A Tangled Skein
By JOHN BULL
OXFORD sceptics have struck again. This time it is investing in ordinary shares which is under attack. It is not that investing is an immoral activity (that is not the sort of con- clusion an ()Ilford don would work towards anyway), but rather that it is irrational. Examin- ing a company's earnings record provides little guide to future performance. And it is not the case that low-yielding stocks, the shares which the market. rates most optimistically, do con- sistently better than the rest of the pack.
These are the themes of Higgledy Piggledy Growth Again, by A. C. Rayner and I. M. D. Little (author of an article on the same subject in 1962), published by Basil Blackwell at. 18s. The book's implications need to be studied well beyond Throgmorton Street.
If successful investment is pure chance, then the Stock Exchange is not carrying out the eco- nomic function with which it is credited. Funds are being channelled haphazardly to good and bad firms alike, and • the former cannot expect to borrow more cheaply than the latter. It is not only smart stockbrokers with their computers whom Messrs Rayner and Little are attacking : they suggest that an essential cog in the capitalist machine is missing.
The first part of the book deals with the ques- tion of whether past growth leads to future growth. Or, to put it another way, whether a successful management continues to do well. A wealth of statistical expertise is brought to bear on the problem, but none of it does much to disturb the conclusions derived from the first and simplest routine in the exercise. Against a straight line representing the average growth in earnings by all the companies in a particular industry over a decade, each unit's variations from the norm are plotted. What one expects to see is a series of roughly parallel lines with the best company consistently showing, say, an earn- ings growth 25 per cent or so better than the industry average and the worst a similarly steady path below. But the graphs show nothing of the sort. What meets the eye is a tangled skein. The company which beats the industry average by 40 per cent in year one lags behind by 10 per cent in year two, by 25 per cent in year three and then in year four rises to the top of the class. And so on. There are, indeed, no parallel lines.
But in each of the two graphs in the book, there is one company which comes within nod- ding distance of a consistent path, Marks and Spencer in stores and Rugby Portland Cement in building. However, the authors reckon that 'it would be difficult to convince oneself that the performance of the firms that do show some consistent growth is any more than the result of chance factors.'
An effort is also made to see whether either size or ploughback (that part of a company's earnings which is kept back for future expan- sion rather than distributed to shareholders) has any effect on growth. Again the answer is a depressing negative.
Conditioned by these results, it is no surprise to find that the public's expectation of the future of a firm (as expressed by the yield basis of its shares in the market) bears only a passing re- semblance to what actually does happen to it. One set of figures shows that 'if the market became optimistic about some share, the earnings of the company fell almost as frequently as they
rose.' Luckily, the investor- is better at predicting dividend growth. Why? Dividends are a more stable quantity than earnings. Directors are in- fluenced by the market's rating of their com- pany. They make dividend forecasts which they like to meet, even if earnings do not live up to expectations. And investors have had luck on their side because dividend payments have be- come more generous in relation to a given level of earnings. But in the long run, if you cannot predict earnings, you cannot foresee dividends or market prices.
What can be set against the 'higgledy piggledy conclusions? First, the fact that there are a large number of professional investment managers about who do manage to beat the market con- sistently. One feels that their number is higher than the laws of chance would suggest.
Secondly, the fact that one well-established in- vestment method has not been tested to destruc- tion—the 'spot the anomaly' procedure. One takes the market as it is and looks for (and often finds) shares that are out of line (in terms of yield) for no very good reason. This approach, of course, requires treating the long-term as a succession of short-terms.
Thirdly, the fact that the successful investor is often the man who looks for special factors. There is, for instance, a strong connection be- tween the latest Defence White Paper and Rolls- Royce's order book for the next five years.
And finally, the fact that investors as a whole are now a good deal less willing than they were during the period which the book covers (1951-61) to trust low-yielding shares. The market has already learnt to be more sceptical.
Previous page
