Evening Fool

Friday, 12 June 1998

Market Close
FTSE 100 5769.80  -82.70  (-1.43%)     
FTSE AS  2761.31  -35.33  (-1.28%)

Yeeeeeeha
Free Fall Footsie.

Another 83 points were wiped off the FTSE 100 shares today, adding to the pain of yesterday's 135 point fall. Wall Street fell 160 points overnight, and the Asian economic and currency concerns still abound.

Many pundits have been contending that the market is overvalued for years now. Despite the doom and gloom, the market has continued to climb the wall of uncertainty. But, is this the end? The last 3 years have seen world markets climb at unprecedented levels. Logic and pure valuation say that this growth can't continue for much longer -- it is simply not sustainable. What is sustainable, however, is the 12% average annual growth in the stock market stretching back to the early part of this century. The stock market is still the best vehicle for long-term growth. An investment of £10,000 right now, presuming the market continues to grow at its historic average rate, will be worth £96,463 in 20 years time. In the building society, earning a net 5% per annum, it would be worth only £26,533. As the years roll by, the difference just keeps on getting bigger and bigger.

The growth in the market capitalisation of many companies over the past couple of years has been fuelled mainly by expanding price to earnings (P/E) multiples. Over the long term, actual earnings (profits) growth is the ultimate decider of the direction of a company's share price. Take Qualiport company Rentokil Initial, for example:

1st January 1998
Share price: 264p
1998 estimated EPS: 12.4p
1998 estimated P/E: 21.3

12th June 1998
Share Price: 404p
1998 estimated EPS: 12.4p
1998 estimated P/E: 32.6

The company's aim is to grow sales and earnings by 20% per annum. Over a long period of time, if they can keep achieving that aim, shareholders should expect the share price to grow, on average, roughly 20% per annum. The 53% appreciation in the share price in this year to date is clearly unsustainable.

Market tumbles, especially the irrational ones (this is an orderly retreat so far, unlike the big plunges we saw in October last year) can often present buying opportunities in quality companies. In fact, as net purchasers of shares, we should be cheering each and every market fall. The next purchase is hopefully getting cheaper and cheaper. Hang on in there, Fools.

Conquerors

On a big-ish down day for the market, two of the top seven largest companies by market capitalisation actually rose. Considering that the movement in the FTSE 100 index is governed by weighted average, you can imagine that the carnage would have been bigger were it not for the rises in Glaxo Wellcome, 2p to 1742p and SmithKline Beecham, 19p to 737p. The well worn City rumour mill was in full action again today regarding these two companies. Hitting the top of the list was that SKB Chief Executive Jan Leschly was to stand aside in order for the merger talks between the pharmaceutical giants to be rekindled. Compensation of £100m was bandied about at one stage. What would Mr. Leschly do with all that dosh? Send some this way, please.

Staying with pharmaceuticals, Nycomed Amersham jumped another 18p to 419p. The company split their shares 5 for 1 this week, with 419p translating to 2095p in the old currency. Share splits change absolutely nothing about the company or its valuation, but it is amazing how shares of these companies often edge upwards in the immediate aftermath of the event. A share split is usually seen as a sign of confidence by the company, although again there are many reasons for companies to split their shares, and not always because the share price is high. A recent example is Northern Leisure, which announced a one for one share split despite the company's share price at the time being around the 520p mark. Rentokil Initial split in half in May 1997 when their share price was only about 400p.

E D & F Man jumped another 24p to 305p in response to yesterday's results.

Fool UK favourite dog Powerscreen International had its second successive day in the spotlight, and shares in the beleaguered Northern Irish engineering company positively surged 30p to 101p. Putting that into perspective, however, their shares peaked at 763p a little more than 6 months ago. The company released yet another statement to the London Stock Exchange, but this time the market perceived it to be good news for once. Powerscreen confirmed that their 1998 pre tax loss will be about £65m, and that trading in the new financial year is progressing satisfactorily despite the obvious difficulties. A banking facility of £85m with the group's bankers is in place.

Osborne & Little, a leading designer and international distributor of fine furnishing fabrics and wallpapers, announced full year results to March 1998. Turnover increased 12.5%, and EPS by 10% to 53.5p, beating estimates of 52.1p. The share price shot up 73p to 648p mainly in response to the 15% dividend increase plus a special dividend of 20p per share. The group had £4.2m in cash at the year end and, not having anything better to do with the money, Foolishly decided to hand it back to shareholders.

Vanquished

The banks were again lower today, although that didn't stop Halifax from continuing on their share repurchase programme. Although the shares dropped 22p to 805p, they bought 2,360,000 of their own shares at 821p for cancellation. A company usually repurchases its own shares when it perceives them to be undervalued and/or it has surplus cash. The effect is that with fewer shares outstanding, all else being equal the earnings per share number will increase. As companies are ultimately usually valued on a multiple of their EPS, by increasing that base number companies like Halifax that are buying back their own shares are hoping that over the long term their share price will benefit. They see this as all part of their duty to increase shareholder value. Barclays, down 39p to 1668p, is another bank that is systematically repurchasing their own shares.

Other banks to fall included Abbey National 39p to 1017p, HSBC 14p to 1433p, Alliance & Leicester 18p to 800p and Northern Rock 25p to 560p. Only a few short months ago the appreciation in the banking sector share prices was helping fuel the bull market. How the perception can change so quickly. Investors with a longer time frame than a few months might want to keep their eye out for a bargain amongst the well managed banks.

Granada Group, the hotels, rentals, television and catering company, announced today that it will premiere drive-in movies for families at their 39 roadside service areas. It is all part of their grand plan to actually have you spend your whole holiday at one of their service areas. The market was suitably unimpressed, and the shares lost 7p to 1123p. The busiest motorway services area in the country is Granada's Hilton Park service area on the M6. Next time you pop into one of these, try to imagine how much cash they must generate. I'm yet to be in one that is not busy. This is almost a toll-bridge business in the truest sense.

Specialist used car retailer The Car Group crashed for an 86p loss to 106p after releasing a far from buoyant trading statement. The company said that the demand for used cars has continued to be depressed, and this coupled with price falls across the used car market has led them to expect that profits to August 1998 will be significantly below current market expectations. Before today, EPS estimates had the company earning 13.1p, versus 10.2p in 1997. That 29% growth may have lead the unwary investor to believe the shares undervalued, as they previously traded on a forward P/E of 14.6. The used car market is personified by its cyclical nature and razor thin margins.

And Finally...

If you are looking at a struggle to get to work next Monday because of the London Underground tube strike, help may be at hand. White Horse Fast Ferries, the Thames ferry operator currently applying for an Ofex listing, said it is extending the timetable on its current service in order to help commuters during the strike. You've got no excuses now, except of course if you don't live near the Thames.

Don't forget to check out all the pieces of content we've got here at Fool UK. For a quick and easy rundown of the week's events, check out the Weekly Digest. It is updated each Friday evening.

Also, we've signed up Richard Hay to pen our daily Foolish look at the World Cup. Each afternoon for the next 31 days, read about France 98 as you'll never read anywhere else. I'm sure Richard would like some feedback, or some ideas about future articles. Feel free to email him.

Don't forget to pop by the message boards, where you can learn from other Fools. Feel free to post away.

Have a good weekend, Fools.

Bruce Jackson (TMF Googly)

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