Great Titchfield Street, London -- Every so often, you come across a share that seems to defy gravity. HIT Entertainment (LSE: HTE) seems to be one such share. A positive AGM statement drove the shares close to £4 this morning, valuing the company at a smidgen under £540m. The company owns the rights to Bob The Builder and a plethora of other children's characters such as Barney, Angelina Ballerina and the recently acquired Pingu.
The company appears to be popular with private investors. Even though its share price has been oscillating around the £4 level for the last two years, its meteoric rise in the three years prior has secured its popularity. But to paraphrase the old saying -- care not what your share has done for you, only consider what it will do for you in the future.
With the help of recent acquisitions, pre-tax profits for the year to July 2002 are expected to show a quantum leap to around £23m. For the year after, £30m is apparently forecast. Take off 30% for tax and this translates into a price to earnings ratio (P/E) of 33 times for the current year, falling to 26 times for the year after.
But is the P/E an appropriate measure to use for businesses such as these? When you are using a P/E, you are essentially assuming that the current level of profits are sustainable for many, many years to come. The trouble is I have absolutely no idea whether any of HIT's characters will around that long. The signs are encouraging at the moment, of course, but you can't just assume that the current situation will continue.
In fact, you should really be applying a hefty discount for the fundamental uncertainty that exists around all such companies. For every children's character that succeeds, there are dozens that don't. The odds of succeeding with investments in this area are pretty poor. It is certainly not a percentage shot and the shares are a gamble at best.
More: HIT Entertainment discussion board
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