Baker Street, London -- Comments by one of the world's richest men have spoilt the technology stock party which has been bubbling along for the past few years. Steve Ballmer, president of Microsoft(NASDAQ: MSFT), the world's largest company, said he thought the group's shares had "looked highly valued" for a "long time". After hearing this from the horse's mouth, so to speak, analysts, who had spent the past five years talking up the shares suddenly started selling them. This dragged the Nasdaq composite index down 3.8% yesterday, sparking a worldwide decline in share prices. London didn't escape the downturn. The tech-heavy FTSE 250 was worst affected. But the shock £20.85b bid for NatWest (LSE: NWB) by the Bank of Scotland(LSE: BSCT) set the financial sector alight, lifting the FTSE 100 off its lows in the process. If this hadn't happened who knows what short term horrors we would have been looking at today!
Not surprisingly the Bank of Scotland's (LSE: BSCT) audacious bid for NatWest (LSE: NWB) set the city buzzing today. This mooted deal swelled turnover of shares in the FTSE 100. In an effective reverse takeover, the Scots will offer NatWest shareholders 1250p per share. This will be paid in paper and not cash, though. NatWest is still in the process of negotiating its deal with Legal & General (LSE: LGEN). But the Bank of Scotland has had itchy feet ever since being forced to turn away passionate evangelical Pat Robertson, following his "affectionate" comments about the tartan-clad land. TMF Essex dissects the deal in detail in today's Lunchbox. Whether the offer really goes through is another matter, but in the short term investors revelled in the action as NatWest zoomed a staggering 308p, or 29%, ahead to 1354p and Bank of Scotland shot up 43.5p to 750p.
The top nine risers in the FTSE 100 today were all financial stocks, lifted in the wake of the above bizarre offer. Analysts now think this proposed deal brings virtually all banks into play, despite their relatively hefty prospective price to earnings ratios of around 15. The Royal Bank of Scotland(LSE: RBOS) jumped 127p to 1276p, Barclays (LSE: BARC) was up 81p to 1736p and Standard Chartered(LSE: STAN) put on 60p to 884p. But the major beneficiaries of this general re-rating were the recently de-mutualised building societies, all seen as vulnerable takeover targets. Abbey National(LSE: ANL) rose 85p to 1086p, Halifax (LSE: HFX) leapt 31.5p to 723.5p, Alliance & Leicester(LSE: AL.) went up 42p to 807p, Norwich Union(LSE: NU.) improved 17.5p to 469p and the Woolwich (LSE: WWH) was up 8p at 459.5p.
Elsewhere, cigarette makers staged a slight recovery, following falls earlier in the week after the US Government pledged to sue tobacco companies for excess healthcare spending on ex-smokers. Imperial Tobacco(LSE: IMT) rose 3.5p to 704p.
Another bouncing stock was beleaguered retailer Storehouse (LSE: SHS). The owner of the Mothercare and British Home Stores chains improved 2.5p to 88.5p after a sell-off earlier in the week. Other retailers staging a turnaround included Debenhams (LSE: DEB), up 13p to 330p, and WHSmith(LSE: SMWH), which went up 17pt 520p.
Transport companies continued to steam ahead with Arriva (LSE: ARI) standing out from the crowd with a 11p rise to 341p, as dealers speculated about a bid for the bus operator.
The one financial company unable to muster enthusiasm to join in the Anglo-Scottish takeover party was jilted Legal & General(LSE: LGEN). The index tracking specialist was being suited by NatWest. But who knows what will happen now? Investors departed in their droves and the shares shed 11.5p to 180.5p. The non-voting shares of Schroders (LSE: SDRC) also fell 62p to 932p as shareholders despaired about a bid ever materialising for the defiantly independent British merchant bank.
Most of the fallers today were technology-related shares, following Nasdaq's overnight drop. Qualiport stock Misys (LSE: MSY) fell 31p to 564p. Fellow computer services groups Logica(LSE: LOG), down 29p to 740p and Admiral (LSE: ADC), off 22.5p at 820p were casualties as well. Worst affected though was traffic information provider Trafficmaster (LSE: TFC), which plummeted 24.5p to 511.5p.
Something also seems to be up with media companies at the moment. Or at least the market seems to know something which dealers are alarmed about. Yesterday's victim Reuters (LSE: RTR) dropped a further 28.5p to 697.5p. Also affected today were newspaper publishers the Daily Mail & General Trust (LSE: DMGT), down 161p to 2984p, and United News & Media(LSE: UNWS), off 24p at 575p. Perhaps this is related to Procter & Gamble's plans to pay for advertising on the basis of a campaign's success rather than a block rate. This could hit publisher's earnings.
That's the golden question, isn't it? We all like to check our portfolios and see what percentage gains we have made. But should we really focus all our attention solely on share prices when we are assessing our returns? There is a great danger that we judge the success of our investments by short-term price movements. Just because the price of a share goes up, it does not mean we have made a sensible investment. And conversely, a price fall does not mean we have made a mistake. This is especially true when we look at short-term price movements. This and other common investing mistakes are covered in this excellent article on the US site's Boring Portfolio, which is well worth reading.
What would be useful is some way of breaking down our portfolio's gains into market sentiment and other factors. I've had a stab at that below and, with TMF Googly's permission, used the Qualiport as an example. The premise is quite simple. I've taken the latest historic earnings figures when each share was bought and compared that with the latest historic earnings data. This enables us to see what price earnings ratio (P/E) the stock was bought on, and what P/E it currently sits at.
This way we can split down the movement in the share price into two. Firstly we have the movement in P/E, and secondly we have the change in earnings. Confused? Let's look at a numerical example. The table below is based upon the Qualiport numbers as at the close of play on Monday.
Stock Bought P/E then P/E now Price P/E Earningschange change change
IIG Oct 98 15.0 17.2 +11.2% +14.6% -2.9%
DELL Jan 99 124.0 84.0 +9.1% -32.3% +61.1%
PIZ Nov 98 29.7 25.1 +6.6% -15.6% +26.2%
MSY Apr 99 36.5 35.4 +2.6% -2.9% +5.7%
RTO Dec 97 27.2 18.8 -5.9% -31.0% +36.3%
EMA Apr 98 26.2 19.9 -14.4% -23.9% +12.5%
ULVR Jul 98 29.5 22.2 -21.1% -24.7% +4.7%
Average 41.2 31.8 -2.4% -16.5% +20.5%
The price change column tells us what we already know. The Qualiport's returns so far have not been that impressive. Overall, four Qualiport stocks are up and three are down. Despite the fact there are more ups than downs, significant losses on both EMAP (LSE: EMA) and Unilever(LSE: ULVR) have dragged the portfolio into an overall loss.
But a different picture emerges when we break down the price increase into the change in P/E and the change in earnings since the stock was bought. Six out of the seven Qualiport stocks have shown an increase in earnings but a decrease in P/E since they were included in the portfolio. Perversely the stock with the biggest price gain, Independent Insurance(LSE: IIG), is the only company which has seen a decrease in its earnings and an increase in its P/E.
Overall the average rating of the Qualiport has fallen by 16.5%, and the rating of two stocks has fallen by more than 30%! So is this poor stock selection or unfortunate timing? Personally I think it's more a case of the latter, especially in the case of EMAP and Unilever. Other Fools will no doubt have their own opinions! There is little doubt that all the Qualiport stocks are well-run companies. They have the track records to prove it. The average entry P/E, at over 40, is pretty high by most peoples' standards. Dell(NASDAQ: DELL) distorts matters somewhat but even excluding it, the average entry P/E is about 27.
Such high initial P/Es do run the risk of disappointing returns in the short term. The Qualiport has been unlucky six times out of seven. Maybe you can see why we include the phrase "nothing TMF Googly recommends" as part of our investment strategy for the Motley Fool Investment Club.
But out of the two columns, P/E change and earnings change, which do you think is more important for long term returns? If you said the former, go and stand in the corner. As time progresses, P/Es will wobble about but earnings have the opportunity to compound year after year. I believe you can do very little about the P/Es of your stocks, they are determined by market sentiment and other people's opinions. But you can pick stocks which you believe have a good chance of significant earnings growth. And luckily it is this factor that is more important in the long run. Unfortunately, it's not quite that simple.
But it does demand the question: when you look at your long-term portfolio, should you look at the overall price increase, or should you look at the change in earnings and ignore P/E ratios? Or to put it another way, rather than how much are you up, maybe the question should be, how much are you really up?
As a brand new Foolish offering, we are highlighting a few company results due out next week along with what Wise analysts are expecting companies to report.
Tuesday looks like being a particularly frenetic day as internet access provider Freeserve's (LSE: FRE) results for the 16 weeks to August 21st are unveiled. A £6m loss before tax is forecast. More interesting to follow will be the revenue figures, measured per subscriber. Also metrics such as how many pages each subscriber is viewing per visit will be most revealing as to how "sticky" and addictive Frreserve's various channels are proving to be. Expect fireworks.
Other interesting companies reporting on Tuesday include BATM Advanced Communications(LSE: BVC), whose shares have leapt more than tenfold this year. The Israeli company designs high-speed data communications equipment and switches for telecoms companies. Watch out for latest developments.
Struggling retailer House of Fraser (LSE: HOF) unveils its interim figures on Wednesday. Losses are predicted to rise by one and a half times to £4.7m. Also on the podium is bold bidder for NatWest, the Bank of Scotland (LSE: BSCT), and recent faller from the FTSE 100 Smiths Industries (LSE: SMIN), which reports finals. Earnings are expected to be up 8.4% to £237.5m, or 52.65p per share.
Finally, on Thursday, department store Selfridges (LSE: SLF) brings out its second set of interim results since it got spun off from Sears a year and a half ago. Profits before tax and one-off costs are expected to drop £1.1m to £8.6m.
Here's one for the weekend. Shares in recently floated German sex shop chain Beate Uhse (GR: USE) drooped today as the imminent departure at the end of month of upbeat chief executive Hans-Dieter Thomsen was released to the market. The figurehead has completed 41 years of hard work for the group. Speculation mounted that recent recruit to the management board 50-year old Gerard Cok might take-over the arduous role. The Dutchman came from a Belgian-Dutch sex chain to which Beate Uhse has only just finished making amicable approaches. Never have executive comings and goings been so wildly exciting. Please post any revealing feedback on the Daily Fool message board.
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