A PRIMER OF SCIENTIFIC VESTMENT By EMIL DAVIES Author of "The Money and the Stock and Share Markets FOURTH EDITION Published by H. E. MORGAN, 53 FETTER LANE LONDON, E.G. I D '~ net. (Copyright) A PRIMER OF SCIENTIFIC INVESTMENT By EMIL DA VIES Author of The Money and the Stock and Share Markets' FOURTH EDITION Published by H. E. MORGAN, 53 FETTER LANE LONDON, E.G. Price D net. (Copyright) FOT(EWORD. IT is a well-known fact that, while the public occasionally gains, and frequently loses, over its investments, the few big financial houses of the world, conveniently covered by the designation of la haute finance, consistently make large profits. The explanation of this indisputable fact is not to be found in the possession of large resources, for, as many private investors know to their cost, it is as easy to lose large sums as smaller amounts. The success of the great financial houses is built up on the same basic principle as that of the arge industrial concerns which employ the best trained chemists and expert brains that money can procure to improve and perfect their processes of manufacture ; in other words, by the application of science to industry. Each of the financial houses of the world has its " general staff " of experts its intelligence department constantly engaged in watching and studying the economic development of every country, the advance or retrogression of every trade and industry, the trend of prices in the different markets of the world, and the progress of the principal undertakings in every branch of industry. The private investor, acting on his own initiative or on a chance " tip," can no more hope to pit his knowledge and judgment against that of the trained experts of the great financial houses, with their mass of systematised information and statistics ever up to date, than a small artisan or trader can hope to be successful against one of the giant industrial concerns to which reference has already been made. The individual investor can, however, at least profit by learning something of the scientific methods adopted by these formidable competitors, and with this end in view the present treatise has been written. A PRIMER OF SCIENTIFIC INVESTMENT CHAPTER I. INVESTMENT VERSUS SPECULATION. "T" KNOW scores of well-to-do men," said a well-known I financier in conversation recently, " who are not specu- lators in the ordinary sense, but who place their money in stocks which they hear, from one quarter or another, are ' good for a rise,' and who would be thousands of pounds better off in the long run if they were to place their money in safe fixed interest-bearing securities, yielding between 4 and 5 per cent." The idea underlying the foregoing remark is perfectly correct, and applies with equal force to avowed speculators, who, if they knew the real forces arrayed against them, would be appalled. There is no science of speculation, except such as is com- prehended in the word " don't " ; but in the more profitable, if less exciting, field of investment, it is possible to work upon scientific lines, which it is the purpose of this booklet to indicate. A PRIMER OF SCIENTIFIC INVESTMENT INVESTMENT A SCIENCE. The investment of capital is a science, but, like economics, to which it is closely related, it is less definite than most sciences, because it is affected by so many ever-varying influences. None the less, it is possible to determine upon certain basic principles which, if followed out intelligently, secure the maximum yield with the maximum degree of security, and to this extent one is justified in speaking of a science of investment. THE AIMS OF INVESTMENT. It at once becomes necessary to determine the aims or object of investment. It may fairly be assumed that the aims of every investor are : To secure as high a rate of interest as possible without any interruption in the payments of same. 2. To keep the capital intact that is to say, to be able at any time to get back the whole of the original capital. 3. To increase, if possible, the amount of capital invested, by growth in the value of the securities held. To formulate these desiderata is not a matter of difficulty ; to give full effect to them is less easy, for on examination it will be found that one aim militates against the accomplish- ment of the other. It is easy to secure absolute safety of income (albeit at a low rate of interest) by placing all one's capital in Consols ; but it is only too notorious that this safety of income is not equalled by safety of the invested capital, as the individual who put 1,000 into this security ten years ago, when Consols were at par, could now only obtain about 820 for it. Strictly speaking, such an individual has not been receiving 2j per cent, on his capital, for of the 250 received as interest during the ten years, 180 has been swallowed up by the depreciation in the value of his Consols, so that the true yield to him has been less than J per cent., and if he has spent the 180 under the impression that it was income, he has simply been diminishing his capital. We see A PRIMER OF SCIENTIFIC INVESTMENT here, therefore, that the obtainment of regular income on capital (aim No. i) is of little value unless accompanied by stability of value of the capital itself (aim No. 2). Stability in the value of capital over a lengthy period may be arrived at by placing one's capital on deposit account with first-class banks, but only by the sacrifice of aim No. I viz., a good rate of interest. As to the third aim viz., an increase in the value of the capital invested this usually involves the purchase of securities at the present moment inferior, but the prospects of which appear promising, and as this necessarily implies greater risks, both aims Nos. i and 2 have to be sacrificed to some extent. Probably not one investor in a thousand has ever taken the trouble thus to dissect and analyse his motives in laying out his money, all feeling in a general sort of way that they wish to make the best possible use of their capital. None the less, a clear understanding of the three different objectives aimed at, and of their conflicting nature, is essential to a com- prehension of the principles of investment. IS THE ACHIEVEMENT OF ALL THREE AIMS POSSIBLE? Owing to the apparently conflicting nature of these aims, the question may well arise in the mind of every thoughtful investor, is the achievement of all three possible ? There is no certain method of getting rich quickly, although there is a sure method of getting poor i.e., speculation. But however much the aforesaid three aims conflict one with the other, it is possible to arrive at the greatest common measure of all three, and the whole science of investment lies in so distributing one's capital as to achieve the maximum degree of success in all three aims with the minimum risk of loss, and in changing from one investment to another as, by the force of ever-changing circumstances, a security already held ceases to fulfil all the requirements, or another security is found to fit the case more nearly. A PRIMER OF SCIENTIFIC INVESTMENT If this is done properly, regularly, and in a scientific manner a safe and relatively high yield, combined with stability of capital, with incidental profits arising from occasional read- justments, may be obtained. We will now proceed to indicate how this may be done. CHAPTER II. ESSENTIALS OF SUCCESSFUL INVESTMENT. AVERAGING THE RISKS. IT is not sufficiently recognised by the ordinary investor that risks should be spread. The adage that one should not put all one's eggs in one basket is more honoured in the breach than the observance as regards capital outlay. Merely to distribute it amongst a number of securities in the same country by no means meets the case, even if they are of diverse or contrasting character. There are two main influences governing each separate investment : first, the locus the general conditions obtaining in the country in which the security is located ; and, second, the merits or demerits of the particular investment, apart from such general considerations. The first influence is more easily determined than the second. It is evident that both the value of money and trade conditions vary in different parts of the world ; what would seem an exorbitant rate of interest in England or France may appear quite reasonable in a new country like Brazil or Mexico, where wealth is more rapidly created. For example, in Buenos Aires local capitalists are able to place their money out on first-class mortgages to yield 7 and 8 per cent., so that Argentine securities generally give a A PRIMER OF SCIENTIFIC INVESTMENT higher yield than the same class of securities in Europe. But the individual who placed all or the greater part of his money in the Argentine would be acting very foolishly, for in the event of that country passing through a period of bad trade or political disturbance he might surfer considerable loss. The same remark holds good of any single country, even the United Kingdom being no exception to this rule, so that it can at once be seen that to obtain a perfect equilibrium in the value of capital, such capital must be spread in equal parts over different areas of the world's surface and in stocks of equal grade or quality. A poor harvest or period of trade depression in the United States and Canada would for the time being bring about a fall in the market value of American and Canadian securities ; it is out of the question, however, that every country in the world should at the same time be in similar case. On the contrary, what is the misfortune of one is often to the benefit of another, and it is quite likely that as has already happened more than once while North American crops were poor, Argentina had a bumper harvest and sold at good prices on account of the shortage elsewhere. Thus, what the wise investor may lose through unforeseen circumstances in one direction must, humanly speaking, and almost by virtue of such circumstances, be made up by the gain in another direction ; and an appreciation in, say, his Argentine or Brazilian securities would balance any depreciation in his North American investments. But, as has already been indicated and the point needs em- phasising to effect this it is necessary that as much of the investor's capital should be placed in one part of the world as in another. This involves the demarcation of the earth's surface into investment divisions, and before describing this method, let us summarise the benefits accruing to the investor from this scientific repartition of his capital. i. The value of the total capital invested remains more stable, for under no conceivable circumstances could the safety of investments in all parts of the world be simultane- ously threatened. 10 A PRIMER OF SCIENTIFIC INVESTMENT 2. A higher rate of interest is earned without lessening the security, because the total received represents the mean between all the rates obtaining throughout the world, which in many countries are appreciably higher than those obtainable in Europe. 3. With a well-distributed list of investments there will always be some showing a good profit. By exchanging these for similar grade securities as described on page 26, a reserve fund supplementary to the original capital may be built up. There is another manner of building up, more or less unconsciously, a reserve account which may well be adopted by the possessors of large sums of capital, and this is by having surplus income placed to a separate bank account. We will assume the case of a man having 20,000 invested, who in the ordinary way would be satisfied with, and whose requirements would be met by, an average yield of 4 per cent., but who, by means of a scientific averaging of risks as here indicated, is successful in obtaining 4^ per cent, without any increase of capital risk. By instructing his bank to place all interest in excess of 4 per cent, received during the year on the total sum invested, to a No. 2 deposit account, he will automatically at the end of ten years have built up a reserve of 1,000 exclusive of interest. INVESTMENT DIVISIONS. The areas constituting separate investment divisions should correspond as nearly as is practicable with the different climatic, trade, and political influences, and should comprise a number of different countries offering variety of choice ; for there will always be one, among a number, offering at a given moment more favourable opportunities for investment than the others. Man has already divided the earth's surface into certain broad divisions, following natural features, and we cannot do better than follow this division into continents, except that as North and South America present such different characteristics political, natural, and climatic, it is advisable to keep them distinct. ii A PRIMER OF SCIENTIFIC INVESTMENT For investment purposes, therefore, the world may be divided into seven divisions viz. : United Kingdom. Europe. Asia, including the East Indies, Philippines, etc. Africa. North America, including Canada, Mexico, and West Indies. South America. Australasia, including New Zealand and the Pacific islands. Any sum of capital evenly divided over these investment areas will conform to the first general principle of the science of investment viz., the averaging of risks, and will escape violent fluctuations arising from natural, industrial, or political causes. EQUALITY OF GRADE ALSO NECESSARY. Compliance with this general principle does not, however, of itself suffice to insure complete success, because if the securities in one investment division are badly chosen, or are inferior in quality to those in other divisions, the scheme will to that extent be dislocated ; so that it becomes needful to insure equality of grade. With this achieved, an invest- ment scheme is perfect, and as the sum total of the world's prosperity is steadily increasing concurrently with the increase in population (or even more quickly, on account of the growth of invention), this means that in aiming solely at perfect equilibrium or stability of capital one is insensibly aiming at increased value of capital, for the normal trend will be upward. As will be shown later, by constantly watching over the different stocks held, taking good profits where they are obtainable and an equally good but cheaper stock in the same division is available, it is quite possible to increase the total value of one's capital. This requires more atten- tion than either of the other two aims, and, after all, it is worth a little trouble. 12 CHAPTER III. THE CLASSIFICATION OF INVESTMENTS. DEBENTURES, PREFERENCE AND ORDINARY SHARES. B EFORE we can grade investments it is desirable that we should attempt some classification of investment securities. The classification and grading of negotiable securities may be done in various ways, but it is important at the outset to have quite clearly in one's mind the distinction between securities rendering one a creditor and securities rendering one a partner. In the former category are included all Government and municipal loans and all classes of deben- tures. Holders of this description of security are in the position of lenders ; they are entitled to their interest whether profits are earned or not, and, in the event of default, they have in the majority of cases redress ; furthermore, with few exceptions, their capital is repayable at some period or another. Holders of shares or ordinary stock are in the position of partners ; the interest they receive is contingent upon the profits, and in the event of failure they may only share in the division of the assets after the debenture holders and other creditors have been satisfied in full. 13 c A PRIMER OF SCIENTIFIC INVESTMENT By way of compensation, their dividends are not limited to a fixed rate, but vary according to the profits. Holders of preferred stock or shares are in the same position of partners, except that their dividends are usually limited to a fixed rate, in compensation for which they come before the ordinary shareholders, both as regards dividends and repayment of capital invested, in the event of a winding-up ; but their dividends are still dependent upon profits being earned, and in any case, the claims of the debenture holders and ordinary creditors have to be met in full before anything can be repaid to the holders of preference shares. It is obvious, therefore, that both ordinary and preference shares are of a more or less speculative character the ordinary shares more so than the preference and that from the investment point of view debentures are infinitely to be preferred to them. Plain as this fact is, there are thousands of people holding ordinary shares the annual return on which is no more, and often less, than on debentures. The only justification for this would be the likelihood of such an increase in the value of the shares as to atone for the vastly enhanced risk : this is, however, seldom the case. It might be argued that ordinary shares in a sound under- taking having no prior charges in front of them are less speculative than the preference shares of another concern which has issued debentures. This is true of some cases, but the fact remains that the holder is still in the position of a partner, instead of a protected lender, and subject to the fluctuations in earnings which affect the value of every partnership. CLASSES OF NEGOTIABLE SECURITIES. The negotiable securities quoted on the Stock Exchanges of the world may be conveniently divided into the following classes, according to the nature of the borrower or under- taking: A PRIMER OF SCIENTIFIC INVESTMENT 1. Government Loans. 2. Corporation i.e., Municipal Stocks. 3. Railway Debentures and Stocks, British. 4. Colonial. 5. Indian. 6. American. 7- ,> Foreign. 8. Waterworks. 9. Gas Companies. 10. Electric Light Companies. 11. Electric Light and Power Companies. 12. Tramway Companies. 13. Telephone and Telegraph Companies. 14. Banking Companies. 15. Land Companies. 16. Shipping Companies. 17. Commercial and Industrial Companies. GOVERNMENT, STATE AND CORPORATION LOANS. In Classes I and 2 we have certificates of indebtedness, the payment of interest on which, and the repayment of the capital of which (except in those few cases such as Consols, French Rentes, etc., which are either perpetual or only redeemable at the option of the borrower) are uncondition- ally guaranteed by the State, province or town, as the case .may be. In some instances certain assets and revenues are specially hypothecated as security for such loans, but as one has really to do with a moral obligation on the part of a Government or a city, it is evident that in appraising the degree of security offered by loans of this nature, the history and character of both Governments and people must be taken into account, so that there is room for a wide divergence in quality among the various loans in these three classes. On the other hand, 15 A PRIMER OF SCIENTIFIC INVESTMENT it is to be said in favour of this class of security that taxes and rates (which form the security for the payment of interest) have to be paid, and it is on this account that loans of this description are almost invariably quoted at higher prices than others, and consequently give a lower return to the investor. Even here an anomaly has to be noted. Government loans are usually priced more highly than town loans in the same country, but a good town loan is probably a better security than a Government loan, because in the event of default there is the central Government to put pressure on the municipal authorities, whereas in the event of the State itself defaulting, there is no higher authority to which one may appeal. Moreover, Governments may change, but the old- established town goes on. LOANS GUARANTEED BY GOVERNMENTS. There are many loans in existence which are specifically secured upon a certain undertaking, such as a railway, but are also guaranteed by a Government. If such guarantee relates to both interest and repayment of capital, the loan may be regarded as of the same quality as a Government loan ; if anything, it is better. RAILWAY DEBENTURES. In the case of Classes 3 to 7 we have the debentures and the preferred and ordinary stocks of railway companies in different parts of the world. As there are ranking behind the debentures large amounts of preferred and ordinary stocks, it is easy to form an idea of the degree of security afforded on the basis of past results by showing what dividends have been paid on stocks ranking behind the debentures, and what proportion the total bears to the amount required annually for the payment of interest on the debentures. Other factors, however, such as the progress of trade in the particular country, the extent of actual and potential com- petition, all have an influence on the value of the securities of 16 A PRIMER OF SCIENTIFIC INVESTMENT railway companies, and only by a careful investigation of all the circumstances can the relative value of the different railway debentures and stocks be determined. PUBLIC UTILITY COMPANIES. In Classes 8 to 13 we have to deal with what may be called Public Utilities. Now, while these are in a sense industrial companies, they really rank higher, provided their concessions (or franchises) are perpetual or for a number of years in other words, that they enjoy a monopoly. As the services they provide are largely of an indispensable nature their revenues are necessarily more secure than those of any undertaking liable to competition, and as, generally speaking, the demand for these services increases concurrently with the increase in population, the securities of companies of this description are well worthy of attention. Great care must, however, be taken to see that the con- cessions are sound, and that, in the not uncommon event of the municipality having the right to buy out the company at a given date, the conditions of purchase as set forth in the concession are such as would leave the company with sufficient to pay the debenture holders in full. Here, also, it will be seen that careful investigation of numerous factors is necessary before the relative value of the securities of companies of this nature can be arrived at. BANKING COMPANIES. The assets of a bank, which consist usually of advances to customers and negotiable securities, are not suitable security for debentures ; consequently, except in the case of land- mortgage banks, with which we deal under the heading of " Land Companies," bank debentures are almost unknown. For some reason or other, preference shares are seldom, if ever, issued by banking companies, and as the business of a well-established bank is of a lucrative and safe character, the 17 A PRIMER OF SCIENTIFIC INVESTMENT ordinary shares of companies of this description, having neither debentures nor preference shares ranking in front of them, are usually less risky than ordinary shares of other commercial undertakings. Those banks firmly established in " new " countries such as Argentina, Canada, Brazil, Mexico, etc., the prosperity of which necessarily grows at a much more rapid rate than that of older and more highly developed countries, are attractive, as they have every likelihood of sharing in such increased prosperity. The general factor of importance here lies in selecting that country which, at the moment, offers the greatest prospects of increased commercial prosperity. This decided, one must select the particular banking institution working in that country whose shares at that juncture happen to be the cheapest, after allowing for the amount and regularity of dividends. Many bank shares are only partly-paid, and others carry a special liability in connection with note issues and deposits. Such shares are to be avoided unless the yield on the price is sufficient to constitute ample compensation for this serious disadvantage. LAND COMPANIES. Land being one of the first essentials of life on this planet, and the supply being limited, the debentures and, for high yields, the preference shares of good land-owning companies are an excellent form of investment. But the value of land is dependent upon certain conditions, and in measuring the value of any securities of this nature care must be taken that the property consists of well-developed land, or land which will have an assured value when developed, and that the amount of indebtedness does not bear more than a safe proportion to the lowest selling value of the property. If the surplus revenue from the land for the last few years has not been well in excess of the amount required to meet the interest on the debentures, the latter, however good the undertaking may appear to be, are not a safe investment. 18 A PRIMER OF SCIENTIFIC INVESTMENT The bonds or debentures of banks or companies doing a land-mortgage business are usually well secured, for such companies lend only up to a certain percentage often 50 per cent. of the assessed value of the property mortgaged. Moreover, as these loans are repayable by instalments, the first of which falls due shortly after the granting of the loan, the margin of safety is at once increased. The value of such bonds varies according to the special circumstances of each company : i.e., the proportion the bond issues bear to the capital ; the amount of capital and reserve funds ; all require careful investigation. There is no doubt, however, that it is among securities of this description that some of the highest yields, compatible with well-nigh absolute safety, are to be obtained SHIPPING COMPANIES. Shipping companies usually issue debentures, but we are not enamoured of this class of security. Theoretically, the shipping industry enjoys the advantage of mobility that is to say, if business is bad in one part of the world the vessels may be diverted to another part where conditions are more favourable ; but in practice, and in face of the internecine competition which prevails in this industry, this advantage does not count for much, and the shipping trade is of too fluctuating a character to render the debentures suitable for the majority of investors. The ordinary shares of shipping companies are altogether speculative. COMMERCIAL AND INDUSTRIAL COMPANIES. In our opinion, the majority of industrial and trading com- panies are not undertakings on the security of which deben- tures should properly be issued. In view of the enormous number of debentures of this description which are quoted on the stock exchanges this statement will appear somewhat far- reaching, but that we cannot help. From the standpoint of a trading company earning profits in excess of 7 or 8 per cent. , it is, of course, good business to raise capital at from 4 to 19 A PRIMER OF SCIENTIFIC INVESTMENT 6 per cent., but from the point of view of the investor it is a question whether a commercial trading concern gives com- mensurate security. The success of an ordinary commercial business depends upon so many unstable factors fashion, the business ability of a single individual, the life of a patent and is ever exposed to the danger of competition. We will not go so far as to say that commercial debentures should under no circumstances be held, particularly in cases where a high return on the capital is looked for, but extreme caution should be exercised in their selection, and only those should be passed which are amply secured by the special hypothe- cation of immovable assets of a realisable nature. Even new buildings may prove not to be worth their cost price if they have to be realised, for a huge structure like a hotel or a big department store which fails may be suitable for no other purpose, and on that account realise only a trifle in a forced sale. Where debentures or shares in trading concerns are held, the annual balance sheets should be subjected to a most stringent analysis immediately after their appearance, for from the growth of certain items and shrinkage in others, as well as other indications familiar to the expert, the first signs of decay or unsatisfactory management may often be detected. CHAPTER IV. THE GRADING OF INVESTMENTS. THUS far we have dealt with the classification of the various forms of stock exchange securities, and enough has been written to show that some generalisation as to the superiority of one class of loan or undertaking over another is possible. But it is evident that a scientific system of investment cannot be built up upon mere considerations of a general character; for while, as a rule, a railway debenture is safer than the debentures of a commercial concern, the debentures of the best commercial company in a given country are probably better in quality than those of the least successful railway company situated in the same region. If, however, each investment is examined upon its merits, taking careful account (i) of the considerations of a general character already referred to, and (2) of the special position and circumstances of the particular loan or undertaking in view, it becomes possible to put such investment in its proper place as regards comparative value with other securities, or, in other words, to grade it. We would divide Stock Exchange securities into five grades, as follows : 21 A PRIMER OF SCIENTIFIC INVESTMENT GRADE I (EXCELLENT). Securities which may be considered either as absolutely safe as regards payment of interest and (where redeemable) repayment of capital when due, such as the loans of the British Government and Municipalities, and of first-class foreign and Colonial Governments and Municipalities, or in which the possibility of default is exceedingly remote. In this grade would be included the bonds of the best land- mortgage banks, the debentures of railway and other " public utility " companies of the very first order, and the first mortgage debentures of a very limited number of manu- facturing or commercial companies, which are so well estab- lished and so well covered by assets and annual profit-earning capacity as to place them in the first rank. In this grade there is often room for some appreciation in the capital value of securities. GRADE II, (Gooo). Securities where the interest and repayment of capital appear to be well secured, but subject to some slight risk, such as the loans of South American or Mexican provinces and municipalities, the debentures of public utility companies of second rank or in countries of the second grade, shares in banking companies established some years and paying regular dividends, the debentures of well-established industrial or commercial companies offering an ample margin of security, and the preference shares of some first-class commercial and industrial companies. Securities of this grade have a good chance of appreciating in capital value, but require more careful surveillance than those of the first grade. GRADE III. (MODERATELY SPECULATIVE). Securities, the capital and interest of which appear to be " fairly safe " ; as, for example, the debentures of trading 22 A PRIMER OF SCIENTIFIC INVESTMENT companies which are sufficiently covered by assets and annual profits, but without any appreciable margin of safety. In this category, too, would be placed Government loans of low rank, and the preference and ordinary shares of many commercial companies paying regular dividends. Securities of this grade naturally show greater chances of appreciation and depreciation than those of the first two grades, the limits of fluctuation being wider. GRADE IV. (SPECULATIVE). Speculative stocks or shares, such as the ordinary shares of companies whose profits and dividends fluctuate con- siderably from year to year, the majority of tried mining enterprises, and the preference or ordinary shares of new undertakings whose prospects appear promising. These securities may be termed " speculative/' and are not suitable for investment purposes. GRADE V. (HAZARDOUS). New companies, the profits of which are wholly problema- tical, untried mining enterprises, and speculative schemes of all descriptions. CHAPTER V. HOW TO CONSTRUCT AN INVESTMENT SCHEME. ONCE the grade of the different securities is established it becomes possible to devise a scientific scheme of investment, dividing one's capital, however large or small it may be, into seven equal parts, each part being spread over one of the investment areas indicated on page 12, in securities of the same grade. WHICH GRADE ? Naturally Grade I. affords the greatest possible degree of security, but with a correspondingly low rate of interest. By separating his capital over the seven investment areas, however, the investor undoubtedly obtains a higher rate of interest than if it were all placed in British stocks of the same grade. If, for example, the investor buys 1,000 of 2 1 per cent. Consols at 82, at which price they yield 3 per cent., and 1,000 of Prussian 3 per cent. State Loan at the same price, at which it yields 3! per cent., he obtains an average yield of 3fV per cent., as compared with the 3 per cent, he would get if the whole of the 2,000 were placed in Consols. As regards security he is a positive gainer, the Prussian national debt being, as a matter of fact, more than covered by the value of reproductive assets belonging to the State. 24 A PRIMER OF SCIENTIFIC INVESTMENT At the present juncture Grade I. securities properly dis- tributed in the manner indicated would produce a yield of between 3^ per cent, and 4^ per cent., and, as will be shown later on, give an investor, working on scientific lines, oppor- tunities for increasing his capital without in any way lessening its safety. Grade II. securities are suitable for those individuals who are willing to incur a very slight risk for the sake of a relatively high yield, with good chances of capital increase, but such investors must be prepared continually to watch over their holdings, and to effect frequent changes as circumstances arise, rendering the sale of one security and purchase of another desirable. At the present time a yield of about 5 per cent, may be obtained on securities of this grade. Grade III. securities should only be held by those investors who attach considerable importance to an increase in the value of their capital, and who are prepared to face the greater risk involved. To minimise the risk it is advisable, with securities of this grade, to spread the risk over as large a number as possible of different stocks or undertakings ; consequently it is easier to work on this grade of security with a large capital than with a small one. An average rate of 6 per cent, can be obtained in this grade. Grade IV. securities can only be recommended to indivi- duals who fully appreciate the risk they are running, or where a certain sum is deliberately set aside for the purpose of laying it out in securities of this description, the possi- bilities of gain and loss on which are naturally greater than with the grades already mentioned. It is unnecessary to speak further of securities coming under Grade V. Where the investor hesitates between two grades he may, if his capital is sufficiently large (the smallest sum which 25 A PRIMER OF SCIENTIFIC INVESTMENT should be placed in any one security is 100), decide upon spreading his money over two grades, but it should be divided equally over each investment area, otherwise the first rule of scientific investment is at once transgressed. We will assume now that the capital at the investor's disposal has been divided in the manner indicated. The task is by no means finished, for, as a result of the thousand and one influences, natural, economic, and political, to which each security is subject, what is to-day the best and most remunerative investment of its grade and class may, in a month's time, have changed its rank. It may, for example, have risen somewhat in price, while, during the same period, another security of equal grade may, owing to some adventitious circumstance such as, for instance, the pressing for sale of a large parcel of stock belonging to a deceased holder have fallen temporarily in price, with the result that an exchange from the first to the second security is advantageous, the amount of income being left unchanged, but the profit constituting a valuable reserve. Circum- stances may arise of an unfavourable nature in connection with one of the investments, rendering an immediate sale advisable. It will be seen, therefore, that it is not sufficient merely to grade one's own investments, but necessary to watch all other investments of similar grade, so as to be able to avail one's self of any favourable opportunities occurring. For obvious reasons the necessity for this action cannot be escaped by the holder of even the finest gilt-edged securities. This is certainly a formidable task imposed upon the investor, and how he can achieve it is set forth in a sub- sequent chapter. FOREIGN MARKETS. London undoubtedly has one of the world's most im- portant stock exchanges, and the five or six thousand securi- ties quoted in the official list offer considerable scope for 26 A PRIMER OF SCIENTIFIC INVESTMENT selection. But London is by no means the only important stock exchange in existence, and it is obvious that, the wider the field of selection, the more likely is one to find good securities. Furthermore, in framing an international scheme of investment it must necessarily happen frequently that a foreign security can be obtained more cheaply on its home market than a similar grade of investment, belonging to the same country, which has been introduced on another market. The extent to which this occurs would surprise the majority of investors if only they were in a position to make the necessary comparisons. On the other hand, the average investor naturally prefers to deal on a stock exchange with the customs of which he is more or less familiar and where he can readily follow the course of quotations. A good list of investments must, however, include a certain number of securities which are quoted on foreign stock exchanges, this being an additional influence in assuring stability of the total sum invested, for the tone of the market and, consequently, quotations may be good in Paris or Berlin at a time when, on account of local conditions, they are bad in London. These market conditions, which may vary in the different stock exchanges of the world, con- stitute a secondary influence on prices, the primary influences being, of course, those which affect the intrinsic value of the security viz., the general condition of affairs in the country or region in which is situated the authority or under- taking whose loan or shares are held, and the actual position of the authority or undertaking itself. This secondary influence brings about opportunities of more favourable investments in one financial centre than another, and affords increased facilities for advantageous exchanges by selling in a good market, and at once reinvesting the proceeds in securities of similar grade, though temporarily depressed, in another market. The inclusion of some foreign quoted stocks in every scheme of investment is highly desirable, and the larger the total capital invested the larger should be the proportion of such stocks. 27 A PRIMER OF SCIENTIFIC INVESTMENT ONLY QUOTED SECURITIES SHOULD BE HELD. Only such loans, debentures, or shares as are regularly quoted on some stock exchange or another should be held. Without this the investor loses all possibility of ascertaining at any time the market value of his holding, and consequently the amount of his capital ; for, once invested, the amount of that capital is, of course, no more and no less than the sum obtained by the sale of the securities. The price originally paid no longer enters into the question. UNQUOTED SECURITIES. Owing to the enormous profits attaching to them there is a much larger business done in unquoted stocks than the average investor dreams, and before purchasing any security recommended to him the investor should satisfy himself that it is quoted on a stock exchange, or, in the case of a new issue, that the prospectus contains the specific assur- ance that a quotation will be applied for. If not, his position, should he wish to sell, will probably be an unenviable one. The only means he has of ascertaining the realisable value of such securities, or of checking the prices furnished to him by interested parties, such as the vendors, is to inform the latter that he wishes to dispose of his holding, and to ask point- blank the price they can offer for it. This, however, he will not do if he wishes to preserve his peace of mind. I CHAPTER VI. DISABILITIES OF THE INDIVIDUAL INVESTOR. SUMMARY. F we summarise the essentials of successful investment as here set forth, we find that it is necessary 1. To average the risk by spreading one's capital in equal parts, and in securities of the same grade, over the whole of the earth's surface, adopting for this purpose certain well-defined investment areas. 2. To keep a sharp watch over the general trend of things the value of money, the crop outlook, the course of trade, political conditions, etc., in the different countries comprising each investment area. 3. To follow carefully the development of each under- taking in which one has money invested, and with this end in view, to scrutinise searchingly the annual reports and balance sheets, and any other particulars available. The lower the grade of security held, the more imperative the need for this regular supervision and investigation. 4. To watch the quotation of all securities of similar grade and class in the same investment area, including new issues 29 A PRIMER OF SCIENTIFIC INVESTMENT offered for public subscription, and to change from one security into another of equal quality as soon as the discrepancy of price and general conditions warrant such a course. Now, it is quite obvious that no single investor is possessed of either the time or ability to comply with all the require- ments indicated as being essential to successful investment. In the first place, he must keep himself au courant with all that goes on throughout the world having any bearing upon investment conditions in general and his own investments in particular. It is not sufficient to read one or even three, financial dailies. A perusal of the Statist, the Economist and the Investors' Review, all containing sound and reliable infor- mation, would require to be reinforced by a study of the articles and prices in such foreign publications as the Moniteur des Interets Materiels of Brussels, the Cote Defosses or L' Infor- mation of Paris, the Berliner Borsen-Zeitung, La Finance Egyptienne of Alexandria, the Commercial and Financial Chronicle of New York, the Monetary Times of Toronto, Capital of Calcutta, and a score of others that could be named. In an obscure financial journal published in Mexico, Buenos Aires, or some foreign or colonial centre, there may be an item of news relating to a tramway or lighting concession, or to a particular company, which may mean hundreds of pounds to the investor. The few financial houses referred to in the introduction to this little book will be made aware of this item of news ; but not so the individual investor, who has to wait weeks and sometimes months before he sees the inward explanation of certain price movements that have hitherto been inexplicable to him. Then, assuming that the individual investor has sufficient financial knowledge and judgment to allocate the principal securities to their respective grades, he must for this purpose have access to the financial reference books of the world ; in addition to the excellent British works of reference such as the Stock Exchange Official Intelligence and the Stock Exchange 30 A PRIMER OF SCIENTIFIC INVESTMENT Year-Book, he will find the numerous French Annuaires, the splendid Belgian Recueil Financier, the German Saling's Borsenpapiere, the Austrian Compass to name only a few absolutely indispensable ; and if he is to ascertain which are the cheapest and most profitable securities of a given grade or class at any particular moment, he must have facilities for studying the lists of quotations of the principal stock exchanges of the world. THE NEED FOR EXPERT AID. It is quite apparent that no single individual can hope to possess either the capacity or the facilities for any such scientific method of investment, and that if the carrying out of any such method is to be rendered possible, some organisa- tion built up on the lines of those intelligence departments mentioned in the preface must be available for the use of private investors ; in other words, expert and professional assistance is necessary. And, after all, how can there be any doubt on this point ? When a man builds a house, he employs the services of an architect that is, a building expert ; if he raises, or invests in, a mortgage, he employs a solicitor. There are consulting engineers, architects, physicians why not consulting financial experts ? In all these matters a man recognises the fact that he is an amateur and requires professional aid ; and if pro- fessional assistance is necessary in the laying out of a house, surely it is still more necessary in the laying out of one's fortune, be it large or small. The fact that an investor avails himself of the service of professional financial advisers does not imply that he should surrender control of his fortune. He can consult his expert advisers, weigh up their recommendations, insist upon full reasons being given, and all the evidence adduced in support of such recommendations. Then, after having been placed in possession of the facts which have caused his advisers (with the superior facilities and all the machinery at their A PRIMER OF SCIENTIFIC INVESTMENT disposal) to advise a certain action, if he does not agree with such advice, he is under no necessity to follow it. In the following and concluding chapter of this little work, we show how both the large and small investor may have at his disposal all the machinery of a perfectly-equipped financial house, right down to the minutest detail, including the services of a highly organised intelligence department, and the impartial advice of leading investment experts, without any additional cost to himself, the manner in which the company, offering these facilities, recoups itself being clearly and unequivocally indicated. CHAPTER VII. THE BRITISH, FOREIGN & COLONIAL CORPORATION, LIMITED. THE British, Foreign and Colonial Corporation,* Limited, has been constituted to carry out for its customers, on the scientific basis outlined in this book, all the work connected with their investments. By means of its unrivalled statistical and intelligence department it is able to advise investors as to the most lucrative manner in which they can lay out their surplus capital, and systematically to supervise their investments, advising from time to time when circumstances render a change from one security to another profitable. The Corporation is also prepared to look after every detail of investment, including the purchase and sale of securities in the best market, the cashing of coupons, the presentation of bonds and debentures when due for repayment, etc., etc. In short, all that the intelligence department of a great financial house, as described in the preface, can do for its firm, the British, Foreign and Colonial Corporation does for its customers, placing at their full disposal all the machinery of a modern financial establishment. * 88 Bishops^ate Street Within, London, E.G. 33 A PRIMER OF SCIENTIFIC INVESTMENT The different ways in which the Corporation can be of service to the investor will best be illustrated by some actual examples ; but, before doing so, it is necessary to give a description of the methods and system by which such an organisation is arrived at. THE INDEX OF INVESTMENTS. In the first place, the list of every important stock exchange in the world is carefully gone through, and the name of every security of apparent worth extracted. The size of the residuum i.e., stock exchange securities which to the eye of the expert are immediately rejected as unsuitable for investment, would surprise and appal the average investor. Each security selected at this preliminary stage is traced back in the reference books and subjected to a critical in- vestigation. If it survives this ordeal it is classified and graded according to the system already described in Chapters III. and IV. Those securities which are not invest- ment stocks at all are at once eliminated. The remaining securities are now sorted out according to their respective areas, and are entered in separate indexes (one for each investment area) in which are shown the essential particulars of each stock, such as the nature of the security, the amount of debentures ranking in front, the amount of preference and ordinary shares ranking behind, the date of redemption, the dividend dates, etc., so that each volume contains a bird's-eye view of all the good investments in a determined area, divided up into their various grades of safety. Now the latest quotation of each security is written in, and the net yield which, at that price, it gives to the investor, is worked out. These particulars are constantly revised as quotations change, and the index is continually undergoing alteration ; for if the analysis of a company's balance sheet shows that it has fallen from the standard which determined its inclusion into its grade, or if any other circumstances are known which render it a less desirable investment, it is taken out of the list. In the same way, every new public issue, in every 34 A PRIMER OF SCIENTIFIC INVESTMENT financial centre, is carefully examined, and if found suitable is classified, graded and added to the index. What we have thus far described, however, is merely the preliminary or " working " index. After the quotations have been revised in accordance with latest prices, the most attractive stocks in each grade are selected, undergo a further careful investigation, any points requiring elucida- tion (and this is of frequent occurrence) being cleared up either by reference to the houses responsible for the issue, or by inquiry of the Corporation's agents in the different financial centres, and are then entered in the final index, which shows at a moment the pick of the world's investment securities quoted on the different stock exchanges. A detailed description or analysis of each loan or security included in this final list is made and filed for easy reference. PURPOSES SERVED BY INVESTMENT INDEX. The purposes served by the index are manifold, for not only does it enable one to select the most remunerative investment in any class, grade or country, but it also serves as a standard of value against which may be measured the value of any existing investment or any new issue. NEW ISSUES. For instance, a 4 per cent, loan of the city of Budapest is offered in London to the investing public at 95 J i.e., 95 los. for the 100 bond. An investor inquires how this loan compares in price with loans of similar grade, and if it is to be recommended. Analysis of the prospectus, together with further parti- culars culled from Austro-Hungarian reference books, show that the security is excellent, and although the political situation in Hungary is not wholly satisfactory, the safety 35 A PRIMER OF SCIENTIFIC INVESTMENT of the loan of this city of over 800,000 inhabitants, with a rapidly increasing population, itself holding property con- siderably in excess of its total indebtedness, cannot be ques- tioned. It therefore falls into Grade I., and at the issue price yields 4 45. per cent. On turning up the index to ascertain how this loan compares in price with other European securities of similar rank, we find that, at that moment, other 4 per cent, loans of the city of Budapest are quoted in Budapest itself at 92, yielding 4 6s. nd. per cent., and that the Roumanian 4 per cent. Gold Loan, which is redeem- able at par by semi-annual drawings between now and 1940, and therefore offers the chance of a handsome bonus at any moment, is quoted in Berlin at 90^, yielding 4 8s. 6d. per cent. ; that the Bucharest 4! per cent. Loan is quoted, also in Berlin, at 98, yielding 4 us. 6d. per cent., not counting the profit on redemption ; whilst the Roumanian 5 per cent. Loan is quoted in Amsterdam at 98 J, yielding 5 2s. 3d. per cent. All these loans are of the same grade ; therefore, while the new City of Budapest 4 per cent, issue is an excellent loan, it is not as cheap as others of the same quality, and the customer had better place his money in one of those named. INVESTMENT OF A CAPITAL SUM. Or, again, an investor may write that he wishes to lay out the sum of, say, 5,000, to the best advantage. On being ques- tioned as to the precise nature of his requirements it is found that he will be content with an average of about 4} per cent, interest, provided he can sleep soundly on his invest- ments and be sure of no loss of capital. This capital is divided into seven sums of about 700 each, and by means of the index two first-grade investments are selected in each investment area in such manner that the yield averages fully 4! per cent. From the moment of purchase a careful watch is kept over each security held by the investor, who is from time to time advised of any change 36 A PRIMER OF SCIENTIFIC INVESTMENT in his investments that circumstances make desirable. Such a list as this, scientifically framed from the outset, gives the minimum of trouble, and as the yield expected is a reason- able one, it requires less readjustment as time goes on than in cases where 5 per cent, interest or more is expected. A GOOD INVESTMENT. Another investor may not be wholly converted to the idea of scientific investment of capital, or may be loth to part with those of his existing investments, the sale of which is necessary to the adoption of the principle ; but he has a sum of money available and wishes to lay it out to advantage. On his requirements being made clear, he is given the choice of those investments which the index shows to be the safest and most profitable of their kind at the moment. RE-FORMING INVESTMENTS. Another typical case is that of an investor having some 10,000 placed in various securities. He is slightly sceptical both as to the advantages offered by any scientific scheme of investment and as to the bona fides of the institution anxious to advise him. As a keen man of business, however, his mind is always open to new ideas, and he is curious to see to what extent other people, claiming to be experts, can improve his list of investments. He accordingly sends in a list of his stock and share-holdings, which proves to be one of the usual heterogeneous masses of all sorts of securities, ranging from Grade I. down to virtual rubbish. While some of the securi- ties held are undeniably good, his interests are confined far too much to one or two countries, and he holds several stocks of quite inferior rank (ordinary or preference shares) which yield less return on the invested capital than he can obtain by purchasing debentures of better concerns secured by a first mortgage. By means of the index it is not a difficult matter to suggest a certain number of exchanges (all quoted securities) which will improve both the average yield and the security. 37 A PRIMER OF SCIENTIFIC INVESTMENT The improvement is so obvious that the investor, and his banker, to whom he shows the list, are convinced as to its superiority, and the scheme is carried through. LIMITATIONS. It is unnecessary to multiply these instances. Of course, impossibilities cannot be achieved. The widow who is left 1,000, and requires at least 7! per cent., which must be absolutely safe, as this sum is all she possesses in the world, cannot be satisfied by the means at the disposal of the Cor- poration. She will be advised to content herself with from 4f per cent, to 5 per cent., with the likelihood of a gradual increase of capital, that being the highest yield at present obtainable consistent with the degree of safety vital to one so circumstanced. If an investor asks for an investment scheme giving an aver- age yield of over 6 per cent., combined with absolute safety, he s informed that what he desires is impossible. What the Corporation can do, with all the facilities at its disposal, is to draw up a list of investments giving the desired income, which are certainly safer in the aggregate than any list of invest- ments the investor himself or an ordinary broker, with their more limited resources and knowledge, could hope to obtain, and it is in a position to give such a scheme the unceasing surveillance that is absolutely necessary if it is to be successful and result in an increase of capital. INQUIRIES. Isolated inquiries as to the position or prospects of individual stocks or undertakings are answered with the same care as those of a wider nature, the same resources naturally being available for work of this description. STATISTICAL DEPARTMENT AND LIBRARY. In the Statistical department of the British, Foreign and Colonial Corporation are filed the lists of all the principal 38 A PRIMER OF SCIENTIFIC INVESTMENT Stock Exchanges of the world. By means of one of the most highly specialised libraries in existence, containing financial works of reference in all languages, as well as the principal Home, Colonial and Foreign financial journals, combined with the services of a network of agents and correspondents in every financial centre, the Corporation is able to give the latest information and special advice, based on expert know- ledge, regarding every security no matter where quoted. The reports and accounts of all undertakings in which customers are interested are subjected to minute analysis, daily fluctuations in the prices of the leading securities in all the markets of the world are carefully watched, and investors are immediately advised when any favourable opportunity for a change in investment arises. Investors are invited to make the fullest possible use of the Library and of the services of the Statistical Department, and are also invited to call and examine the system, described in this chapter, in full operation. METHODS OF BUSINESS. The investor who wishes to avail himself to the full of the advantages offered by the British, Foreign and Colonial Corporation will send in a statement of his present investments (forms for the purpose will be furnished on application) for criticism. A detailed opinion on the composition of the investments and any recommendations of a general character arising therefrom will then be submitted to him. The employees of the Corporation are pledged to secrecy in the same way as all bank employees. TERMS. The investor will now be asked whether, if he agrees in prin- ciple with the recommendations, he wishes the Corporation to advise him fully and in detail as to the changes he should 39 A PRIMER OF SCIENTIFIC INVESTMENT effect in his investments in order to bring about the desired degree of income and safety. It is made clear to him that if he entrusts the sale and purchase of securities, resulting from the recommendations, to the Corporation, no charge is made for the work performed, but if he gives the business elsewhere (and some investors not unnaturally prefer to give all their business to the brokers or others with whom they have always dealt), a fee agreed upon is charged. The Corporation buys and sells stocks from or to cus- tomers at net prices not exceeding the official stock exchange quotations, but where this is impossible the Cor- poration is also prepared to act as agent, charging a commission for its services. By virtue of its better financial knowledge, its extensive connections and the size of its dealings the Corporation, which has agents and representatives all over the world, is able to buy and sell to very much better advantage than individual investors. Stock exchange securities are surprisingly like other mer- chandise : there are wholesale and retail prices, lines avail- able or wanted in certain quarters, and special terms for large traders, if one knows where to go. The Corporation can frequently give better terms to customers than they would get by selling or buying through the ordinary channels, and in no case does the customer have to pay more or receive less than the stock exchange quotation of the day. Furthermore, the Corporation, which carries on general banking business, also undertakes the underwriting of Government and municipal loans, and debentures of the quality and value of which it is satisfied, after subjecting them to the same strict scrutiny and tests that are applied by the Statistical Department to stocks already quoted. The British, Foreign and Colonial Corporation Limited* does not recommend or undertake speculative business, and any orders of such a nature will be respectfully declined. * 88 Bishopsgate Street Within, London, E.G. THIS BOOK IS DUE ON THE LAST DATE STAMPED BELOW AN INITIAL FINE OF 25 CENTS WILL. BE ASSESSED FOR FAILURE TO RETURN THIS BOOK ON THE DATE DUE. THE PENALTY WILL INCREASE TO 5O CENTS ON THE FOUR! DAY AND TO $1.OO ON THE SEVENTH DAY OVERDUE. NOV 20 IS37 APR LD 21-100m-8,'34 W. H. SMITH 5 5 Fetter Lane, I &Arden Press,]