650 million in total annual revenues in 1972 to over $1.4 billion today.

Whirr, click, click, beep. At United Telecom, these are the sweet sounds of success.

For our complete growth and earnings story, write for our latest annual report to: D.A. Forsythe, United Tele- communications, Inc., Box 11315, Kansas City, Missouri 64112. New York Stock Ex- change symbol: UT. News- paper listing: UniTel. An affirmative action employer.

United Teleo Eli? United Telecommunications, Inc.

More than a telephone company.

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Rockwuell is more than the builder of America's Space Shuttle.

Designedfor 55 separatefirings.

M such more. A

If you thnk of Rocwell Intr- sam aomut-nsryc pn, divie, steel (anstled, fsalum7:$15bionum national as acompany that akes applyin adace ecnlgytawdewe Ls mecanca dnevices, catings

engines, and for integration of the en- ofour balanced diversification. sengerfcars

tire ShufflOe systemyandseltrcte aoywi- las TheLiE t Rockwell-builthorbiteristheAerospTwell brakes. We're

fiscal 198 $1.4 bilion.)hlpso a tajrsuckpliver longrf

If7 you think of Rockwel11 Inter- is a major multi-industry company, drivelines, steel and styled aluminum |

national as a company that makes applying advanced technology to a wide wheels, mechanical devices, castings, spaceships, you have good reason. We range of products in aerospace, stainless steel wheel covers, reinforced are prime contractor to NASA for automotive, electronics and general in- plastic and other components for Space Shuttle orbiters and their main dustries. Following are some examples trucks, trailers, buses, vans and pas- engines, and for integration oftheen- c of ourbalanch eddiversification. |sengercars. tire Shuttle system and selected payloads. The Rockwell-built orbiter is the Aerospewe. 1wer Tripmaster t

worldns first reusablespaokwell cap and afeet operator manaagce t into space and back. It will launch like Iment extends well beyond the 1i ld illlllllll lliVlI a roc ket, h aulI l ike a tru ck, wo rk l ike a |S pa ce S h uttl e. O ur roc ket IiiZ1 LI2;\llllllil ul ltllil

space station,thenreturnrtooEartheand re d haircrAveft. And ue

Butaerospe1978 ionatpar fhe pro itoras, atdeosmir andb er Itis oin ct

Rockwell story. Rockwell International of U.S. military aircraft. well is creating products that can help



I_EMost of Am erica's major daily e They c i aot" one operating efficiency. Some of our com- newspapers are printed on Rockwell- percent of America's total scientific- ponents that can help cut a trucker's Goss presses. We also make textile engineering community. This fuel consumption and increase equipment, industrial sewing machines, technological base positions us for payloads include a new power tools, water and gas meters and leadership in each of our product aluminum front axle other products for utilities, areas. It also makes our corporate beam, Taper-Leaf?X)A In addition, our extensive tech- slogan,"..,. where science gets down springs and ,7 nology is being applied to the to business,' a fact.

brakes. Our { ~ ;X alternate sources of ener-| Buiessgod weight-saving . \gy. We're involved in | \Rockwell products for projects for nuclear International's total cars Include re- 4 8\energy, coal gas- I &Nsales for 1978 were inforced plastic )1g\ification, flue gas | d1977: $5.67 billion. components and desulfuriza- 4.18 Fiscal 1978 wasMthe

wheels. quarter-million-bit solar, wind $399M in Rockwell's history. bubblememorydevtce

< D ~~~and geo- 1 979: Net income, up 23%

Eleetronis,e thermal $s .rg over fiscal 1977, intrm o sWe also generating a record

We're one of the world's leading manufacture $5.02 per share. suppliers of avionics communica- the first company valves -plug,

t n a a ightontrolvequip-ein theworldtoproducea pipeline ball, Earningsperbshare

tions naviationand lighticonto equip 260-btmmorenry- for1,3 0sietA

|ment for air transport, general aviation commercial applicatiots, gate, globe and government aircraft. We also make angle and microelectronic systems and devices check valves for America's For more of the and guidance and control systems. And power needs. Our Flow Control Rockwell story, please write us: we manufacture and install telecom- Division is one of the world's leading Rockwell International, munications systems for businesses suppliers of high-technology valving Dept. 815E, 600 Grant Street, and governments worldwide. for U.S. and international energy Pittsburgh, PA 15219.

One of Rockwell's latest elec- markets. Rockwell valves are used in tronic achievements is the production oil and gas production, transmission of bubble domain memories. We devel- and processing; natural gas _I_ oped and market a device measuring distribution pipelines; coal slurry m i Rockwell about two-fifths of an inch square that pipelines; synthetic fuel processing Vads i tern tion an store up to 256,000 bits of infor- plants; electric power plants; I n er ora

mation. It has no moving parts and re- shipboard power plants; and in many ta in s its data without use of power. other energy-related markets. ...wherescience gets d owntobusiness



Inflalion: 8% Grace: 17%

The 1978 figures are in.

And at W. R. Grace & Co., we've stayed more than one step ahead of inflation with a 17% increase in net income for the year.

Earnings per common share were up 17% as well. Dividends on common stock rose. And sales for the year were over $4.3 billion-the highest in our 124-year history.

It takes balanced diversity and an aggressive business posture to achieve results like these. And we think Grace has both.

Our specialty chemical operations, including packaging materials, petroleum and automotive catalysts, and construction products, showed a 16% increase in operating income after taxes*

Our natural resources group, with interests in coal, natural gas, oil,and

oil field services, showed a 16% increase on the same basis.

And in the consumer area, after-tax operating income was up 19%- despite the high costs associated with a 30% increase in the number of specialty retailing and restaurant units.

Our long term picture is equally impressive. Since 1968, Grace's net income has grown by an average annual rate of 16%. And we see no reason why the trend shouldn't continue.

Our annual report can tell you more. Send for it by writing to W. R.Grace & Co., Grace Plaza, 1 1 14 Avenue of the Americas, New York, N.Y 10036, Dept. FAJ-6.

*Computed before gains or losses on disposal of businesses, foreign currency translation related to FAS No. 8 and allocation of general corporate overhead and general corporate interest.

One step ahead of a changing world.GRApw

chemicals * natural resources * consumer products

W R.Grace & Co., 114 Avenue of the Americas, New York, N.Y. 10036



V| >?\(C \a\CX *. i0 -

*As published in BUSINESS WEEK, April 23. 1979 All tigures. except those tar Manutacturers Bank, supplied by Standard & Poor s Gompustat Services Inc

135 East Ninth Street, Los Angeles, CA 90015-213/628-0311. Offices in Downtown Los IViA NUFl1 A COT URDE RS Angeles, Hollywood, Beverly Hills, Encino, Sherman Oaks, Granada Hills, Van Nuys, Il|Un nn and Newport Beach. Member FDIC. We are traded over the counter. NASDAO symbol l n ot j ust a noth er ban k MBLA. Write or phone Alex Alt, Vice President, for 1978 annual report.



Energy growth 3 boosts fully diluted earnings to record $4.30. Tenneco's success in oil and natural gas played a major role Fully Diluted Earnings Per Share in moving 1978 fully diluted earnings per share to $4.30, topping five years of steady growth from $2.43 in 1973. At the same time, primary earnings -.

per share were increasing to -

$4.53 on 96 million average | shares outstanding, up from $2.79 on 73 million shares. ,

Other record highs were Lf- 1974 -.- ,;

set in 1978 as well. Net sales and operating revenues reached -_ $8.8 billion, up 116% from $4.1 "-_ billion in 1973. Net income rose 94% to $466 million from $240 million five years earlier.

During that same 5-year period, capital expenditures increased 151 % to $1 billion and total assets climbed 81 % to $10.1 billion. In its 35th year, Tenneco is the youngest company in the nation's top 25 industrial corporations.

Tenneco's emphasis on energy has increased earnings from our oil and natural gas foreseeable future. That's Tenneco today: a businesses by more than 172% We will also continue to growing energy company with since 1973; today energy gen- strongly support our diversified other profitable diversified erates two-thirds of the Com- non-energy businesses-con- businesses, well positioned for pany's income. Because the struction and farm equipment, future growth. need and the opportunity are so automotive components, For further information, great in this field, we will con- chemicals, agriculture and land write Tenneco Inc., Section Y-2, tinue to invest most of our management, packaging, ship- RO. Box 2511, Houston, TX resources in energy for the building and insurance. 77001.

TENNECO OIL O TENNESSEE GAS TRANSMISSION O J I CASE O TENNECO AUTOMOTIVE 0O TENNECO CHEMICALS O3 NEWPORT NEWS SHIPBUILDING O3 PACKAGING CORP OF AMERICA O3TENNECO WEST

enneco



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