AT the end of last year I had started suggesting that cash might be no bad thing to hold in 2008. So far so good. If you are holding cash you are at least evens on the month so far, but if you’ve been in the stock market you’ve lost money – and in many cases quite a lot of money.
The FTSE 100 hasn’t done too badly (it’s only off 4%). But there has been carnage further down the scale. The FTSE 250, a better barometer of what investors think about the UK economy as a whole, is down more than 7% on the year and AIM is a mess. Despite rising commodity prices and its heavy weighting towards small mining and exploration companies, it is still falling. Look around the market and it’s hard to find a single sector on the up.
This week’s worst performance prize probably has to go to retail in the wake of Marks & Spencer’s (MKS) disastrous results and the subsequent 19% fall in its share price. It seems that things have got so tight for consumers that they no longer care that you can get a machine-washable cashmere jumper for under £50.
This explains why Debenhams (DEB) is now trading at an all-time low, why Next (NXT) can’t seem to move its stock and why my e-mail pings several times a day with a reminder from French Connection UK (FCCN) that it is having a 75%-off sale. It is also true of PCs, hence the fact that shares in DSG International (DSGI), owner of Dixons, have fallen 30% in the last two weeks.
The next most miserable lot of chief executives (those in charge of our banks aside) will be those heading property and housebuilding companies. The big property firms are 50% or so off their highs and housebuilders look even worse despite gains on Friday.
The result? Many shares look cheap. They trade on low price/ earnings (p/e) ratios, they appear to offer whopping dividend yields, their earnings yields relative to bond yields are good and in the case of the property companies they are on huge discounts to their net asset values (NAVs).
Each British Land (BLND) share can now be picked up for a mere 60% of the value of the land it represents. So it is no wonder bargain hunters and value investors are appearing in droves.
A Canadian group has upped its stake in DSG to 7.35% and a Singapore government fund has taken 3% of British Land, while Anthony Bolton, enjoying his last moment in the spotlight before retiring as head of Fidelity’s Special Situations fund, has been making much of his purchases in the property sector.
So the question is: should we be joining these seemingly clever people in the rush to buy discounted shares? I’m not so sure.
The problem is that all valuation methods rest on assumptions. Take a p/e ratio – the market price of a share divided by earnings per share. There are two numbers you can use for the “e” bit. You can use last year’s profit. This has the advantage of being a real number, but as the past is rarely a perfect indication of the future it isn’t much good. If a company has a low historical p/e ratio, all you know is that its shares would be cheap if it made the same profits it did last year.
What you don’t know is if it will make the same profits as it did last year. That’s why most analysts use the forward p/e instead. But no-one has the faintest idea what the profits of most companies might be. Anyone who thinks analysts can read the future needs only look at M&S’s share price to see that isn’t so.
The same sort of thing is true of dividend yields. Right now DSG looks like it yields 15%. But it will only do so if it pays out the same dividend this year as it did last year. Will it? Doesn’t seem likely. Again, not so cheap after all.
On to property companies. Sure British Land might be at a discount to its NAV. But when was that NAV calculated? Last year? Last month? Yesterday? Commercial property prices are falling and there is every reason to think they will continue to fall. How much? I have no idea, but Barclays is forecasting prices will fall 30% in the next three years.
On to the housebuilders. Persimmon (PSN) says its house sales fell 5% in 2007, that cancellation rates have soared and that its order book is down 15% in 2008. It also says that it is going to raise its dividend and that it is not going to cut prices. I’ll believe that when I see it.
The point I want to make is this: until the City accepts that America is in or nearly in recession, that house prices really are falling, that the consumption bubble is over and corporate earnings are more likely to fall than rise, and when it adds that information to its forecasts, then and only then will stocks be really cheap. Then I’ll buy some.
First published in The Sunday Times 13/01/08