19 MAY 1961, Page 29

Valuing Equities


IF you investors have a little spare time this weekend turn to the back page of the Financial Times and consider the extra- ordinary variety of dividend

yields now offered on well-

64 known equity shares. By your .01 persistent buying of what you As,.'",61 vulgarly call 'growth' you have V;;; :i,:.4 brought some yields down to be-

tween I per cent. and 2 per cent.

By The r an de- t. in that hes,

the en-

the but lot iges Cher able for l'or example, Test° (self-service stores) yield a

mere 1.1 per cent., Easterns 1.2 per cent., Elliott- Automation 1.7 per cent., Boots 1.9 per cent., Mercury Securities (50 per cent. Warburg's) 1.5 Per cent., Pollard Bearings 1.7 per cent.—they even make Marks and Spencer look cheap on a Yield basis of 2 per cent. And there are numbers of

' Property shares (of the popular 'developing'

1YPe) yielding from 1 j per cent. to 2 per cent., while among the favoured life assurance com- Panies Equity and Law (law to itself) offer a 'bean 0.9 per cent. Do you all know what you are buying? Have you calculated future earnings and dividends so carefully that you can say that 5 share is fairly priced to yield currently a mere I Per cent. to 2 per cent.? At the other (unfashion- able) side of the share-shopping street you are A,

content to see a well-run public utility like Anglo- Portuguese Telephone yield over 84 per cent.. a famous mining royalty-investment company like 'Chartered' 124 per cent., good South African gold shares from 10 per cent. upwards, while Ceylon tea equities can be offered on a 20 per cent. yield and attract few buyers. Ah, but a political risk, you say, is anathema to investors. But have you carefully calculated the risks? Or are all these share values the result of blind buy- ing and selling?

It is tempting to believe that as a result of mainly blind buying and selling the 'market'— the final level of prices translated into an index number—has acquired a sixth sense, an uncanny pre-knowledge of the future. The 'market' is god : follow him and obey! This faith was shattered somewhat last year by the fact that different indices told different stories: The Financial Times index pointed to a bear market while those of the Times and Daily Mail never questioned a bull market. Many people, however, believe that 'the market' is inspired by the careful, computer calculations, of the professional inves- tors who run the institutions—the insurance companies, pension funds, investment trusts, unit trusts and merchant banks. But it is curious that when these professionals are absent from a market, as, for instance, in shares with a political risk which they will not touch, the .high yields which result seem to be a much more careful appraisal of the risks involved. It 'is only when the huge mass of professional buying is added to the demands of the private investor that yields become evanescent. This seems to suggest that these minuscule yields reflect, not the wisdom of the analytical investor, but merely the shortage of stock on jobbers' books. You are paying dearly to be in the swim.

What inclines me to a cynical view of the market is that so much of the analytical work of the back-room boys of the investment institutions ends up in a blind judgment. Consider for a moment the baa-room work involved in valuing a company's equity. A study has first to be made of the growth prospects of the industry or trade in which the company is operating. Because a growth industry is attractive to capital, it often attracts too much capital, so that profitability is adversely affected. (This happened in the plastic boom of 1951 and, for different reasons, in the nuclear power boom of 1955.) The relationship between industrial growth and profitability is something which cannot be precisely determined. T hen follows the study of the company's set-up, its capital gearing, its rate of earnings on capital employed, its fixed assets and working capital, its technical skill and management know-how. Here the back-room boys run up against the deceptions of many company accounts, the different allowances for depreciation and re-

search. the varying write-offs for productive or unproductive expenditures. Bravely they attempt on quite inadequate information to estimate the company's future earnings and dividends and arrive at a figure which capitalises future income at a certain rate. On this magical result the directors of the establishment, sitting at the board-room table, are presumed to arrive at their decision to buy or not to buy, but do you imagine that they are guided by mere figures? Not a bit of it. Some distrust figures; some like or dislike the management: some have a hunch or bias; the final vote is a blind act of faith A firm of brokers which sponsored that highly professional investment trust called 'Investing in Success Equities Ltd.' invented these purely mechanical tests in order to get rid of back-room estimates or board-room bunches. They laid it down that trading profits before depreciation in the last financial year must be at least double the average of the two base years within the period June. 1951, to May, 1953, that trading profits must at no time since the beginning of this period have fallen by more than 25 per cent. from the previous peak, that dividends must never have been reduced, that trading profits and earnings must have risen at least 50 per cent. over the past four years. It is too early to say whether this mechanical system gives better results than the 'hunch' system of the average investment board. I am waiting for the launch- ing of an 'Investing in Failure Trust' which picks out the shares of companies which have had a knock on the grounds that they are bound to have a come-back. Surely it is time for one of the big institutional investors to give us all a lead by saying what prompts them to buy equities on a yield basis below 2 per cent.