THERE comes a time in the life of a good many young men when the sporting page of the daily pa-
per begins to divide its interest with the financial page. The change is a gradual one, but it is none the less significant. You will note the young clerk coming from the office, where he has been at work all day, snatch an evening paper from a newsboy and board a car for home. He will probably glance at the more important headlines on the front page, but it will not be long before his fingers slip in between the leaves and his eye scans the latest market news. In company with many thousands of his fellow-beings he is curious to know how the various active stocks have been behaving during the day. The chances are he has money invested in some one or other of them or he is watching for an opportunity to get in on a good thing.
The reports of sales and the stock quotations, which are to be found in every daily paper, are the records of the business transacted on the stock exchange. When we see, for instance, under the heading, Montreal Sales, such an item as this, “Soo com., 50 at 135/’ the meaning is simply this, that on the Montreal Stock Exchange, one broker has sold to another fifty shares of the common stock of the Minneapolis, St. Paul and Sault Ste. Marie Railway Company, (commonly known as the Soo Road), for $135 a share. The transaction has most likely been made for clients of the stock brokers.
One client wants to buy Soo common, the other wishes to sell Soo common, and this they are able to do through their respective brokers.
The evolution of the stock exchange has been a simple matter. Let us go back to the very beginning. Suppose a number of men join together to form a company. Each puts in one hundred dollars to start the business. If there are one hundred men, they will put up among them $10,000, which becomes the capital of the company. To each contributor, the secretary issues a receipt for his hundred dollars. Now we can suppose that as time moves on, one of the hundred stockholders may wish to withdraw from the company. How is he going to get back his hundred dollars? The company is not in a position to return it to him, because all the money has been invested in machinery, let us say. He has to find some other individual who will take his place in the company. It can be readily seen that it will be quite an undertaking for him to search personally for a purchaser. Conversely there may be a man who would like to purchase a share in the company. For him, too, it would be no easy task to find a stockholder ready to sell. Imagine this situation multiplied by the establishment of many similar companies, with thousands of shareholders, and it will be quite apparent that the only solution will be for some man or men to make a business of bringing buyers and sellers togethei. The class of stock broker springs into
existence and a stock exchange, where they can transact their business, is established.
But after all this is a very elementary way of looking at the business of buying and selling stocks. Other considerations and other influences have stepped in, which give a different complexion to the situation. Let us return for a moment to our hypothetical original company and suppose it has been in operation for a year, before any one wants to sell his stock in it. During that year one of two things may have happened; either the business of the company has been better than the investors figured it would be, or it has been worse. If it has been better, then the shareholder will consider that he is entitled to receive a little more than one hundred dollars for his holding. If it has been worse, he will be willing to sell at less than the hundred. It is in just this way that fluctuations begin and these fluctuations have come to-day to be the result of innumerable causes.
Of these causes, naturally, the simplest and strongest is the actual condition and prospects of a company, considered by itself, and gauged usually by the earnings. If a company is prospering, this prosperity should by rights be reflected in the value of the stock. A stock paying a dividend (interest on the money invested) of eight per cent., should, other things being equal, sell at a higher figure than one paying only seven per cent. Fortunately or unfortunately, as the case may be, this condition is influenced in a hundred ways by other conditions and can never be taken as a sole guide.
The element of speculation enters. A company may be seemingly doing remarkably well. Its stock may be considered an excellent buy, but the idea gains ground among certain shareholders that this condition is not going to last. They think to themselves, if we sell now at the present price, we will forestall the drop, which is sure to come, when the earnings begin to fall off. They start in to sell their holdings. It may be that there
are enough buyers, with confidence in the company, to purchase all the stock they have to offer at the market price, but the chances are more likely that there are not. The fact that the supply exceeds the demand, means that the sellers must lower their price in order to get rid of their stock. By the time the last man has unloaded, the price may be away down. All this time the company is prospering and increasing its earnings, so that the drop cannot be explained by its current condition. The drop is purely speculative, based on future beliefs as to its standing.
In a similar way, a number of buyers may speculate on increased earnings and larger dividends. They begin to buy and the price goes up, because the supply is smaller than the demand. Meanwhile the present condition of the company may be most unsatisfactory.
General commercial conditions have a great deal to do with the values of stocks. In a time of commercial depression stocks naturally decline in value, for the reason that the public need money to tide them over the stringency. The market is glutted with stocks and prices drop, because buyers are scarce. But here again we cannot depend on the market reflecting the exact condition of affairs, for the speculator figures on the depress sion before it comes and stocks reach their lowest point months before the lowest point of the depression is reached. Conversely stocks begin to go up before the better times return.
So far we have assumed that a buyer pays the full market value of the stock he buys in cash from his own pocket. It is true that this is frequently done, and it is really the most satisfactory and secure way of buying stock. People who buy this way usually do it for an investment, being content to receive their dividends and let their securities stay quietly locked up in a safe deposit vault. But there are other people, who, observing the way prices fluctuate, say to themselves, why should not I buy to-day at 80, in
the expectation of selling next week at 90. These people are the speculators. If they have sufficient cash they buy their stocks outright, and in so doing they do wisely. Unfortunately, human nature is not always fashioned of such cautious material. A more risky way has been devised to accommodate the adventurous. This is marginal buying.
Under a system of marginal buying a speculator is able to buy ten. twenty or even twenty-five shares, without expending more cash, than were he to buy a single share outright. If the stock goes up and he sells, he makes accordingly ten, twenty or twenty-five times as much. On the other hand, if the stock declines, he is liable to iose everything he put into it, and therein lies the risk. The idea behind marginal buying is that the purchaser buys the stock, paying usually ten points in cash, while the balance of the purchase money is made up by the broker, who either loans it himself or borrows it for the purpose. The purchaser must, of course, pay7 interest on this loan, and for reasons, which will appear later, the broker holds the stock.
Now, if the stock goes up and the purchaser sells it, he pockets the advance, less interest on the loan, and the brokerage involved in buying and selling. Provided a gain of five points is made and one hundred shares are dealt in, this gain amounts to $500, from which interest and brokerage are to be deducted. But, supposing the stock goes down. The broker must protect himself from loss. He is bound to make good the amount of the loan, and this he can only7 do by selling the stock before it drops ten points, and thereby realizing enough to meer the loan, or else he can call on the purchaser of the stock to advance more money to cover further declines. If the holder of the stock is unable to do this, or reaches a limit beyond which he cannot pay. the broker sells the stock, takes what he requires to clear himself, and returns the balance, if any, to the unfortunate speculator.
Marginal trading, which is very extensively indulged in, has naturally a considerable bearing on the prices of stocks. The constant buying and selling of speculators, many of whom know absolutely nothing about the intrinsic merits or demerits of the stocks they7 deal in, cause inexplicable fluctuations, which upset all calculations.
While most people buy for a rise, there is a class of people, known in the vernacular as bears, who are always expecting declines. These people pursue a different policy7. It is apparent that no one who expected a stock to fall would be willing to purchase it. Naturally, if they7 held any7 of it they would be anxious to sell. But they7 do not hold any7 of the stock. Believing that it is going to decline, they7 go to their broker and say7 in effect, "Lend me so many shares of such and such a stock, for which I will give you my cheque at the current market price, and then sell them for me." Now, if the stock declines, as they7 anticipate. they can re-purchase these shares on the market, return them to the broker, get back their cheque, and make profits equal to the difference between the price at which the shares were sold in the first place and bought in. in the second place. But, should the stock go up, the broker may want his shares back, and then the bears must re-purchase the stock at a higher figure, thereby losing the difference between the buying and selling prices.
Marginal trading is also carried on extensively* by the bears. Instead of giving a cheque for the whole value of the stock loaned by the brokers, they7 put up five or ten points. Then if the price drops they7 realize the full amount of the decline, but if it goes up, they are compelled to keep up their margin, or else lose all they put in.
Sometimes arrangements are made for the loan of stock for a definite period of time, but usually7 the requirement is that the stock should be returned on demand, because the broker
has to secure it very often from third parties.
It can be readily seen that the bears. exercise a very considerable influence on prices, and it is, generally speaking, a healthy influence, for it tends to prevent undue inflation of prices. Between the two opposing forces, stocks fluctuate to an extent that makes any definite forecasts as to prospective moves most difficult to render.
Summing up, the stock market presents a complexity of influences, which no man on earth can gauge accurately. Only close students of the market can hope to make big gains in speculation. It is therefore the wiser course to buy for investment, purchasing
standard stocks, which have demonstrated good earning qualities. Opportunities may come to sell at an advance, and such opportunities should be taken advantage of, but for the average business man or woman, who has other things to think about, it is a serious mistake to start speculating pure and simple. Where purchases are made outright, the buyer can watch the fluctuations of the stock composedly, knowing that if it goes up he is so much better off, and, if it goes down, he does not lose all he put into the purchase and still draws his dividend.
[Editor’s Note.—Next month we will publish an informative article on “Pointers in Buying Stocks.”]
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