Speculation and Investment
From Moody’s Magazine
HE WHO goes to Wall Street goes to buy an income or to speculate, and if he seeks a larger income than the minimum interest rate his income-purchase becomes in itself speculative.
“I never speculate in Wall Street,” says a merchant, “I only buy outright for investment.”
The fallacy that investment and speculation may be divorced is common. The merchant who thinks he doesn’t speculate may buy railroad shares, like Erie or Rock Island, that pay no dividends. This is a hazardous speculation, whether the shares are paid for in full or carried on margin. The purchase of seasoned dividend shares is a speculation, for their dividend rates may advance or decline and their market prices may vary widely in periods of boom or panic. Even the purchase of high-grade bonds is a speculation.
Take the extreme case of the purchase for $1,000 of a $1,000 highest grade 3^ per cent, railroad gold bond maturing in ten years, the investor being assured that he will have no use for the principal until the maturity of the bond. Every year he will receive an income of $35 and at the end of ten years the company will repay him the $1,000 gold. There appears to be very little speculation here. But suppose that in these ten years, by reason of increased production, gold declines and the things that gold buys advance. When the bondho1der gets back his $1,000 gold he finds that it will buy less food, fewer
clothes and less comfortable shelter than when he bought the bond. He is, therefore, relatively poorer. In the meantime the railroad company shares in the general prosperity and increases its dividends to shareholders. Its stocks rise in price. The bond buyer finds he has been speculating in gold.
To put money into good railroad bonds at the beginning of this era of prosperity was a poor speculation ; to buy railroad stocks was a good speculation. Ten years ago Chicago & North Western securities were all of the highest grade. The stock, paying 5 per cent., advanced from $85 to $143, netting only 3^2 per cent, on the investment at the top. The 3y? per cent, general mortgage bonds of 1897 ranged from $990 to $1,020, netting about 3Y2. per cent. also. But the investor who bought North Western bonds at their lowest price ten years ago has not fared nearly as well as the investor who bought the stock at the top. The bonds in 1908 ranged from $900 to $960, an average decline of $75 a bond. The stock, now paying 7 per cent., ranged in 1908 from $135 to $185, and its extreme range in the ten years has been $i2Ó-$270. The investor who bought North Western stock in preference to the bonds ten years ago has received twice as large an income on his money, and has had abundant opportunity to realize on his purchase at a profit of from 50 to 100 per cent.
North Western was a high grade investment stock ten years ago. But
many of the leading railroad stocks of to-day, like Atchison, Union Pacific, Northern Pacific and Southern Pacific, were considered almost worthless ten years ago. The investors who bought the stock of these roads in preference to their bonds, thus speculating on the growth of the West, have made enormous profits. There is Union Pacific. Its first mortgage 4 per cents, sold then above par, and they sold a few months ago $120 below their average price ten years ago. But the common stock, which paid no dividend and ranged from $16 to $44 then, now pays 10 per cent., and in 1908 ranged from $iio-$i85.
A study of railroad securities in our ten years of prosperity shows that gilt-edge bonds have gradually declined in price, while common stocks have risen enormously. The profits have accrued to the speculators in the stocks—whether they bought one share outright or carried a thousand shares on margin.
Speculation has an evil sound to many good folks’ ears. It at once suggests the bucket-shop and the hazardous trading in securities on slender margins. But all business is speculation, and if the American people for the past hundred years had put their money only into gilt-edge investments we would still be reading by candlelight and riding in stage coaches. England became the greatest commercial nation in the world because Englishmen were big speculators. Now we are out-speculating the English and becoming a greater commercial power.
Speculation and industrial progress go hand in hand. It was a hazardous speculation that built the first railroad across the Rockies ; it was a still more hazardous speculation that rescued the property from bankruptcy. In the 90's, when the pessimists thought the country was going to the demnition bowwows, a fox-eyed speculator went from banker to banker in Wall Street, saying. “Here's the bankrupt Union Pacific selling for $3 a
share ; let’s buy up the stock, assess 92
ourselves $15 a share and make a railroad out of it”—the conservative old bankers threw up their hands in amazement. They wouldn’t embark on such hazardous speculation. But Harriman persisted, found men who were willing to join him in the speculation, and we all now marvel at the result. Without speculators like Harriman and Hill the railroads beyond the Mississippi would still be “streaks of rust”—If there were any railroads at all.
But because speculation is the leaven of industrial progress, it doesn’t follow that every man with a few dollars in his pocket should plunge into wild speculation—whether it is buying building lots, eggs or railroad shares. Speculation, especially our modern system of margin speculation, is a highly useful factor in our industrial life, but trading on margin is a hazardous undertaking, and nine-tenths of the players lose. The trouble with the average American is that he wants to make too much money in too short a time. He knows that, with luck, he can make a great deal of money in Wall Street on a small capital, and in his greed for fortune he takes extravagant risks. It is because he takes such chances that he usually loses. Any candid Wall Street broker will tell you that the habitual margin speculators lose year in and year out.
Money may be made in Wall Street, just as it may be made in merchandizing or manufacture or agriculture or mining—by the exercise of ordinary business common sense. “The men who have made the big fortunes in America,” said Mr. Morgan, the other dav, “are those who have been bulls on the country.” One of the Standard Oil capitalists said some time ago, “A man who hasn’t made a fortune in America in the past ten years can’t blame the country.” In this period railroad dividends have increased 250 per cent., steel production 240 per cent., bank deposits 160 per cent.— our industrial progress has been astounding. And the men who have made fortunes have been those who have believed in the country year in and year out.
The conservative investor, with a surplus that he can spare for speculation, has more than a reasonable chance of making a profit by buying good stock in panic periods and selling them in boom times. This may take him to Wall Street only once in a year or two, 'but he will make a good deal more money than the man who goes there every day.
The public is credulous about money making. It always has been. And this credulity is born in cupidity. It’s the desire to acquire money easily and quickly that leads the public into absurd speculative ventures, and that provides a never-ending harvest for the unscrupulous and reckless promoters. The tulip craze in Holland in the 17th century, the South Sea Bubble in England and John Law’s wonderful bank in France in the 18th century, our own extravagant railroad ventures after the Civil War— all grew out of this over-mastering desire for wealth.
There never has been a time when a smooth-tongued financial adventurer—honest enthusiast or scheming fakir—couldn’t stand on the street corner and tempt the coin of the realm out of the pockets of the credulous.
The country merchant, who thinks he is mighty lucky to make $1,000 earn $150 in a year in a home investment, sends his money awav to some clever advertiser who promises to make his $1,000 earn in a year from $1,000 to $10,000. This is happening every day, and there is no way to prevent it. Men who know that two plus two equals four will put their money knowingly into a fraud or a bubble on the chance that they will pull out ahead of the victims. The other day the manager of a Wall Street brokerage house received an order from a customer to buy 1,000 shares of an extravagantly advertised mining stock.
“Why, that’s a fraud promoted by an ex-convict,” protested the broker,
“and I refuse to buy the stock for you.”
“Oh, I know all about it. It’s a plain swindle. But the gang behind it is going to put it up to catch the suckers. I don’t see why I shouldn’t get some of the money—”
“Of the suckers?”
“Well, you buy me 1,000 shares.”
The broker reluctantly bought the stock for $1,400. The next day the stock couldn't be sold for $700, for the manufactured market suddenly collapsed.
Several years ago a well-known circus-poster advertising promoter announced over his signature that the investment of $1,000 in a new copper stock would make a profit of $10,000 to $15,000 in a few days, or 1,000 to 1,500 per cent. Seven days later subscriptions to the stock to the amount of $6,600,000 in cash had accumulated in New York’s biggest bank—an astounding response from a credulous public. We all know that the public didn’t make from $66,000,000 to $99,000,000 on its investment in a few days. Instead it soon faced a loss of nearly $5,000,000, and in four years the market value of the stock showed a loss of all of its original investment of $6,600,000 and more than $10,000,000 besides.
But this same circus-poster enthusiast has repeatedly painted wonderful pictures for the credulous of the easv road to sudden wealth, and the public has always paid for the pictures at fancy prices. Several months ago he invited the public to ioin him in a discretionary speculation pool, promising that he could make 300 per cent, a year on a capital of $5,000,000. He predicted that a $20,000 investment in the shares of the venture would be worth $100,000 within four months ; instead, the market value of the investment declined to $8,000.
If this particular venture collapses absolutely, and the shares that recently sold around $2 go begging again
at a few cents, will it be a bar to the repetition of a similar venture by the same enthusiasts, with another harvest from the credulous? Not at all. The farmer reads in his weekly paper how the three-shell fellows cleaned out the credulous in a neighboring county fair, and then goes to his own county fair and tries to beat the game. He knows the game is crooked, but his cupidity stirs him to think that he can beat it.
Some years ago in Chicago a great discretionary pool swindle took hundreds of thousands of dollars out of the credulous before it collapsed. The same gang repeated the operation on a bigger scale in New York several years later. The swindlers were exposed and some went to prison. Three years later they started out again and took two millions more from the same gullible public. The gang’s stool pigeon promised to pay 520 per cent, a year, and he did pay weekly dividends at this rate (out of the victims’ money, of course) until the police raided his shop in Brooklyn. The same swindle, were it started again, would be just as profitable to its organizers.
In every industrial boom a horde of wildcat promoters invades the market place and offers its wares to the credulous through circus-poster newspaper advertising. The records show that there is not one chance in a hundred of one of these Sunday-advertised ventures becoming a sound business enterprise, and not one chance in a thousand of one of them being the bonanza that they are all painted. In the industrial boom following the flotation of the Steel Corporation, iqo companies offered their shares to the public through a single New York newspaper in a year. Three years later an investigation showed that nearly all of these companies were dead and that not one was earning anything for its shareholders. A mining engineer recently investigated all of the companies brought out in the past ten years through flambuoyant newspaper advertising and found only three on a healthv dividend basis. But in the next industrial boom the wildcat promoters will reap the usual har94
vest from the gullible. As the fakirs
themselves say, “there’s always a new crop of suckers.”
Mr. Barnum said, “The American people like to be humbugged,” and nowhere is the truth of this better illustrated than in the market place.
But there is another side to it. The small investors are not nearly so foolish in their real investments as their absurd chasing after bubbles would indicate. The public in the past few years, largely as a result of the widespread interest in American business affairs, has shown an intelligence in its investments that has surprised the old timers in Wall Street. The Wall Street aphorism, “the public buys at the top and sells at the bottom,” is probably still true in a large measure of the public’s margin speculation, but it is not true of its investments.
“The public invests at the bottom and sells at the top”—and the records of the past four years, more especially of the past two, show this in a remarkable degree. When railroad shares were pushed to the highest prices in their history of the Harriman bull market of IQO6, the talk of the Street was that “the insiders were unloading on the public,” and when the crash came in 1907, with terrific losses Ín market prices, every sourfaced looker-on thought he saw a cruel shaking-out of the public, with bargains falling into the laps of the big speculators.
What happened was just the other thing. When prices were in the skies in the full and earlv winter of TQO6 the public was selling out on Wall Street, and the public never came back to reinvest its gains until the panic lvt the market and snilled the big speculators’ loads out on the bargain table. In the great advance in prices from the snrinçr of T004 to the winter of Toofi-v the public soin manv millions of dollars of securit'es to speculators in WaU Street, because investors found that stocks were selbng so high that their income return was less than savings bank interest rates. Tn the first collapse in the bull market early in T907 investors began reinvesting their savings in good railroads and industrials, and when the bank panic in October drove prices to the lowest in years, a flood of investment buying resulted. In two years not less than 400,000 new names were enrolled on the stock books of the railroad and industrial corporations listed on the Stock Exchange. A dozen of the biggest corporations gained 100,000 shareholders.
Great Northern, when it was selling at a fancy figure late in 1906, had only 2,700 shareholders. The long decline in 1907 attracted 4,000 new shareholders up to the week of the bank panic, and in the months of depressed prices following the panic 7,500 more bargain-hunters came to Wall Street to buy “Jim” Hill’s stock, with the result that Great Northern now has five times as many shareholders as it had two years ago. The public similarly unloaded its Reading shares on Wall Street in a bull market and bought them back in the panic. Before the bull market collapsed the holders of Reading common numbered only 1,700. During
the bear market 1,000 new investors bought the shares, and in the panic the list rose to 4,300. When Wall Street began bulling Reading again last summer the shareholders took their profits, and early this winter, when Reading had doubled its panic price, the number of shareholders had declined to 3,000. For years the list of Pennsylvania Railroad sharehold.ers has risen in bear markets and declined in bull markets. The common gained nearly 20,000 shareholders in the bear market of 1907, and since then the list has been gradually der dining with the recovery in the price of the stock.
The great recovery in security prices since the panic, while helped along by manipulation, has been built on the solid foundation of the public’s investment of several hundred million dollars in Wall Street at the bargain prices from March, 1907, to March, 1908. When the speculators boom the market to the skies again, the public will convert its stocks into cash and await the inevitable collapse.
The lambs are learning.
The development of one’s personality cannot be accomplished in isolation or solitude ; the process involves close and enduring association with one’s fellows. If work were purely a matter of mechanical skill, each worker might have his cell and perform his task, as in a prison. But work involves the entire personality, and the personality finds its complete unfolding, not in detachment, but in association.
Hamilton Wright Mabie.