Sam:
You and I are thinking along similar lines then, when it comes to the "half the height" of the masthead light issue. I thought he was tap dancing as fast as he could.
One would think that in the context of the exchange between Stone and Gibson ("lights look queer, now;" "big side out of the water;" "ship does not fire rockets for nothing;" etc), that IF Stone really thought the rockets didn't go high enough, he would have commented on it to Gibson in the course of those conversations.
It is tempting to speculate on the reactions of Stone's colleagues the next morning. We have Stewart waking up Evans ("For God's sake get to your key; there is a ship that's been firing rockets and we have done nothing!"); Stewart's initial thoughts that "something had happened" and his acknowledgment that white rockets meant distress; Groves bounding out of bed and across the hall to Stone's room ("Is this right about the Titanic?" - "Yes, and I saw rockets in my watch."), etc etc.
You can imagine as the enormity began to sink in of what had transpired just a few miles away from them, how they must have all turned to Stone with wondering, questioning eyes and begun to badger him. And Stone having to decide whether to let it be known that he had notified the captain three times (and thereby making it Lord's fault), or to try to minimize what he had seen (rockets didn't go high enough; ship seemed to be steaming away; etc).
"...What I believe is that Stone realized that he was seeing distress signals and needed an excuse for not really doing anything..."
Yep, I think you're right. I also wonder if he was trying to be careful not to get Lord angry at him - at least not this early in the unfolding events (that is, the morning of the disaster). By the time he was asked to write his private account, and later give testimony in England, he may have been more willing to point fingers (eg at the Inquiry: "I informed the master, and let him judge.")
Dave Billnitzer