Back in the happy days of the late 1990s, investors were not much interested in cash, they preferred promises.
The more they heard about how companies were investing for future growth the happier they were, regardless of the losses many of those companies were making.
That all changed in 2000 as it suddenly became clear that however many promises were made all those losses were not turning into profits. In the aftermath of the subsequent crash, investors turned their attention back to the present.
The result has been what you might call a ‘show me the money’ market investors are demanding that they receive instant rewards, in the form of buybacks and dividends. And the corporate sector has been paying attention: according to Fidelity, a fund manager, Britain’s blue chips raised their payouts by more than 10% last year, not far off five times the rate of inflation.
But while from an investor’s point of view this has been nice, it comes with long-term problems. The more a company pays shareholders, the less it has left to invest. And if companies are too short-termist to invest at least a little in the things that bring growth (staff, marketing, research and development, technological equipment and so on) the odds are that they won’t get any and then they won’t be able to generate the cash to pay dividends either. Then they won’t be growth stocks or income stocks -they’ll just be failures.
This suggests that after the excellent performance of income stocks over the past five years (the FTSE high-yield index has risen more than 50% whereas the low-yield index is down about 40%) it might be time for investors to think about looking for more growth.
The problem is knowing where to look. Lots of companies intend to grow fast but few do. Consider the small-cap market. We take it for granted that smaller companies are growth stocks, because it is easier to double the size of a £ 100m company than a £ 1billion one, and in some cases that expectation is perfectly reasonable.
But not now. Many of Britain’s smaller firms (I’m excluding the many oil and mining companies listed on AIM) are very geared to the British economy; when it grows they grow, and when it does not they very often don’t either -and the British economy doesn’t look like it is growing much at all.
The CBI’s February retail survey showed that high-street sales are down again, with the hardest-hit companies being in hardware, furniture and DIY products, as a result of the dwindling level of house sales.
People who don’t buy new houses seldom buy new kitchens, sofas or picture hooks.
Unfortunately, matters are not going to improve soon. Not only are house prices falling (down 0.2% in February, according to Nationwide) but unemployment is rising (MFI is to cut 1,500 staff) and inflation is really beginning to take hold.
Who is going to feel like shopping when they are losing money on their house, their job is in danger and their gas bill has just gone up 24%?
Nor is the slack likely to be taken up elsewhere -business investment is now at its lowest level as a percentage of GDP for 40 years and manufacturing output fell 2.5% last year.
Clearly, if you are after growth, investing in UK- dependent firms may not be the best idea. So what should you do? One answer might be to move up the size scale and look for shares in companies that have exposure to growth in the wider global economy.
However, even then caution is required. One would not, for example, want to be too heavily invested in companies whose growth depends on increasing sales to America.
As was the case in Britain until last year, much US consumption is based on rising house prices, but the house-price boom there is also beginning to slow.
What this means is that we need firms with exposure to much more of the world.
One I’m keen on is Mothercare. The company is keeping its head above water in Britain, where sales rose 2.3% in the 13 weeks to January 6, but it is also making great strides abroad. It is opening shops in places where people really do have money to spend: it has 84 in the Middle East and is planning 40 new stores in India this year.
That’s not to say it isn’t missing a few tricks in Britain. It still doesn’t sell the one thing its pregnant and carbohydrate-craving customers want most – chocolate. Come on, Mothercare, you know it makes sense.
First published in The Sunday Times (12/03/2006)