Chapter III: Part II (3)

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The purchasers of privileges are sometimes perplexed by market changes which are brought about by dividend payments. The rule is that the dividend always goes with the stock. The simplest way to arrive at correct figures is, to mentally lower the price of either the “put” or “call,” by the exact amount of the dividend payment. Thus, if B holds a “call” on Steel at 43 and a dividend of 2% is paid on the stock during the life of his option, his “call” becomes operative at 41 as the dividend goes to him. If he holds a “put” at 37, and 2% dividend is paid on the stock, his “put” is not operative until 35 is reached, as the dividend goes to the maker of the “put.”

Privileges in grain or other commodities are based on the same general rules and principles as those on stocks. These privileges are heavily dealt in on wheat and corn in Chicago. They are designated, however, as “ups” and “downs” in order to evade local laws prohibiting transactions in “puts and calls.” The “ups” are calls; the “downs” are puts. Most of the grain privileges handled in Chicago, or based on Chicago prices, are of a day to day character, insuring only for the next day’s price changes. The ordinary charge is $1 per thousand bushels. For $1, therefore, the small gambler, or speculator, may purchase, say a call on 1,000 bushels of wheat at 90½ when the last price recorded was 90. If wheat reaches 91½ during the next day’s session, he has a gain of $10 less the cost of the “call” and brokerage.

The small capital required for this form of trading, the fact that loss is limited to the original cost of the privilege, and the great possibilities in case of extreme movements, make “puts and calls” very popular. It may be said, however, that they are, as a rule, poor property. The writer kept account of the transactions in “puts and calls” handled through a large concern for almost two years and found that only about 35% of the money paid for these privileges returned to the purchasers. That is to say, the profit shown to purchasers of “puts,” “calls,” and “straddles,” was only about $350 out of each $1,000 received by the sellers. After deducting the item of commission charges, it was found that the sellers of privileges reaped over 50% profit each year. The experiment referred to was based on grain privileges, but would probably hold good in stocks. The _sellers_ of these “puts and calls” are among the brightest men in the street, and when they make prices they do so on the absolute basis that they have the best of the bargain and the buyers are usually a public element. In the test referred to, there were never three consecutive days when either “puts” or “calls” were good. There was on one occasion in the period consulted, an advance of over 20 cents a bushel in wheat in three days, but “calls” were good only on the first day of the advance. On this occasion the “calls” were good for about 2 cents per bushel on the first day’s rise, but the sellers offered nothing for the second day, except at prices far above the market, and although the market advanced 6 cents per bushel, wheat was not “called.” On the third day, prices for “calls” were prohibitive, ranging from ten to twenty cents above the closing price and again wheat was not called, although the market advanced 8½ cents.

In the accounts examined, one seller of privileges on wheat had an open order to sell 100 puts and 100 calls every day at the ruling price. He thus received $200 daily and invariably “took his loss” whenever the privileges operated against him. That is to say, if wheat closed one cent per bushel above the call price, he would be called for 100,000 bushels on his privileges, making him short that amount of wheat. This he bought in at once and pocketed a loss of $1,000 less the $200 received. Although he accepted some severe losses now and then, his account showed over $30,000 profit on a year’s business.

Another account was operated on a different principle by the seller of privileges and resulted in even larger profits. This individual would sell ten “puts” and ten “calls” on wheat each day. In the event of his being called, i.e., short of the wheat, he would, on the next day sell no “calls,” but 20 “puts.” In the event of a decline below the “put” price, he had enough short wheat to protect ten of his “puts” and in reality automatically close out his ten thousand short, frequently at a profit. As has been stated, his profits were greater than in the first instance quoted. There was, of course, a more highly speculative element in his form of operating than in the other method, but the operator was never either long or short more than 10,000 bushels, and received about $6,000 a year or 60 cents per bushel from his privileges, in addition to the accruing of profit or the curtailing of loss by his mechanical method.

In the accounts examined the persistent purchasers of privileges all finally lost money, except in a few cases where lines acquired on “puts or calls” were carried to a successful conclusion in the course of time. That is, a purchaser of “calls,” finding a profit in his privilege, would call the wheat and _keep_ it. This, however, resolved the matter into pure speculation, as the maximum benefits derived from this form of trading can only be correctly measured by the profit shown at the expiration of the “put” or “call.” That is to say, the seller need suffer no greater loss than that shown when the contract he has given matures, and consequently the profit to the buyer cannot be greater except through speculation.

It would appear from these facts, that the purchasing of privileges is a poor business proposition, while the selling of privileges is a money making affair. This is true. We need only compare the kind of men who _buy_ “puts and calls” and those who sell them to have this truth made apparent. The late Russell Sage was a persistent writer of these instruments and made a great deal of money by the process. The late Edward Partridge also made a good deal of money in this manner in the Chicago Wheat Market. He also used privileges to aid his manipulative campaigns. On several occasions, he sold “calls” heavily through the day, then suddenly bid wheat up just at the close of the market, effecting a closing just above the call price. The scattered purchasers would call the wheat and put Mr. Partridge short several millions at a high price, which was just what he wanted. He could not have sold as much wheat in the open market without breaking the price several cents. On the same principle, he used sometimes to sell a great many “puts” when he wished to cover a line of short wheat and rush the price downward at the close, thus enabling him to purchase a great line without disturbing the market by bidding for it. The process only worked a few times, however. As soon as it was discovered it failed, as the call price, when reached, met with such a wave of selling that it was impossible to break through it, and the manipulator was “hoist with his own petard.”

There is another drawback to the habit of buying privileges--a mental one. They are frequently made the basis of positive trading with disastrous results. The man who believes in an advance in certain shares or commodities, frequently purchases privileges instead of following out his own convictions by actual trading. Thus the man who had good reasons for expecting an advance in wheat at the time of the 20 cent advance mentioned above, and who used either “puts” or “calls” or both, as a means of operating on his opinions, would have reaped less than two cents a bushel during an advance of twenty cents. He might, of course, have called the wheat on the first day of the advance and remained long, but in that case he would merely have been speculating with equal chance of loss or profit in ensuing transactions. Aside from the initial two cent gain, he would have been in no different position than if he had purchased and held the cereal on margin.

It is the writer’s opinion, founded on the experience set forth above, that it is much better to effect transactions in the ordinary manner, than to depend on privileges. If “puts and calls” are dealt in at all, they should be sold, not purchased. The insurance companies make more money than is paid out in losses; so do the sellers of privileges. It may be well to add, however, that the man who runs an insurance company is in danger if he does not understand his business and his risks, or if he enters the field without sufficient capital to provide for possible initial losses. All this applies to the seller of privileges.

VII

The Question of Dividends

It is a certainty that the short seller of dividend-paying stocks suffers a drawback from dividends, except in the rare cases where interest is allowed on short stocks. If we sell short a 6% stock at par and at the end of a year find the stock still selling at par, we have lost 6% without adverse market action. This onus cannot be escaped by short-time commitments; it is merely a matter of degree. The chronic short seller is swimming constantly against the current.

There is one point about dividends which is widely misunderstood by ordinary traders. It appears impossible to make a great many individuals understand that short sales may be as intelligently made the day before a stock sells “ex-dividend” as at any other time. Even when good reasons for a decline exist, traders fight shy of “swallowing the dividend,” or retire commitments just before dividend payment for no other reason than that such distribution is to be made, which is, in fact, no reason at all.

The disadvantage to the seller of stocks through the earning capacity or increment is the same on the day or the week preceding a disbursement as at any other time. The earnings of the company are a steady day to day affair, and are, as they accrue, constantly considered in the price of the stock. In other words, the prices of listed shares are at all times “flat.” At a point midway between two dividend days, the stock reflects in its current price half the amount of the undistributed dividend, or other increment. For example, if a certain stock sells normally at par and pays 6% per annum (3 per cent. in January and 3 per cent. in July) the price of the stock in March, eliminating speculative influences, would be 101½ and in July 103. When on July 1st, the 3 per cent. is distributed, the amount is simply taken away from the company and from the price of the stock also. It now returns to its normal price, 100, and whether it will go up or down from that point is a question for speculation. The factor which made the price 103 has been eliminated and it remains for the corporation in question to again earn 3% available for distribution before the next dividend day.

Perhaps this point may be made clearer by assuming that a certain stock is not handled on the “flat” basis, but is dealt in “and interest” after the method sometimes employed in bond transactions. Let us again eliminate speculation and take for example a stock selling at 100 and paying 6%. Assuming that a dividend had been paid on this stock on January 1st, the purchaser of the stock on February 1st would pay 100 for his shares, and would also pay to the seller the accrued dividend for one month, or ½ of 1% which is exactly the same proposition as if the stock had been quoted flat on the Stock Exchange at 100½. On March 1st, the purchaser would pay 100 for his shares and 1% accrued dividend or 101, etc.

It appears, therefore, that the widespread idea that it is dangerous to sell a stock just before a dividend day is not sound. In fact, the whole matter may be dismissed by saying that if there was any good or logical reason for expecting a premature recovery of the price of dividend-paying shares, or an advance founded on any reason in connection with dividends other than the gradual accumulation from one date of disbursement to the next, the whole problem of making profits in Wall Street would be solved. The rule must necessarily work both ways, and if it is dangerous to sell at certain periods, it must be, in inverse ratio, safe to purchase. All we would need to do therefore, would be to await the dates on which shares sold “ex-dividend” and make purchases. Here then, is exploited a patent way of getting the best of the market without study or effort. In truth, there is nothing whatever in the theory any more than there would be in buying Government bonds for a rise just after the interest had been paid on them. If good reasons exist for sales, they may be made as confidently at one time as another. The disadvantage of being short of dividend-paying stocks is always present, and it cannot be escaped, but the operation is a day to day affair not a matter of certain dates.

_Basing Railroad Values._

“The problem of railway valuation is comparatively
simple, and beyond the reach of but few. A railway is
primarily a carrier, a carter, a drayman. Obviously
then, in considering an investment, we shall ask,
What sort of a road has it? What sort of vans, and
what sort of horses? What sort of trade? A teamster
doing business on a fine level macadamized road, with
big, heavy vans, and heavy draft horse, can work at
a profit and underbid a carrier with old vans and
poor horses, working on roads of heavy grade. So,
for example, a railroad, other things being equal,
with a water grade like the New York Central, has a
tremendous advantage over an up and down grade like
that of the Erie. The Illinois Central can do
business much more cheaply than the Missouri Pacific.
A road with a magnificent equipment like the Lake
Shore can undercut a poorly equipped road like the
Nickel Plate.

“The initial facts that we wish to know of a railway
then are, What sort of a road has it, what is its
traffic, does it get good rates? When we know what
business it does, what its earnings are, then we
shall ask, how is it capitalized, what are the fixed
charges these earnings have to bear, what is there
left, and what is the amount of stock which has to
share the surplus? We shall ask if its earnings are
stable, if the maintenance is adequate, if the policy
of the road is conservative, if its management is
good or bad. When we have done all this, then we
shall go into the market, ask the prevalent rate
of money, and by a simple rule of thumb, we shall
know, in a broad way, whether the stock is cheap or
dear.”--From “American Railways as Investments,” by
Carl Snyder.

_The Effects of Business Depression on Rails and Industrials._

“There is apparently a popular belief that the general market always moves together in a considerable swing, and that any advance in one set of stocks would be accompanied by a corresponding advance in others. So far as the general tone of a day’s market is concerned this is true; but, nevertheless, individual stocks or groups of stocks can easily and gradually change their selling basis in a brief period of time. In 1901, for example, the industrial stocks reached their high levels, and suffered a considerable decline in 1902. Meanwhile the rails were advancing. To illustrate and confirm this statement the highest prices of both Rails and Industrials in July, 1901, and July, 1902, are set forth in the following tables. There can be no unfairness in choosing this particular period. What is to be demonstrated is that it is possible for the groups to cross each other in price in a given time. The ten most active stocks have been chosen in each group as fairly representative of the entire market:

RAILROAD STOCKS.

High in High in
Stock July, 1901 July, 1902
Atchison 89⅜ 95¾
B. & O. 108¾ 112⅛
Can. Pac. 108¼ 139¾
St. Paul 177¼ 189⅜
Erie 43⅝ 39½
L. & N. 111 145⅞
Mo. Pac. 121⅞ 119½
Penna 151¾ 161¾
Reading 47 69⅞
Union Pacific 110⅞ 110⅝
------- -------
Average price 102.97 118.41

INDUSTRIAL STOCKS.

High in High in
Stock July, 1901 July, 1902
Amalgamated 124¼ 68¾
American Smelting 58 47½
American Sugar 145⅝ 134½
Anaconda 48⅞ 27
Col. Fuel & Iron. 116⅛ 102¼
National Lead 23 22¼
Tenn. Coal & Iron 72½ 69½
Rubber 21¼ 17
U. S. Steel 48⅞ 41
U. S. Steel, Pfd. 99½ 92⅛
------- -------
Average price 75.80 62.18

“These tables show that during the fiscal year used, railroad stocks advanced an average of over 15 points, while industrials declined almost 14 points. In other words, the spread was 29 points. The man who bought rails and sold industrials would have made on the average 29 points. This exhibit entirely overthrows any argument that the market moves one way or the other homogeneously.

“There was a reason for the spread illustrated above. There always is a reason. We had big crops in 1902, which helped the railroads. The industrials, on the other hand, were busily discounting the business depression of 1903.

“Precedent shows that in a period of general depression Industrial stocks suffer about 33% more than rails. That is to say, in the high and low prices covering a long period, industrial securities should show a distinctly greater pro-rata of decline. Let me illustrate, using the stocks employed in the former table and covering the period of our last great cycle, 1901-02-03. As most of the high prices in rails were made in 1902, the highest prices of both 1901 and 1902 will be used, and the lowest of 1903:

RAILROAD STOCKS

High in Low in
1901-1902 1903
Atchison 96⅝ 54
B. & O. 118½ 71⅝
Can. Pac. 145¼ 115⅝
St. Paul 198¾ 133¼
Erie 45½ 23
L. & N. 159½ 95
Mo. Pac. 125½ 85¾
Penna 170 110¾
Reading 78½ 37½
Union Pac. 133 65¾
------- -------
Average price 127.11 79.22

INDUSTRIAL STOCKS.

High in Low in
1901-1902 1903
Amalgamated 130 33⅝
Am. Smelter 69 36¾
Am. Sugar 153 107⅛
Anaconda 54¼ 25½
Col. F. & I. 136½ 24
Nat’l Lead 32 10½
Tenn. Coal & I. 76⅝ 25⅞
U. S. Rubber 34 7
U. S. Steel 55 10
U. S. Steel, Pfd. 101⅞ 49¾
------- -------
Average price 84.22 33.01

“It will be observed from the above table that Industrials declined about 51 points while rails declined about 48 points. But the decline cannot be figured in points. The higher range of railroad shares must be considered. A decline of two points in a stock selling at 100 is only equivalent to a decline of one point in a stock selling at 50. Therefore, in order to get a correct view of the matter, we must reduce the decline to percentages. On this basis, railroad stocks lost about 38% of their value, and industrial stocks lost about 60% of their value.”--From Thomas Gibson’s Market Letter, May 4th, 1907.

_Undigested Securities._

“The new methods and the new projects are going through the test of fire today, and some of them are being consumed. The tests which weeded out the badly organized and incompetent of the early stock companies, which drove to the wall the “wildcat” banks of ante-bellum days, and which wiped out dividends and stock rights in badly managed railways, are now being applied to the new forms of organization which have been the growth of the past decade. But the stronger and better organized of these new corporations are likely to meet these trials without disaster, or to modify their methods to conform to the teachings of experience, until there remains to the financial world a valuable residuum of new methods for giving flexibility to capital and promoting its transfer promptly and efficiently from the industries where it is not needed to those where it will render its highest service.”--From “Wall Street and the Country,” by Chas. A. Conant.

_How to Compute the Value of Rights._

“Inasmuch as the method of computing the value of rights is slightly complicated, an illustration may be given. Let us take the instance of St. Paul again, where the stockholders were allowed to subscribe to 23% of their holdings to new stock at par. The common stock was at that time selling a little below $200 per share. Let us take the round figure, and the operation is as follows:

One hundred shares at $200 per share equals $20,000
Twenty-three shares at $100 equals 2,300
-------
Total cost of 123 shares $22,300

“Average cost, $181 per share.

“Deducting $181 from the market quotation leaves $19, the value of the rights on each share of St. Paul stock. As a matter of fact, the selling price was a little below $200, and the highest price of the rights fell a little below $19 per share.

“In other words the process is simply to take the number of new shares per hundred shares of the original holding to be subscribed for, and add the value of these new shares at the subscription price to the cost of one hundred shares at the market price; then divide the total cost of both old and new shares by the total number of shares, and deduct the average price from the market quotations. This gives the selling value of the rights.”--From “American Railways as Investments,” by Carl Snyder.

_Barometer of Averages._

“In order to facilitate the examination of properties and their comparative condition, the following table has been prepared. The figures were arrived at by averaging the operating expenses, fixed charges, margin of safety, and dividends of principal properties for the last fiscal year. The stock prices are based upon the closing figures of June 6, 1907. The margin of safety shown, is the margin over common dividends. Results were as follows:

Average operating expenses 69.01%
Average fixed charges 54.70%
Average margin of safety 5.28%
Average dividend common 6.03%
Average price of stock 1.09⅝

“As in all computations of this kind the figures are comparative and not basic. The fact that one stock is in a much better position than others does not necessarily mark that stock as a purchase, for _all_stocks may be too high, and underlying conditions may not warrant purchases in any quarter. Again, we must always consider the fact that important elements which cannot be tabulated in figures may be present. However, the table possesses value as a rough barometer, and after it has been broadly applied, specific influences may be given due consideration. If, for example, we find a common stock selling well below 109⅝, with operating expenses below 69.01; fixed charges below 54.70; margin of safety above 5.28 and the dividend rate above 6%, we have a remarkable combination of facts favoring the shares and investigation will be stimulated. The figures vary widely at times in different corporations and cannot always be considered either bullish or bearish, as the good or bad features may be already discounted in the current price of the shares. It may also be found that one property is going backward gradually while another is improving its position.--From Thomas Gibson’s Market Letter, June 8th, 1907.

_The Best Method of Trading._

“It may appear that if the market is to sway back and forth, sales on advances, and purchases on declines would offer the maximum of opportunity to the shrewd trader. But not so. To illustrate this, a market movement from high to low prices as shown by a chart is presented on the following page.

“As simple as this illustration may appear, it is
worthy of most earnest consideration. True, the
upward and downward movements show opportunities
on both sides, but if the _purchaser_ makes a
mistake, as all speculators will, he is hopelessly
involved. If he buys at the wrong point he will
never see daylight during the progress of the
movement. Look at the other side of the matter.
The _seller_ cannot make a mistake. No matter
at what point he sells a profit lies before him. A
little reflection will show what a tremendous
difference exists here.”--From Thomas Gibson’s Market
Letter, Feb. 2nd, 1907.

_Indications of Crises._

“Preceding Indications.--This preceding period is characterized by well-defined indications, some of which develop contemporaneously, but which, so far as they are distinct in time, occur in approximately the following order:

“1--An increase in prices, first, of special
commodities, then, in a less degree, of commodities
generally, and later of real estate, both improved
and unimproved.

“2--Increased activity of established enterprises,
and the formation of many new ones, especially those
which provide for increased production or improved
methods, such as factories and furnaces, railways
and ships, all requiring the change of circulating to
fixed capital.

“3--An active demand for loans at slightly higher
rates of interest.

“4--The general employment of labor at increasing or
well-sustained wages.

“5--Increasing extravagance in private and public
expenditure.

“6--The development of a mania for speculation,
attended by dishonest methods in business and the
gullibility of many investors.

“7--Lastly, a great expansion of discounts and loans,
and a resulting rise in the rate of interest; also
a material increase in wages, attended by frequent
strikes and by difficulty in obtaining a sufficient
number of laborers to meet the demand.”--From “Crises
and Depression,” by Theodore Burton.

_The Ordinary Swing of Prices During a Cycle of Speculation._

_The Factor of Safety._

“There remains but one point to which, in view of the conditions roughly sketched above, the writer would call especial attention. That is, that the investor should look well, always, to the factor of safety. Before he puts his money into any road, no matter if it be on the recommendation of the greatest banker in the United States, let him consider how far that company is prepared to weather a storm. Few roads ever prospered under receivership, no matter how honest or how able. The receivership itself is a handicap. No matter how high the yield, no investor whose primary regard should be the safety of his money will put it into a road whose fixed charges, after ample charges for maintenance, consume much more than 50% of the total net income available for interest, dividends and improvements--that is, save in exceptional cases like the New York Central--and until he has satisfied himself thoroughly that the property is sound.

“For the convenience of those not well acquainted, the following list of the principal roads is given, with the percentage of total net income consumed by fixed charges in the highly prosperous fiscal year of 1905:

TABLE OF FIXED CHARGES.

Atch., Top. & S. Fe 42% Chi. & East. Illinois 68%
Atlantic Coast Line 57% Chi. & N’western 39%
Baltimore & Ohio 39% Chi., Bur. & Quincy 45%
Boston & Maine 78% Chicago Gt. Western 67%
Canadian Pacific 33% Chi., Mil. & St. Paul 32%
Central of Georgia 47% C., St. P., M. & O. 42%
Cen. R. R. of N. J. 50% C., C., C. & St. Louis 69%
Chesapeake & Ohio 53% Col. & Southern 55%
Chicago & Alton 73% Delaware & Hudson 40%
Del., Lack. & West 38% N. Y., Chi. & St. L. 41%
Denver & Rio Grande 52% N. Y., N. H. & H. 48%
Det., Tol. & Ironton 87% N. Y., O. & Western 53%
Du., S. S. & Atlantic 115% Norfolk & Western 37%
Erie 66% Northern Central 28%
Gr. Rap. & Indiana 76% Northern Pacific 29%
Grand Trunk 65% Pennsylvania 38%
Great Northern 26% Pitts. & Lake Erie 11%
Hocking Valley 31% P., C., C. & St. L. 54%
Illinois Central 47% Reading 45%
Iowa Central 79% Rock Island 83%
Kansas City South’n 54% Rutland 69%
L. Erie & Western 69% St. L. & S. Fran. 82%
Lehigh Valley 46% St. L. & S’western 76%
Long Island 101% Seaboard Air Line 78%
L. S. & M. S. 38% Sou. Pacific 49%
Louis. & Nash. 54% Southern 69%
Maine Central 46% Texas & Pacific 40%
Michigan Central 57% Tol., St. L. & S’w’n 61%
Minn. & St. Louis 77% Union Pacific 31%
M., St. P. & S. S. M. 44% Vandalia 54%
M., K. & T. 75% Wabash 80%
Missouri Pacific 60% Wheel. & Lake Erie 90%
N. Y. C. & H. R. 64% Wisconsin Central 69%

_Importance of Fixed Charges to the Investor._

“The high degree of stability imparted to interest payments and dividends by a low percentage of fixed charges, and the high degree of instability imparted by a large percentage, is so elementary that it would seem to need no emphasis. And yet this item is habitually disregarded by perhaps 90% of bond and stock buyers. On this account it may be worth while to illustrate by simple comparison the effect of a 20% decline in gross or net earnings. We will compare the conditions of two roads whose fixed charges are respectively 75% and 25% of the total net income. The operation would be as follows:

Suppose a 20% Decline
Say Earnings $1,000,000 $800,000
Exp. (70%) 700,000 560,000
---------- --------
Net $300,000 $240,000
If F. C. 75% = 225,000 225,000
---------- --------
Surplus for div. $75,000 $15,000 (Case I)
Decrease 80%
If F. C. 25% = 75,000 75,000
---------- --------
Surplus $225,000 $165,000
Decrease 26% (Case II)

“It will be seen from the above that a 20% decline in the net earnings would, in the first instance, mean a decrease of 80% in the surplus; while in the second case, the same decline would mean a decrease of only 26% in the surplus--figures which sufficiently indicate what a high percentage of fixed charges means.

“In this connection it may be further noted that in the large holding companies, like the Pennsylvania, the New York Central, the Union Pacific, and others, the factor of safety and the surplus shown tends to be relatively more stable than in companies largely or exclusively dependent upon the earnings of their own roads. This is due to the general custom of American Railways of paying out in dividends only a part of the actual surplus earned. From this it results that dividends are much more stable than earnings, and that the income of the holding companies from this source will correspondingly show smaller fluctuations than earnings. When, therefore, as in the case of some of the large holding companies named, the income from investments represents a considerable portion of the total net income shown, the surplus, other things being equal, will be much more stable than in other companies.

“It is needless to add that this stability is still further heightened when, as in the case of the Pennsylvania, Union Pacific and some other roads, the percentage of fixed charges is at the same time low.”--From “American Railways as Investments,” by Carl Snyder.

_Borrowing and Lending Stocks._

“When a speculator sells stock which he does not possess (when he sells it short) he (or what is the same thing, the broker who acts for him) has to borrow the stock to make delivery to the purchaser. The one who possesses stock (who is long of it) is, in ordinary circumstances, as anxious to lend it as the one who has sold it short is anxious to borrow it.

“The lender of stock receives from the borrower the market value of it in money, but except when the stock is lending flat (without interest) or at a premium, the lender of the stock pays to the borrower of it interest on the money paid for the stock by the borrower. The rate of interest is determined by bid and offer.

“On the New York Stock Exchange, brokers who have stocks to borrow and brokers who have stocks to lend assemble immediately after the close of business on the exchange and those who need stocks borrow amounts necessary to make deliveries the next day. Those who neglect to borrow at this time must do so the next morning, or some time in the day before the delivery hour, 2.15 p. m. There is no loan crowd in the morning, but borrowers seek lenders at the posts on the floor of the exchange around which the particular stocks that they require are dealt in.

“The same rules govern the receipt and delivery of stocks borrowed and loaned as govern stocks bought and sold. In returning borrowed stock the borrower must notify the lender before 1 o’clock on the day of delivery; the lender in calling or demanding the return of stock must do likewise.

“When a stock is loaned flat, the owner is relieved from the cost of carrying the stock. If loaned at a premium he is still better off, for the premium is so much gain. When a stock is loaned at a premium, the premium applies in the absence of a renewal of the loan only to the day on which the stock is loaned.

“If a stock that has been borrowed advances in market price the lender may require the borrower to pay to him the difference between the price at which the stock was loaned and the new higher price. On the other hand, if the stock declines in price the borrower may require the lender of the stock to return to him the difference between the price at which the stock was borrowed and the new lower price. These differences are called market differences.

“When a corner is being worked up in a stock it is the practice of those engineering it freely to loan the stock in order to encourage the creation of a short interest in it. When this short interest has become large enough, or in other words, when the stock has become sufficiently oversold, a demand for the return of the stock brings the corner to a culmination.

“An apparent borrowing demand for stocks is sometimes created by the efforts of money lenders to obtain higher interest on their money than is obtainable in lending it in the money market. If the lending rate for a particular stock is, say, 6 per cent. when money is lending at 4½ per cent. in the money market the money lenders will borrow the stock in order to obtain the extra interest.

“When a seller of long stock (stock actually owned) desires to create the impression that he is selling short stock (stock not owned or possessed) he has his broker borrow stock for delivery to purchasers. Then when he has completed his sales he delivers his own stock to the ones from whom his broker borrowed.

“Also, when a seller of stock desires to conceal his identity, he has his stock transferred or made out in the name of his broker, or a clerk, or some other person previous to its delivery to purchasers.

“Arbitrage dealers often sell stock held abroad which will not be received for some time. They borrow for delivery to purchasers and when their own stock arrives they make returns to the ones from whom they borrowed.

“Corporations intending to issue new stock have been known to sell the stock in advance of its issuance and to borrow to make delivery to purchasers. Then when the new stock was issued it was used to make return to the ones from whom stock had been borrowed.”--From Smith’s Financial Dictionary, by Howard Irving Smith.

_Scalping._

“There are many different methods and degrees of scalping. The word is supposed to express all the forms of trading between the “Chaser of eighths” and the man who operates for a profit of several points.

“Scalping operations are more common than any other form of trading. There are several reasons for this. Many people consider the market a machine, and base operations on pictures of the past, i.e., charts. These misused and mischievous instruments show so many opportunities of profit in movements both ways, that the unsophisticated trader sees what was _possible_, while the _probable_ is overlooked.

“Again, the desire to scalp is helped by impatience and greed. The small trader will grow disgusted if there is the slightest delay. Dullness is unbearable to him. Also, he will frequently close good commitments merely for the sake of ‘seeing the money.’ I have seen many traders ‘clean up,’ receive a check which was of absolutely no present use to them, gloat over it for a while, and pay another commission to replace the trades. Ridiculous, but true.

“I may say, as a general principle, that I consider scalping the poorest form of trading. It involves the continued multiplication of commissions, and constant personal attention. I know of but two men who have made any considerable amount of money by scalping methods. They are exceptionally fitted for this form of trading, and have the ability to take a small loss quickly. This is a trait which is very rare among public traders. A man will usually accept a small profit for no other reason than that it _is_ a profit, and will sit stubbornly on a loss for no other reason than that it is a loss.

“The man who has reason to believe that a stock will advance or decline ten points, will, in nine cases out of ten, realize more profit by merely making his trade in the stock and going about his business until he considers it wise to terminate the contract. I will say decidedly that more traders will do better, make more money, and suffer less loss of time, and less annoyance by abandoning scalping tactics altogether.

“This view will no doubt cause my friends in the brokerage business much wrath and indignation. They naturally prefer to have ten commissions rather than one, and I fear that in many cases they recommend scalping tactics for no better reason than the one mentioned.

“That constant and repeated operations are disastrous, is pretty well shown by the remark of a successful ‘Bucket-Shop’ man: ‘I don’t care what they do, or what the market does, if I can only keep them coming up to the order windows every few hours,’ said this gentleman. And he was right; for the ordinary scalper is no more than a gambler, basing his operations on possible variations, and paying a great percentage.

“But if one will insist on scalping, it may be well to examine the subject from the other side and see how the least of the evils may be chosen. Without recommending the practice, or qualifying the views expressed above, I will therefore give my idea of the safest methods of scalping.

“The man who attempts to operate on both sides of the market during the same period, is the most deluded individual in the speculative world. I have already stated, that I have only seen two traders out of thousands I have observed, who could do this with any degree of success. These hybrid Bull-bears are certainly not working on any definitely formed opinion of the future. They are worse off than even the traders who are unchangeably and constitutionally wedded to one side of the market the year round. These latter prejudiced and inflexible individuals will occasionally have a turn in their direction, whatever their position may be, but the Bull-bear will go from one month to another, never seeing anything more than a temporary gain.

“It is important, therefore, that the active trader should form his ideas, base his views on something, and, if he wishes to entertain himself with repeated operations, map out a plan of campaign which shall be, at least, intelligent in its original conception.

“Just how successfully the plan suggested will result, depends largely upon the alertness and understanding of the individual who engineers it. If the active participant is easily moved from his position by changes of a point or two against him; if he is easily frightened by wild rumors and inspired talk; if he expects to gain thousands in a few days by venturing hundreds; or if he believes that he can operate in stocks so shrewdly as to guess high or low points within a dollar or two a share, he will meet with disappointment and loss. If he can overcome these drawbacks, he may do very well as an active trader, but I wish to reiterate my views that the man who takes a position on the market and retains it, will make more money than the scalper.

“As a test question, let me put this inquiry to the active traders who read this letter:

“When you have been correct on a certain movement of say ten points, and have made repeated operations, did you make any more money, or as much, as you would have realized on a single trade showing a ten point profit?”--From Thomas Gibson’s Market Letter, February 14th, 1907.

_Crop Damage._

As to the crops, we find many over-optimistic people trying to belittle positive crop damage. It cannot be belittled. It is dangerous and foolish to evade an issue instead of facing it. The argument that our surplus from last year will carry us through a shortage is puerile. That surplus has already been considered. Wheat in the bin is money; some of that money has already been spent and all of it has been given due consideration in the basing of our wealth. A number of writers attempt to make a probable crop of 2,500,000,000 bushels of corn a “bumper crop.” Their methods of arriving at this conclusion are not sound. It is certain that we should, in the natural course of events, raise more and more wheat and corn each year as the population of the world, and the uses of the cereals increase. To compare one year with another will not do. Particularly in Corn and Cotton must we steadily increase in acreage and production, for we supply the world with those commodities. To illustrate this point, let us go back a few years and see what has occurred.

COTTON AND CORN PRODUCTION OF THE UNITED STATES FOR TWENTY-FIVE YEARS.

Bushels Bales
Year Corn Cotton
1880 1,717,434,543 5,789,329
1885 1,936,176,000 6,550,215
1890 1,568,874,000 8,655,000
1895 2,151,139,000 7,157,340
1900 2,105,102,516 10,383,422
1905 2,707,993,542 11,345,988
1906 2,927,416,091 13,000,000

The time is very near at hand, when anything less than 3,000,000,000 bushels of corn will be a crop failure; and high prices cannot be considered a great compensation in lean years. Short crops mean decreased demand for labor and loss of purchasing power by the common people, who are after all the best spenders.--From Thomas Gibson’s Market Letter, July 13th, 1907.

_The Selection of Securities._

When so many seductive baits are offered, so many nets and traps contrived and constructed by clever brains and cunning fingers are spread for the capture of those having money, is it surprising that the careless and credulous are victimized, and even that the sagacious and prudent should sometimes be taken in? Nevertheless, for the losses they have sustained, investors, as a rule, have themselves chiefly to blame. The mistakes made, in nine cases out of ten, have been the purchase of “cheap” securities. The hope of realizing a little more than ordinary interest, by buying paper at a discount, has proved to be the rock on which unnumbered capitalists have split. In addition to their money’s worth, they have endeavored to get something for nothing, with the result of most generally getting nothing for something. It is remarkable how blind are people, ordinarily sagacious enough to make money, to the fact that property cannot pay a revenue beyond its producing capacity. For instance, how can a trolley company, whose line is wholly or mainly built from the proceeds of mortgage bonds, sell them at a heavy discount, besides allowing large commissions for the selling, and then pay both this interest and dividends on a large issue of watered stocks? Or how can a poor agriculturist, occupying a half improved farm out on the frontier, with a family to support and grain selling barely above the cost of production, pay ten or twelve per cent. upon the capital with which he does business?--From “The Art of Wall Street Investing,” by John Moody.

_The Bank Statement._

“A statement or exhibit of the condition of banks.

“In New York the Bank Statement is issued from the clearing house on Saturday. The consolidated statement (or as it is officially designated, the “summary of the weekly statement of the associated banks”) is the collective showing by the banks belonging to the clearing house--the showing when the returns of the individual banks have been consolidated (put together).

“The consolidated bank statement shows the average deposits, loans, specie, legal tenders, circulation, reserve and surplus reserve of the banks for the week ending with and including Friday.

“The term deposits includes the net deposits (credit balances) of persons and concerns (designated as individual deposits), balances to the credit of other banks and all money and credits subject to withdrawal. Loans include money loaned and likewise paper (promissory notes, drafts, etc.) bought. Specie includes not only gold and silver coins, but also gold certificates, which are redeemable in gold or silver, as the case may be. Legal tenders as the term is used in the bank statement, means, United States notes (greenbacks) and Treasury notes (notes issued for silver bullion purchased under the so-called Sherman act).

“Note.--As defined by the statutes, legal tenders include United States notes, Treasury notes, gold and silver coins and minor coins, but not gold certificates, nor silver certificates.

“Circulation means the notes issued by national banks, to secure the redemption of which Government bonds have to be purchased by the banks and deposited with the Treasurer of the United States. A bank cannot count circulation in its reserve; whether it is its own circulation or the circulation of some other bank, makes no difference. Reserve means the total amount of specie and legal tenders held. Surplus reserve means the total amount held in excess of legal requirement. A national bank (in New York City) must, by law, maintain a reserve equal to 25 per cent. of its deposits; a state bank must, by law, maintain a reserve of 15 per cent. In compiling the bank statement a reserve of 25 per cent. is allowed or figured for state banks as well as for national banks.

“The consolidated statement formerly was issued from the clearing house in the following form, the changes (increases and decreases) resulting from comparison with the preceding statement (the statement issued the week before):

Loans $874,647,900 $2,344,000 Increase
Specie 152,338,200 1,068,300 Increase
Legal Tenders 67,274,300 1,319,000 Decrease
Deposits 872,340,600 164,600 Increase
Circulation 36,072,500 411,600 Increase
Decrease of reserve, $291,850

“The (final) item reserve in the statement as issued from the clearing house, meant surplus reserve, although not specifically so stated.

“In the newspapers the statement appeared as follows; being elucidated so as to show the reserve held (that is, specie and legal tenders which are generally referred to as cash holdings), the reserve required and the surplus reserve with the changes in these items:

Current Preceding
Week Week Changes

Loans $874,647,900 $872,303,700 In. $2,344,200
Deposits 872,340,600 872,176,000 In. 164,600
Circulation 36,072,500 35,660,900 In. 411,400
Legal Tends. 67,274,300 68,593,300 De. 1,319,000
Specie 152,338,200 151,269,900 In. 1,068,300
--------------------------------------------
Reserve held $219,612,500 $219,863,200 De. $250,700
Res. req’r’d 218,085,150 218,044,000 In. 41,150
--------------------------------------------
Surplus $1,527,350 $1,819,200 De. $291,850

“In 1902 the Secretary of the Treasury (Leslie M. Shaw) suspended the requirement to keep a reserve against government funds on deposit in national banks upon the ground that these funds were special deposits which were fully secured by pledge of bonds with the Treasurer of the United States. This action by the Secretary of the Treasury caused a change in the make-up of the bank statement by the addition to it of figures showing the average amount of government funds on deposit. The consolidated statement was thereafter issued from the clearing house in the following form:

Loans $874,647,900 $2,344,200 Increase
Specie 152,338,200 1,068,300 Increase
Legal Tenders 67,274,300 1,319,000 Decrease
[3]Deposits 872,340,600 164,600 Increase
Circulation 36,072,500 411,600 Increase
Reserve on all deposits 291,850 Decrease
Reserve on all deposits
other than United States 325,825 Decrease

[3] United States deposits included, $40,633,400.

“In the newspapers the statement was made up in both the old and the new forms as follows:

Current Preceding
Week Week Changes

Loans $874,674,900 $872,303,700 In. $2,344,200
Deposits 872,340,600 872,176,000 In. 164,600
Circulation 36,072,500 35,660,900 In. 411,400
Legal Tends. 67,274,300 68,593,300 De. 1,319,000
Specie 152,338,200 151,269,900 In. 1,068,300
-------------------------------------------
Reserve held $219,612,500 $219,863,200 De. $250,700
Res. req’r’d 218,085,150 218,044,000 In. 41,150
-------------------------------------------
Surplus $1,527,350 $1,819,200 De. $291,850

Deducting the United States deposits held by the banks from the aggregate deposits the bank statement compares as follows:

Current Preceding
Week Week Changes

Tot. deposits $872,340,600 $872,176,000 In. $164,600
U.S. deposits 40,633,400 40,769,300 De. 135,900
----------------------------------------
Dep’s 25% $831,707,200 $831,406,700 In. $300,500
Reserve held 219,612,500 219,863,200 De. 250,700
Res. req’r’d 207,926,800 207,851,675 In. 75,125
----------------------------------------
Surplus $11,685,700 $12,011,525 De. $325,825

“The detailed bank statement, which is issued simultaneously with the consolidated statement, contains first the number of each bank (each bank has a number by which it is known at the clearing house) and then the name of the bank, after which follow the amounts of its capital, net profits (surplus and undivided profits), specie, legal tenders, deposits and circulation.

“The bank statement is said to have been made up on rising averages when the items in it have been increasing in amount during the week, or the statement is said to have been made up on falling averages when the items in it have been decreasing in amount during the week.

“Generally speaking, the bank statement is favorable or good when it shows that the position of the banks has been strengthened, as by an increase in the surplus reserve through, or by means of an increase in their cash holdings rather than by a decrease in their deposits, which often is effected by the calling of loans--by demanding and obtaining the payment of money loaned on call. As money loaned is credited to borrowers on their deposit accounts and increases the total deposits of the bank, so the payment of loans by borrowers takes from and decreases deposits. As will be seen, the calling and consequent payment of loans does not increase cash holdings but merely changes balances in individual accounts. A reduction in deposits reduces the amount of cash required to be held as a legal reserve and correspondingly expands (increases) the surplus reserve. Generally speaking, also, the bank statement is unfavorable or, if particularly unfavorable, is bad when the position of the banks has been weakened, as by a decrease in the surplus reserve through a decrease in their cash holdings rather than by an increase in their deposits, which often is effected by an expansion in (increase in amount of) their loans, which correspondingly expands (increases) their deposits and correspondingly increases the amount of cash required to be held as a legal reserve. This additional amount is deducted from and correspondingly reduces the surplus reserve.

“The bank statement may be said to be favorable or good, however, if an increase in loans is reported when the banks are surfeited with money: also the bank statement may be said to be unfavorable or rather not good (but hardly bad) when it shows that money is accumulating in idleness in the banks--when deposits are increasing, not as a result of increasing loans, but in the absence of a borrowing demand for money.

“There are other circumstances which make the bank statement favorable or unfavorable as disclosed in the circumstances themselves.

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The cycles of speculationChapter III: Part II (3)

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