Isaac Newton (1642–1727) was one of the greatest scientists of all time. Less well known were his speculations on the London Stock Exchange. How did the brilliant Newton fare? Well, let’s just say he wasn’t one of the greatest investors of all time.
His investments were usually prudent and profitable. But then, late in life, he placed nearly all of his wealth into the stock of one company.
It was the South Sea Co., set up in 1711 to restructure the British government’s onerous debt load. Basically, it was a vehicle for converting public debt into equity – holders of government bonds were called upon to exchange their securities into South Sea Co. shares.
Dividends were paid on the stock at a lower rate than interest on bonds. However, the potential for dividend increases and sizable capital gains was created when Parliament gave the company a monopoly on trade with Spain’s colonies in South America.
Newton began buying the stock in 1712. Over the next eight years, he picked up more shares, using his savings and the proceeds from selling his shares in other companies. In 1720, he converted his government bonds and annuities into the stock.
During Newton’s period of accumulation, the war between Spain and England ebbed and flowed, curtailing South Sea Co.’s trading opportunities to the point where it remained unprofitable. Still, its shares enjoyed a gentle appreciation because of the prevailing notion that the trade monopoly would be fully implemented once a lasting peace was won.
What helped spread this belief was a new, burgeoning medium: the newspaper. The number of dailies in London, for example, went from one to 18 during the seven years to 1709. Glowing articles appeared, written in some cases by famous authors such as Jonathan Swift and Daniel Defoe.
In the absence of an armistice with Spain, the British government remained burdened with debt. This presented John Blunt, one of the founders of the South Sea Co., with an opportunity to make the company profitable.
In late 1719, he struck another deal with the government to alleviate its debt. The South Sea Co. would commit to paying a very large sum of money to Parliament in exchange for the right to offer public debt holders a swap into his company’s shares at their par value.
What conversion at par value meant was that "the higher South Sea stock climbed, the fewer shares needed to be issued in exchange for the debt and the greater the company’s profit,” Edward Chancellor wrote in a December article in Reuters Breakingviews.
Next came rumours and incredible tales about South American gold, silver and other commodities just waiting to be imported back to Europe. The stock was also made easier to buy, for example, through instalment plans with 10-per-cent down payments.
The price of South Sea Co.’s stock shot up in 1720, from £128 in early January to £350 in April. At this point, Newton unloaded most of his shares for a profit of more than £20,000 (about $4-million in current U.S. dollars).
The stock kept soaring. With England in a euphoric mood, watching from the sidelines was hard to do: Newton jumped back in during June and went all in at about £700 a share. Shortly after, the price hit £800, making the company worth twice the value of all the land in England.
But the share price could only be increased so far above the company’s fundamental value. In the summer, news broke that insiders were selling. The stock began to tumble and within a few weeks, plunged all the way back to the £200 level. So ended the infamous South Sea Bubble.
Newton began 1720 with stocks and bonds worth approximately £32,000 (close to $6-million in current U.S. dollars), according to Professor Andrew Odlyzko’s research in the Royal Society Journal of the History of Science. Newton ended 1720 with a third less capital, his portfolio consisting mostly of South Sea shares. The South Sea Co. remained in business, but its shares never did regain their glory before Newton died in 1727.
The South Sea Bubble is alleged to have prompted the immortal scientist to exclaim: “I can calculate the motion of the heavenly bodies, but not the madness of people.” But some individuals did, by luck or design, calculate the madness.
One person who did become rich was bookseller Thomas Guy. Like Newton, he built up a huge stake over several years and began selling in April, 1720. He did not buy back into the bubble, thus preserving his fortune – about a third of which was used to build Guy’s Hospital in London.