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We will conclude our study of Philip Carret and his1930 book, The Art of Speculation, with his final six rules for investing:
7. Avoid "inside information" as you would the plague.
Looking at the psychological aspects of "tips", Mr. Carret said that they appealed to an investor's vanity since such confidential news sets the recipient apart from the rest of the market. He recommended that the investor view him or herself as being the thousandth rather than the first or second person to get the story. Such lack of self pride would, in Mr. Carret's words, be "well rewarded."
8. Seek facts diligently, advice never.
Mr. Carret tells the story of a gentleman who was offered the chance to purchase a significant (1/6th) interest in a new technology company of the time, American Telephone & Telegraph, for $10,000. He sought the advice of a friend in a similar industry, the president of Western Union Telegraph Co., who advised him to save his money. His friend viewed the new invention, the telephone, as impracticable. The president also advised him that Western Union owned patents which gave it a better claim to the invention. The gentleman, unfortunately, took his friend's advice. And, as they say, the rest is history.
9. Ignore mechanical formulas for valuing securities.
Although Mr. Carret recognizes that some measures of a company are helpful, he warns against "unintelligent use of a convenient yardstick of values." He gives the example of the price earnings ratio, which is calculated by dividing a stock price by the prior year's per share earnings. The result represents the price earnings ratio. The higher it is, the more expensive the stock appears to be. Mr. Carret says this ratio is a good start, but the investor can not rely on it alone. Intelligent analysis will always come down to careful consideration of all aspects of both a stock and the company which has issued it.
10. When stocks are high, money rates rising, business prosperous, at least half a given fund should be placed in short-term bonds.
This rule recognizes the cyclical nature of the stock market. When the market in general and an investor's particular stocks have greatly risen in value, an investor should anticipate a drop at some point. This can be seen as a form of market timing in which the investor tries to "buy low and sell high." Mr. Carret is suggesting that at what appears to be a market top, the cautious investor should sell his or her stock and put the proceeds into income producing securities to wait out the imminent and inevitable fall in prices.
11. Borrow money sparingly and only when stocks are low, money rates low or falling, and business depressed.
When Mr. Carret wrote the articles which became his book many individual investors bought their stocks on margin, which means that they put up only a small portion of the purchase price and borrowed the balance from the brokerage house who sold him the stock. If the stock went up in price, then the profits, after repaying the loan, would be larger than if the investor only bought what he or she could afford. The problem was that if the stock went down enough to wipe out the small "equity" held by the investor, the loan was called and the investor would be sold out of the stock by the broker to recoup the loan, resulting in a loss of the entire investment. He is recommending that an investor should borrow on a limited scale and only on occasion. I personally believe that investing on margin is not something for the individual investor. If you own stocks outright, a small decline in price will not affect your holdings.
12. Set aside a moderate proportion of available funds for the purchase of long-term options on stocks of promising companies whenever available.
Mr. Carret is describing the type of security known as option warrants which are usually offered to investors in bonds and preferred stock issues. These can be sold separately from the bonds or preferred stocks they come with. He says that they were offered in many instances to give the broker selling the bonds or preferred stock a "talking point" since they had little initial value and their chances of appreciation were "microscopically small." However, he felt this was a cheap way to get in on the ground floor of a "promising company." This seems a game best left to the "professionals on a closed track", as the TV car commercials warn.
There are two types of history books. The first type is written by a present day historian about events which occurred in the past. The second and, I feel, more interesting type is one written by someone living through the events. Mr. Carret's The Art of Speculation is one of the latter. His very readable book talks about the market from a then current perspective; now, a historical one for us. The book is still in print today, a testament to its continuing value and relevance. It is well worth reading for the beginning investor.
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