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.
| Stock | High in July, 1901 | High in 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.
| Stock | High in July, 1901 | High in 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.
| Stock | High in 1901-1902 | Low in 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.
| Stock | High in 1901-1902 | Low in 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 allstocks 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.