This page is quite old hence its rather spartan appearance.
Why not check out our Latest Stories page for our newest articles or search our site for anything.
By Bruce Jackson (TMF Googly)
Baker Street, London -- In the short term, the good old price to earnings ratio (P/E) is often the driver of share prices. The current P/E of the FTSE 100 index is 27.5, which is historically very high. The reciprocal of the P/E (1 divided by the P/E) allows you to compare it to other forms of investment, particularly interest rates. At 3.6%, it is very low -- base interest rates are currently 5.25% and forecast to rise further.
The big unanswerable question is always "what is the correct P/E?" and this applies to both the overall market and to individual companies. Some say the 30-year bond yield is a good proxy for the "correct" P/E, and with the former standing at 4.76%, it implies a P/E of exactly 21. The 10-year bond is yielding 5.68%, bringing the "correct" P/E down even further, to 17.6.
If I were a Wise market commentator, or possibly even a stock market historian, I'd now probably go on to say how over-valued the market is, and that it's time to sell up and head for the hills. We all know markets crash in October, and these numbers prove the market's a sell.
Get real!
You see, whichever way you look at it, the P/E is a one-dimensional tool for valuing shares. There is no "correct" value for it. I believe each company should be judged and valued on its own particular merits. I also believe that a company's value can only be calculated by adding up its total future cashflows, and discounting them back to the present. Where's the P/E come into that? Nowhere! Discounted cashflows are easier said than done, of course, but that's the challenge for stock analysts. As Malcolm Fraser, former Australian Prime Minister, said, "Life wasn't meant to be easy." Part one in the valuation process is choosing to value a company with predictable earnings. These are relatively rare.
Emap's (LSE: EMA) share price continues its downward slide, presumably because of continued doubts over their recent acquisition of US company Petersen. Having read TMFpyad's excellent article about crisis investing, it got me thinking a little more about the possibility of topping up the Qualiport's holding in Emap. At the current rate of attrition, the shares could be looking quite cheap in the following weeks. Ideally I'd like to be able to see, in the form of results, tangible evidence that the Petersen acquisition is working. However, sometimes you've got to take the bit between the teeth, and pluck up the courage to back the management, despite the uncertainties. After all, this is the same management we backed only a year ago.
With the usual great sense of timing, the Qualiport's visit to the Misys (LSE: MSY) analyst meeting coincided with a sharp fall in the share price of our FTSE 100 IT company. At one stage, Misys were trading at about 500p, which sort of felt like it was a level at which I might consider topping up the existing holding. The fall was as a result of a broker downgrade from Merrill Lynch. As an example of how short-sighted the market often is, take a look at this forecast earnings per share (EPS) table.
2000 2001
Consensus 18.3p 21.6p
Merrill 16.7p 20.1p
Merrill's 2001 guess, because it can never be anything more than that, is 7% lower than the consensus. That's nothing really for long-term investors to fret about. If it was a case of estimates being edged downwards year after year, then that might be more of a problem. It was only in January this year that Misys smashed earnings estimates when releasing interim results, sending the shares soaring higher. How soon the City forgets.
Having a look back at my latest valuation spreadsheet, and doing a little bit of tinkering, I reckon their fair value is about 550p. I will place a 470p top-up price on Misys, being about 15% below their current intrinsic value. Like Rob, I was impressed by their presentation, and the company's future plans. Basically they are aiming to grow their existing businesses by 20% per annum, which is impressive going, with future growth coming from acquisitions. The underlying 20% growth won't last forever -- see what happened to Rentokil!
Last Monday, I said I was considering placing a couple of existing Qualiport companies on "double secret probation". Those familiar with the hilarious cult movie Animal House will know what I'm talking about here. Basically, I've got my eye on them. They are Rentokil Initial (LSE: RTO) and Unilever (LSE: ULVR). Although I've not lost faith with either company, especially the latter, in this low inflationary environment they are just not growing quickly enough. Both have low single-digit sales percentage growth rates, with no tangible evidence that this is going to change any time soon. Over the very long term, it is better to buy a faster-growing company at a high P/E than a low-growth company which may be trading at much lower P/E. That's the immense power of compounding returns at work. The difficult part is identifying the companies which are going to grow consistently fast over an extended time frame. Because you are paying a higher price for that future growth, the margin of error will be greatly reduced.
My gut feeling at the moment tells me that both Rentokil and Unilever are trading at a discount to what I consider to be their fair value. I'm not desperate to sell either of them, as they remain solid companies with steady long-term prospects. Yet, if push came to shove and the Qualiport needed to sell in order to buy, those two would be at the top of the pile. Having said that, I also believe that buy and sell decisions should be made independently, because the best time to buy shares in one company will never coincide with the best time to sell shares in another. It therefore makes sense to calculate a sell price; the price at which you'd be willing to consider selling. For Unilever, the company which I freely admit I overpaid, that price could be something like 650p. But, that's just off the top of my head.
And as for replacement candidates? How about Yahoo! (Nasdaq: YHOO)? Of all the Internet companies out there, and following on from their recent estimate-busting 3rd quarter results, I'm more convinced than ever that they are going to be a big winner. The valuation, as ever, may be the stumbling block, but you never know until you look.
See you Wednesday. In the meantime, the Qualiport message board awaits your thoughts and comments.
Company Change Bid DELL(US)+1.10 45.40 EMA -0.32 8.43 IIG 0.00 2.76 MSY -0.01 5.27 PIZ -0.02 8.08 RTO +0.01 2.13 ULVR -0.02 5.70 LLOY +0.04 7.85 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 27/10/98 755 Indep Ins 2.58 2.76 7.0% 29/09/99 356 Lloyds TSB 7.56 7.85 3.9% 04/11/98 245 Pizza Exp 7.93 8.08 2.0% 27/01/99 74 Dell (US) 44.63 45.40 1.7% 22/04/99 348 Misys 5.76 5.27 (8.5%) 19/12/97 783 Rentokil 2.55 2.13 (16.5%) 17/07/98 266 Unilever 7.53 5.70 (24.3%) 17/04/98 169 EMAP 11.34 8.43 (25.7%) Last Rec'd Total # Company In At Value Change 27/10/98 755 Indep Ins 1972.64 2083.80 111.16 29/09/99 356 Lloyds TSB 2723.20 2794.60 71.40 27/01/99 74 Dell (US) 2007.42 2036.12 28.70 04/11/98 245 Pizza Exp 1966.34 1979.60 13.26 22/04/99 348 Misys 2028.71 1833.96 (194.75) 19/12/97 783 Rentokil 2046.53 1667.79 (378.74) 17/07/98 266 Unilever 2052.00 1516.20 (535.80) 17/04/98 169 EMAP 2341.32 1702.86 (638.46) Cash: £2,710.26 Current Total : £18,325.19 Total Invested: £18,184.62 Profit/(Loss) : (£ 1,859.43) Value Per Share Day Month Year Qualiport -0.04% 0.36% -13.23% FTSE 100 0.57% 3.40% 5.99% FTSE All Share 0.43% 2.92% 8.78%