THE WARES OF THE MARKET
It has been seen that the Stock Exchange is a market, of which the wares
are stocks and shares. There is some considerable difference, however,
between stocks and shares, and there are various kinds of stocks and
various kinds of shares. It may be interesting and profitable to inquire
into the distinctions, to examine, in fact, with some detail the wares
of the market. A stockholder is frequently called a shareholder even by
the most precise, but, strictly speaking, the terms are not synonymous;
stocks are not shares. Stock is calculated by quantity and shares by
number; stock is capital in a lump, while shares are capital divided
into equal parts; although the unit of stock is usually £100, any
quantity, such as £218 13_s._ 1_d._ worth, can, in the case of leading
stocks, be bought, whilst shares, which are usually of the denomination
of £1, £5, or £10, are indivisible, and can be dealt in only in
multiples of their nominal value.
All the various kinds of securities--including both stocks and
shares--can conveniently be divided into three main classes according to
the manner in which they are passed from owner to owner. There are
inscribed stocks, registered securities, and securities to bearer; and
this classification has been adopted by the Stock Exchange itself in
drawing up those of its rules which relate to the settlement of
bargains, each of the three classes having its own set of rules.
Let us take first the class known as inscribed stocks, and we may
reasonably do this, for to this particular class belong the premier
securities--Consols, the other British Funds, Corporation stocks, and
Colonial Government securities. The holder of inscribed stocks may have
a bank receipt, but he has no certificate of his holding; his name is
inscribed as the legal owner in a register kept for the purpose at the
Bank of England, or some other bank or office. Such stock cannot,
therefore, be transferred from seller to buyer by the mere delivery of
documents, for there are no documents to deliver. To illustrate the
method of transferring inscribed stock, let us see how Consols, for
instance, are passed from a holder to the person to whom he has sold
them. A ticket, on a form supplied by the Bank of England, is issued by
the broker acting for the purchaser, and passed in the way explained in
describing the settlement. But in the case of inscribed stock the ticket
contains an additional item--the name and address of the ultimate seller
who is going to transfer the stock. This, of course, is filled in when
the ticket reaches the seller's broker. The ticket is taken by the
selling broker to the Transfer Office at the Bank, where the particulars
are copied into the Register. The transferor--identified by his broker,
who attends for the purpose--or his representative appointed by a power
of attorney, then has to sign the register in the presence of a clerk of
the Bank, who witnesses the signature, and also has to sign a receipt
for the purchase money. This receipt sets out simply that the transferor
has received a certain sum, being the consideration for so much interest
or share in such and such a stock which he has transferred to the
transferee. The receipt is subsequently handed over to the buying broker
for his client. The handing of this Bank receipt to the buyer of the
stock is, then, the recognised method of delivering inscribed
stocks--the seller who delivers the receipt before the appointed time on
Settling day is entitled to demand payment of the purchase price. It
will be seen that in transferring stock in this way the purchaser
himself takes little part; but on the receipt there is a special note
recommending transferees, as a protection against fraud, to accept the
stock by signing their names in the Register at the Bank. The use of
this is that the signature can be verified when any future transfer is
made and when dividend warrants are signed.
With the next class of securities, registered stocks and shares, by far
the greatest number of Stock Exchange dealings are concerned. In this
class are included nearly the whole of the securities issued by the
joint stock companies. The distinctive features of a registered security
are that it is transferable only by a separate conveyance or transfer,
and that no holder has a legal title to the security until his name has
been registered as the holder in the books of the company. On the
registration of the holder, the company issues a certificate as evidence
of his title in the manner described in a previous chapter.
Stocks which are neither inscribed nor registered frequently take the
form of bonds to bearer. A large number of foreign loans are issued in
this form, as also are a large number of the stocks of the American
railroads. These bonds to bearer pass from hand to hand in exchange for
money after the manner of bank-notes. They are a very convenient form of
security, but, at the same time, somewhat dangerous, as in case of loss
or destruction the holder has, of course, no means of proving that he is
the rightful owner. In this they resemble bank-notes, but they differ
from them in the fact that their currency is recognised in only a narrow
circle, and in that they, of course, bear interest. The Government or
the company which issues them has no means of knowing in whose hands
these bonds may be at the moment, and therefore it cannot remit the
interest payments as they become due. It is left for the holder to apply
for these payments, and this he does by presenting one of the large
number of coupons attached to each bond, each bearing the date of one
payment. Besides the coupons there is often attached to the bond a
"talon," enabling the holder to demand a fresh set of coupons when his
supply is in due course exhausted.
Although, for the purposes of Stock Exchange dealing and settlement,
securities may be thus divided into three great divisions, from the
point of view of the dealer in the market and of the outside investor
and speculator, there are many more interesting divisions, dependent,
generally speaking, upon the nature and rank of the security. At the top
of the list come the trustee stocks, which are the securities in which
the law of the land permits a trustee to invest the moneys he holds in
trust without incurring liability for any loss that may occur. Roughly
speaking, these include the Government securities of the United Kingdom
and of India; certain Colonial Government securities; the stocks of the
Banks of England and of Ireland; London Corporation and County stocks;
the inscribed stock of any borough or county having a population
exceeding 50,000; the stocks of the British railway companies ranking
before their ordinary stocks, provided a dividend of 3 per cent. has
been paid on the ordinary stock for at least ten years; various Indian
railway stocks, the interest on which is guaranteed by the Secretary of
State; the stocks of the water companies ranking in front of the
ordinary stock, provided that stock has received a dividend of not less
than 5 per cent. for at least ten years; and so on. These, of course,
may all be regarded as securities of the highest class--as what are
termed gilt-edged investments.
Ranking next to them, perhaps, are the first debenture stocks of the
railway and other companies which do not come within the Trustee Act.
Such a statement as this is naturally only general. Some debenture
stocks of industrial and mining companies are far less sound and secure
than the shares of the lowest rank of some well-established
undertakings. There are mortgage debentures and debentures which carry
no right of mortgage, and there are, in the case of many companies,
mortgage debentures of various classes, one class carrying a first
mortgage, another a second, and so on. Mortgage debentures are secured
by a specific charge on certain properties definitely scheduled, and in
case of default in the interest payment the Court will appoint a
Receiver in respect of such properties for the protection of the
mortgage debenture holders. Debentures which are not mortgage debentures
are secured by a floating charge over the properties and assets of the
company, and in the case of its default they rank as ordinary creditors,
being entitled to proceed against the company and levy execution. The
mortgage debenture and debenture stocks of a company are frequently
described as its fixed charge stocks, because not only does the interest
never vary in rate, but has to be paid whatever the profits of the
company. In fact, debenture holders, being creditors and not
shareholders, receive interest and not dividend.
These debenture stocks, like the loans issued by Governments and
Municipal Corporations, may be redeemable at a specified date or after
it. The approach of the redemption date naturally affects the market
price. If a stock at present quoted at 95 is redeemable ten years hence
at 100, the tendency of the price is, of course, to rise to the 100, and
one who buys the stock at 95, in calculating what it will yield him,
takes into account, of course, not only the annual interest, but the
fact that he must receive, as it were, a bonus of £5 when the company
buys the stock on the date of redemption. Similarly, if the stock is
bought at a higher price than that at which it is redeemable at some
future date, the buyer must regard the yield which it gives him as so
much less, for when the date arrives he must take for the stock less
than he gave for it. Some stocks are irredeemable, which means, of
course, that they go on bearing the rate of interest for ever. The
holder of the stock may sell it and thus get rid of the arrangement, but
the company or corporation is saddled with the debt and the obligation
of paying the fixed rate of interest upon it for all time. This may
prove inconvenient and unprofitable if the borrower can obtain loans at
a lower rate, but the only way to get rid of the burden is to make some
arrangement acceptable to the stockholders. Certain of the Government
stocks are redeemable at a comparatively early date, Consols themselves
being redeemable in 1923, but only at the option of the Government.
Although debentures are called fixed charge stocks, partly because their
rate of interest is fixed, and partly because it is a charge on the
income of the company before any consideration can be entered into as to
what profits there are to be divided among the shareholders, the rate of
dividend on certain classes of mere shares which rank after the
debentures is also fixed. A company may issue 4 per cent. or 5 per cent.
preference shares, and their claim upon the profits, as their name
implies, is preferential to that of the ordinary shares, which rank
after them. They must receive their 4 per cent. or 5 per cent., as the
case may be, out of the profits, and the ordinary shareholders have to
look for their dividend to any profits that remain. At the same time,
whereas debenture holders are entitled to their interest as a right, and
may proceed for it legally as for a debt, the shareholders, even
preference shareholders, go without their dividend if there are no
profits--and there is an end of it.
Many preference shares, however, are cumulative preference shares, which
means that if the profits in any year are insufficient to provide their
dividend, the stipulated rate must be made up out of succeeding profits
before the ordinary shareholders can receive anything. In the case of
preference shares which are not cumulative, each year is complete in
itself. They may be entitled to 4 per cent., but if the profits of the
year suffice to pay only 3 per cent., that is all they get. Even if the
profits of the next year are so good as to enable the payment of the
full 4 per cent. dividend on the preference shares, and 2 per cent. or
even 5 per cent. on the ordinary shares, the preference shares receive
only their 4 per cent., because they are not cumulative. If they were
cumulative, they would receive 5 per cent. to make up for the 1 per
cent. lacking in the preceding year, and the ordinary dividend would be
reduced accordingly. Of course, there may be first, second, and third
preference shares, cumulative or non-cumulative, just as there can be
different series of debentures, one ranking after another.
It will be seen that while the dividend on preference shares is more
certain than that on the ordinary shares of a company, it is at the same
time limited, whereas the dividend on the ordinary shares is only
limited by the profit-earning capacity of the company. In the case of a
well-established and prosperous concern, therefore, the price of the
ordinary shares may be very much higher than the price of the preference
shares ranking before them. In such a company the preference shares may
receive a certain 4 per cent., while the ordinary shares may receive 10
per cent., which, although by no means so certain, may be certain enough
for all practical purposes. In the case of many companies, of course,
the dividend on the ordinary shares varies considerably year by year,
and the price of the shares accordingly fluctuates widely.
Some companies, in order to meet this, have divided their ordinary
shares into two new classes, one called preferred ordinary, bearing a
fixed rate of dividend, and the other called deferred ordinary, taking
what remains for division. In fact, the preferred ordinary bears the
same relation to the deferred ordinary as preference shares bear to
ordinary shares. Suppose a company has paid a dividend on its ordinary
shares or stock averaging over a number of years 6 per cent. In one year
it may have paid 4-1/4 per cent., in another year 8 per cent. This
ordinary stock with its fluctuating dividend is divided into two parts.
Each holder of £100 worth of stock receives £50 worth of preferred
ordinary, entitled to a fixed dividend of 6 per cent., and £50 of
deferred ordinary, entitled to the remainder. Thus in the year when the
company paid 4-1/4 per cent., a dividend of 6 per cent. would be paid on
the preferred ordinary and a dividend of 2-1/2 per cent. on the deferred
ordinary--this making an average of 4-1/4 per cent. on the whole. In a
year when a company pays 8 per cent., the preferred ordinary still
receives 6 per cent. and the deferred ordinary 10 per cent. Instead of
the stock being thus divided, the same object is attained by its
duplication or watering. For each £100 of ordinary stock is issued a
nominal £100 of preferred ordinary and a nominal £100 of deferred
ordinary. In the case of the 4-1/4 per cent. dividend, the preferred
ordinary would receive its fixed 3 per cent., and the deferred ordinary
the remaining 1-1/4 per cent. Of course, this stock-splitting or
stock-watering enables the holder of the original stock to dispose, if
he chooses, of either the more speculative or the more stable security.
Even this list of Government loans, home and foreign, of trustee stocks,
of mortgage debentures, of debentures, of cumulative preference shares,
of preference shares, of ordinary shares, of preferred ordinary and
deferred ordinary, by no means exhausts the various kinds of wares dealt
with in the market. For instance, there are founders' shares, which are
usually issued at the time of the flotation of a company to those
specially interested in its promotion. Their peculiarity is that they
usually participate with the ordinary shares in any profits remaining
after a certain rate of dividend has been paid upon those ordinary
shares. There may be 100,000 ordinary shares of one pound each and 100
founders' shares also of one pound each. It may be stipulated that the
founders' shares participate equally with the ordinary shares after the
latter have received a 7 per cent. dividend. Suppose the divisible
profits amount to £20,000, the ordinary shares take their 7 per cent.,
which amounts to £7,000, and the remaining £13,000 has to be divided
equally between the ordinary shares and the founders' shares. The
100,000 ordinary shares receive a further £6,500, raising their dividend
to 13-1/2 per cent., and the 100 founders' shares receive the other
£6,500, making their dividend 6,500 per cent. Had the company earned
only £7,000, that would have sufficed to pay only the dividend on the
ordinary shares, and the founders' shares would have received nothing.
An objection to the system is at once evident. If the directors were
under the influence of the holders of the founders' shares, as they
usually are, they would not be content to earn a steady profit of £7,000
for the advantage of the large number of ordinary shareholders, but
would strain to divide a large profit in one year, even at the expense
of making an actual loss in the next. For this and other reasons
founders' shares are objectionable, especially in the case of those
finance companies which earn their profits by speculation. These
founders' shares are not to be confused with legitimate management
shares entitled to a fair rate of dividend, and issued to the officials
of a company to provide them with an incentive to work well in its
interests.
There are also vendors' shares--shares allotted to a vendor in payment,
or part payment, for the property which he sells to the company. If he
is willing to take shares instead of cash for the property, it is a good
sign, for he shows that he believes in it and desires to continue
interested in it; that he does not wish merely to pocket the cash and
walk off. When these shares come upon the market for sale, however, it
is an obvious sign that the man who probably knows most about the
property is clearing out. The rules of the Stock Exchange recognise this
aspect of affairs by laying it down that no special settlement may be
granted in vendors' shares until six months after the settlement of the
shares issued to the public.
Sometimes amongst the wares of the market there are actually found
stocks and shares which do not exist. A big Government loan is known to
be impending, and although no prospectus has been issued and the market
knows nothing about the terms, dealers, confident that these terms will
be reasonable, and sure that there will be a big public demand for the
stock, offer to sell it or to buy it at a fraction over the issue price,
although they do not know what that issue price will be. Transactions of
this kind sometimes occur not only in the case of a big Government loan
but in the case of the flotation of an important company. After the
prospectus appears, and the applications for allotment of the stock have
been sent in, the dealings become quite general, although no one is yet
in possession of the stock which he sells, nor do even the applicants
know whether they will get the whole of the amount for which they
applied, a part of it, or none at all. Some are tempted by the premium
to sell the full amount for which they have applied, in the hope that
they may get all of it, or, at all events, that they will get some and
be able to buy the balance in the market. Others more cautious can often
arrange to sell at a lower premium whatever amount of stock they may be
allotted. These, of course, are on surer ground, and so are those who
deal in the allotment letters themselves when they actually come out.
The practice of dealing in shares before allotment has from time to time
for very many years past been the subject of much criticism, and the
Stock Exchange Committee has frequently been called upon to put a stop
to it. It has even now and again made attempts so to do, but these
attempts have proved futile, and the penalisation has often fallen upon
the less guilty of the two parties to the bargain, to the advantage of
the one who has turned round and said, "If I complete the transaction,
it will mean loss to me, and I shall not do so, and you cannot compel me
to do so, because you have broken the rules of your Committee in dealing
before allotment at all." Thus after several attempts the Committee
seems to have given up all effort to restrain dealings before allotment,
except by adopting a negative attitude, to the discouragement but not
the penalisation of such dealings. Dealings take place not only in
stocks and shares before allotment and in the letters of allotment, but
also in what is called scrip, which is a provisional certificate issued
some time after the letter of allotment and endorsed with a receipt for
the payment of each instalment on the stock. It is a kind of temporary
stock certificate issued in advance of the real one, which is
forthcoming when the stock is fully paid up.