The Reality Behind Price Earnings Ratios (PERs)
Financial commentators are often hopelessly misinformed when discussing PERs, particularly in the light of Gordon’s Growth Model.
Commentators on local radio and television stations seem to believe that shares of companies are only fairly valued if their PERs are in the vicinity of 10. The sort of comment that moves me to switch to another station or channel is: “You should buy company A as it has a PER of 7”, or “Company B is hopelessly overvalued because it has a PER of 20”. If I were to ask these so-called experts what are the two main drivers of a PER, they would probably reply: “Price and earnings”.
In fact there are three main drivers of a PER, if you use Gordon’s Growth Model (GGM):
1. The proportion of profits paid out by way of dividends (DP%)
2. The risk adjusted rate of return required by the investor (r)
3. The projected growth in dividends (g)
The GGM formula for a PER is DP%/(r-g)/(1+g).
Let’s illustrate by comparing the following:
1. A mining company (MC) is capital intensive so needs to plough back a large part of its profits into its operations. Growth is usually poor and risk is usually high because of fluctuations in commodity prices and the nature of its operations.
2. A retail company (RC) is usually able to fund its largest asset – inventory – by trade creditors, so can pay a large part of its profits by way of dividend. Projected growth is usually higher than that of a MC, and fluctuations of profits are usually low, resulting in a lower risk rating.
Doing the maths:
Share profile MC RC
Dividend payout ratio 30% 60%
Projected growth rate 6% 9%
Required rate of return 15% 12%
Applying the above formula to the PER is 4 22
Based on these inputs and the application of GGM, a fair PER for MC is 4, not 10 and a fair PER for RC is 22, not 10. If you know the commentators I am talking about, please pass this article on to them. And some advice: When next you hear commentators displaying their ignorance by discussing relative PERs, do what I do and switch stations or channels.
As an aside, the GGM is highly theoretical as it assumes growth will last forever. I prefer the Terminal Growth Model, so here is the fourth PER driver, i.e. for how many years are you prepared to discount future growth? ❐
The Best TIP for the Best Week Ever Forever
If I could bottle and sell ‘time’, I would be wealthier than Warren Buffet and
Bill Gates combined.
Clients, friends and relatives daily share their challenge of not having time to do what they want. This is how I manage my time.
Are you respecting and managing your most valuable resource?
If not, it’s time to start and you start with prioritisation.
Current reality: you only have 24hrs a day, 7days a week, 52 weeks a year.
To master all, you need to work within these boundaries to achieve what you really want and need.
How do you do it if everyone says: ‘I can never “find” time for anything.’
If you want time, you must make it!
Start making it
The best tip and tool I discovered and use is “The Ideal Week” and it has transformed my life.
What makes the ‘ideal week’?
Achieving accomplishments within a week make it great.
But accomplishments start with planning, and you will be disappointed weekly if you do no planning.
Step 1 (the fun stuff)
List the things you want to achieve every week – your weekly non-negotiables. Include, in order of importance, your priorities: visiting friends, yoga, grocery shopping, Wednesday movie-night, 15 billable hours per week, R10 000 weekly turnover, date-night, ‘you-time’, and time with the kids.
Get a blank weekly calendar with 30 minute timeslots.
Plot your priorities from step 1 onto the blank canvas.
Start with waking up and end with bedtime.
You will “on paper” either have enough time each week or realise you are overcommitting. If you are overcommitting, back to step 1 and remove the least importants.
Implement step 2 into your actual time schedule.
You now have a structure and foundation within which to work. If you stick to it, you have a great new habit, plus you will have a great week every week.
If it doesn’t work, change and adjust it until it works.
Guaranteed – if you give this tool the time it deserves you will reap the rewards.
Spend your time
As Pulitzer Prize winner Carl Sandburg said: “Time is the coin of your life. It is the only coin you have, and only you can determine how it will be spent. Be careful lest you let other people spend it for you.”
Now. Go. Enjoy spending your time! ❐
Motivational speakers – are they for real?
Motivational speakers eagerly share their secrets to success, but are these appropriate for you?
You see them on the conference circuit and at breakfast meetings. Whole sections of bookshops are devoted to their published work. They are successful in sport or business. Some are adventurers, with impressive feats of endurance to tell you about. Almost by definition, they tend to be highly likeable, inspirational people. And they offer you an alluring path to your own success.
But for those of us that listen to motivational speakers or read self-improvement books in the hope that we will find that elusive formula for achieving our goals in life, a cautionary note is in order: powerful, reality-distorting biases may be at work.
The problem, essentially, is this. There is no doubt that the accomplishments of some of these people may correctly be attributed to transferrable skills. However, it is equally certain that some of them were merely lucky, and in the murky world of human behaviour, it is hard to tell which is which.
This has nothing to do with those few that cynically and deliberately attempt to deceive the unwary. Instead, the real difficulty lies in unintentionally distorted interpretations of the past. It is almost irresistible for human beings to think, in hindsight, that a series of events that lead to a favourable outcome were inevitable, as if chance played no part. So, for example, the businesswoman attributes her success solely to her management methods. The mountaineer thinks that he reached the summit specifically because he did this or that. They really, really believe this stuff. And now, they are ready to share their secrets with you.
Consider the businesswoman. It is plausible that others tried the same strategies as her, and yet did not succeed. From her point of view, this does not matter, because they worked for her. She sees a self-evident causal link between her methods and her success. From your point of view, however, the invisible failures matter a great deal. Survivorship bias means that you are hearing about a management method from the one person for whom it worked, not the others for whom it did not.
I am certainly not suggesting that all motivational presenters are wrong. Instead, I’m arguing that it is highly improbable that all of them are right. Perhaps the real benefit of these people lies in the generalised feeling of well-being they can provide, rather than in the specific detail of their steps to success.
Which is why, if one of my students asks for help with motivational problems, I might recommend reading a self-help book. But I never say which one. ❐
Rejuvenated Profitability Through Integrated Reporting
When authentically implemented, integrated reporting offers measurable bottom line returns and ‘future-proofs’ companies.
Although South Africa’s JSE stock exchange was the first in the world to make ‘integrated reporting’ compulsory, this new form of corporate disclosure is being rolled out across the globe.
Company managements are accepting – even welcoming – the inevitable, as shown in the white paper ‘The 2012 Sustainability & the CFO Study’ recently published by Deloitte Touche Tohmatsu Limited .
For this paper, Deloitte interviewed 250 CFOs from fourteen countries (including SA), representing companies from fifteen different industries. Their businesses generate combined revenue of US$3 trillion. Some 49% of the CFOs saw a ‘significant link between sustainability performance and financial performance’ while 34% were actively transforming their companies in response to sustainability, environment and energy imperatives. A further 22% planned to do so within the next two years.
The key to leveraging the integrated report exercise for bottom-line benefits is how the company approaches it. Will this be a box ticking exercise simply to be gotten out of the way to focus on ‘real business’? Or is this a company ‘future proofing’ tool that will attract longer term investors and uncover innovative new value?
It’s already a given that the way information must be collected and assimilated to support integrated reporting enables companies to scrutinise transparently rising costs such as electricity, raw materials and waste – with a view to their minimisation. This is not only a moral stance, but should generate year-on-year savings that will more than recompense the effort and expense of its introduction.
Yet integrated reporting has so much more to offer. An insight article (CSR as a pathway to innovation) published as part of ‘The State of CSR in Australia Annual Review 2010/11’ states that CSR (corporate social responsibility): “is increasingly being used…to create new value by delivering new products and services. … Respondents that agreed that CSR had delivered new value [climbed]…from a mere 27.3% in 2008 to an impressive 62.5% in 2010/11”. In the same survey, 67.3% of the respondents reported that: “CSR had strengthened its organisation’s competitive advantage”.
The article illustrates this by including a case study on Fujitsu, which launched a ‘green IT’ consulting service, initially to sell more of its products. Its runaway success persuaded Fujitsu to redesign its product range and link its ‘green IT portfolio’ to all its offerings, such as data centres, virtualisation and cloud computing. The pay-back for Fujitsu was profound. “It’s led to a massive change in the company”, says Alison Rowe, Fujitsu’s Global Director, Sustainability, “It’s created a very serious commitment to sustainability”.
Integrated reporting stimulates innovation by establishing a broader-ranging company ‘mindset’, which encourages cross-pollination of ideas and automatically includes social and environmental concerns. The key to fuelling this mindset is effective stakeholder relations, but that’s for the next issue… ❐
For references visit www.accountancysa.org.za
Business lessons learned from poker
If you don’t know what you’re doing in poker, you can lose with the best hand at the table. Conversely, if you’re skilled and a little lucky, you can win with the worst hand. Not always, but often enough to tip the odds in your favour.
It’s exactly the same in business. We don’t get to choose the hands we’re dealt – but we do get to choose how we play them. To succeed, you must know the rules, calculate the odds, take risks and know your opponents.
Being over-cautious can be as dangerous as being over-aggressive. If you play every hand, but are too timid to call a raise, you’re likely to lose. Don’t bet on every hand, but when you do, bet aggressively. If you believe in your cards, go on the attack.
That strategy works in business too: there’s a place for aggression in every tactical toolbox. If you can recognise when to back down and when to push back you have a huge advantage.
Know when to fold ‘em
Knowing when to fold is a critical survival skill. To make the decision, you need information.
How much do you stand to lose if you fold? How many cards in the deck will help you? How much more do you need to invest to stay in? How much do you stand to win if you get the right card? You need to be able to calculate the odds objectively.
A business deal is no different – you need to dispassionately evaluate how much you have invested, what might work in your favour and what it will cost — financially, in time, in energy – to keep going. When does the cost outweigh the reward?
Know your opponent
Evaluate your opponent. What is his/her playing style, how does he/she they react to certain situations, what are their tells? Good poker players watch their opponents at least as carefully as their cards. A realistic assessment of relative strengths and weaknesses allows you to match yourself to the competition in poker and in business.
You can’t bluff in business
The one fundamental difference is that you can win in poker on a bluff and never have to show your cards – in business you always have to deliver. In fact, if you deliver on your word, you might get to choose the game next time around – and it doesn’t always have to be poker. ❐
New Year may ring in sector changes
Investing in a perilous 2013 – where is the money to be made? We consider some options.
Where’s the money going to be made in 2013? Truth be told it won’t be much different to 2012 – trends don’t change just because we ring in a new year.
However, according to Paul Hansen, STANLIB retail director, two major trends of the past 18 months may soon be due for a switch. The first is falling interest rates, which can’t really fall any further; and the second is the weak resources sector, thanks to falling commodity prices this past year, which have probably now bottomed.
Interest rates have been low for several years in developed economies, but over this past 18 months key emerging markets such as China and Brazil also cut their rates. This past year, the bond market (still on a 30-year bull run) and listed properties, were the beneficiaries of low interest rates. But there’s no guarantee this will continue into 2013.
Hansen believes that the low interest rate trend will ‘continue for a while’ but doesn’t expect much more from either the overheating bond market or listed property.
As to resources weaknesses, here Hansen sees some chance for investors to make money in 2013, “particularly if the Chinese economy picks up”. Growth rates in China may still shrink, but there are signs that the bottom has been reached. Hansen adds: “Offshore markets are likely to continue their bull trend. Asian markets performed particularly badly in 2012 and I expect this to change in 2013, especially in the Chinese stock market.”
Tom de Lange, chief investment officer at Emperor Asset Managers, picks the platinum sector as one to watch for 2013, though it’s already recovered 20-25% from its lows.
“Even though you can probably pick up resource and platinum shares now at attractive prices, it doesn’t mean that your portfolio is going to outperform the market. So for those investors that do have an appetite for these shares, buy them on the dips, exercise patience and remain underweight until they show decent momentum” he says.
His picks are for Platinum: Implats, Northam, Aquarius and Eastplats. For resources: Billiton, Kumba, Exxaro, Sasol and Assore.
So where to put your money? De Lange lists this year’s three hot sectors: Consumers, Services & Food and Health. The lagging sectors remain Platinum, Resources, and Industrials. “Using the same momentum approach, on our buying list for 2013 would be: Metair, Pinnacle, Woolworths, Life Healthcare, Mr Price, Aspen, RMI Holdings, Famous Brands, Invicta, Assore, Old Mutual, AVI, Omnia, Imperial, Litha Healthcare, Cashbuild, Shoprite, Coronation, EOH, Naspers, Clicks and RMB Holdings.
“Slightly further down the list, but still worth considering, would be PSG, Resilient, SAB Miller, Richemont, WBHO, FirstRand and City Lodge. If you have the appetite for smaller counters with higher volatility, you may also consider Ellies, Curro, Taste, Brait, Metrofile and Afrimat.
“Happy investing,” says De Lange. ❐