I found the below article on the Hargreaves Lansdowne Website and I thought it was very interesting. It explains what questions drive investors in their pursuit of returns. The interesting thing about this piece is that it talks about investing in listed equities and yet it could be talking about Unlisted Businesses.

In the final analysis, I would say it is fair to say that whatever valuation you placed on your business six months ago, unless things have improved dramatically, you need to be at least 20% cheaper now than you were then.

Sorry to be so pessimistic - but I think that is the reality of where we are today

Spot the difference

Richard Hunter explains why the coming weeks could give us a clearer idea of how well some companies are weathering the economic storm and also gives some tips on what to look out for when buying shares.

Whether the market has begun to show some tentative signs of recovery, or whether we are simply in yet another bear market rally remains to be seen.

There are an extremely important few weeks coming up, partly represented by the UK banks’ interim reporting season, but also by a whole host of other blue chip half-yearly numbers, after which we should have a much clearer idea as to whether the fears of a slump in corporate earnings have been justified.

In the meantime, there has tended to be a “broad brush” approach to marking down share prices, even perhaps some of those which are well equipped to weather a downturn, and this in turn has thrown out some interesting opportunities.

Enter the return of the value and growth investor

The definitions are many and varied, but as a rule it is generally agreed that, to be considered a growth stock, earnings rates must be consistently above average. Value stocks, on the other hand, are ones which investors like to think of as “bargains”, where for whatever reason the investor believes the current share price does not adequately reflect the worth of the business, or indeed its future prospects.

Pure growth stocks tend to be found towards the smaller end of the spectrum and are typified by companies which, assuming they are in profit, will be reinvesting this extra capital in an effort to grow the business further. Growth stocks are very much prone to the vagaries of market expectations, as, in particular, information technology and healthcare stocks have often found. Most of them will tend to be on higher earnings multiples and, not surprisingly, continued year on year growth will therefore be expected. Analysts’ forecasts therefore need to be carefully considered, in order to prevent a rout on the shares in the event of a disappointing trading statement or set of numbers, let alone a profits warning.

The utility sector is one where the traditional boundaries of growth and income are becoming blurred.

On the other hand, value stocks tend to have lower expectations placed upon them by the market. They are often characterised by lower earnings multiples, and therefore relatively lower share prices and can often be found to be amongst the higher yielding stocks, or income shares. On the whole, these tend to be well established, cash generative companies who should not have difficulty in maintaining future dividends.

There are additional complications when stocks exhibit qualities of both growth and income, although this is of less concern to individual investors than to the funds which have firmly set out their stall in one camp or the other. The utility sector, as mentioned above, is one where the traditional boundaries of growth and income are becoming blurred. Furthermore, more risk averse investors have tended towards these more defensive stocks after the bear market at the turn of the century, (and to some extent within recent weeks) and of course this added buying pressure has provided further upward impetus on share prices. Although an investment is not without risk and the value may fall as well as rise.

These are, of course, very general summaries - there are a whole host of factors which investors need to be taking into account, especially when investing at stock level, such as the likelihood of strength in future earnings and just which factors differentiate that company from its competitors.

…there are a number of killer questions which can help separate the successful company from the also-ran.

In addition, there is a whole host of fundamental data which investors will consider when comparing similar stocks. These include, inter alia, the price/earnings ratio, the dividend yield, the return on capital employed, and the gearing (the level of a company’s debt compared with its equity capital). Additionally comes the appetite for acquisitions (or even the likelihood of being acquired should the company have reached saturation in its market or, alternatively, should the company find itself in current difficulty).

Lack of space precludes examining each of the fundamentals, but there are a number of killer questions which can help separate the successful company from the also-ran.

For example, what is the company’s unique selling point? Is there sufficient breadth and depth of management experience? Is the company diversified, both geographically and in the services or products in which it deals, in order to be able to withstand different parts of the economic cycle? Are its profit margins comfortable, or under increasingly severe pressure? Can its business be complemented by the ubiquitous use of the internet?

With every market correction come opportunities, and already the braver investors are scrutinising where these might currently be found.

Richard J Hunter
Head of UK Equities

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