63An equitable solution
Stock-pickers of the world unite and take over
Jerry sat down with me for twenty minutes at the end of each
day.
‘Value companies are mature businesses which produce a steady
stream of earnings. Their prot after tax every year is normally
very consistent. The most important number for the analyst is
the earnings per share, referred to as the EPS by those in the know.
The rst thing an analyst does is take the prot after tax and
divide it by the number of shares.’
Jerry dug into his blazer and ourished the thickest Montblanc
I’d ever seen. ‘Let’s say the company makes prot after tax of
£10,000 and there are 4,000 shares in issue. Each share makes
£2.50.’
Earnings per share
A Profit after tax £10,000
B Number of shares 4,000
C 5 A/B Earnings per share £2.50
‘For each share you own, the company has made you £2.50.
However, it’s extremely unlikely that the company will pay 100
per cent of this money out in dividends. Some money will be
paid out in dividends, but a proportion will be retained within
the company. Finding out what proportion of prots leaves the
company in the form of dividend is vital for investors.
‘Our company pays £1.50 in dividend for every share that you
have. We call that the DPS, short for dividend per share. If you
divide the DPS by the EPS you have the payout ratio, which tells
you how much of the earnings (the prot after tax) is paid out
in dividends.’
Welcome to the jungle64
The payout ratio calculates how much profit is paid out as
dividends
Payout ratio
D Dividend per share £1.50
C Earnings per share £2.50
E 5 D/C Payout ratio 60%
‘Fast-growth companies don’t pay out dividends because they
need all their money. Our strategy is simple. We search for
companies with a very high payout ratio. We market the fund
at older investors, who are far more interested in steady income
than capital gain. My analysts make a list of all available
companies and place them in order of payout ratio. I use my own
experience as a stock-picker to select thirty or forty companies
which I believe will continue with a high payout ratio. My plan
is to hold the shares for a long time.’
The hapless Jonathan Spurrier was increasingly the target of
Jerry’s barbs. Jonathan was once on the phone, trying hard to
raise some more funds from a tough-talking individual. Jonathan
was useless at picking investments and hated explaining just how
badly his choices had performed.
‘I want you to know,’ said Jonathan to his potential client, ‘this
is the best way to a small fortune.’
Jerry, walking through the graduate area, shouted out, ‘The best way
to a small fortune is to give a large fortune to Jonathan Spurrier.’
We all died laughing, except for Jonathan and, presumably, his
furious client.
Another time Jonathan had just nished a call to a pension fund.
The client, Jonathan informed us, was looking at the problem of
early retirement amongst the very successful and relatively young.
65An equitable solution
‘According to their success demographics, I’m an excellent
candidate for early retirement,’ Jonathan proudly announced.
‘When were you thinking?’ I asked.
Before Jonathan could answer Jerry said, ‘If you want, I’ll arrange
it for this afternoon.’
The dividend yield measures the income from a share
Jerry explained to me how he kept the Saiwai client base happy.
‘My analysts focus on the dividend yield. The dividend yield shows
the relationship between the dividend per share and the share
price. Our shares paid a dividend of £1.50 and the share price was
£60. What this means is that every year, if these numbers were
to stay the same, we’d make 2.5 per cent just on the dividend.
Remember, you’re only looking here at the income on the share,
not at any changes in the share price.’
Dividend yield
D Dividend per share £1.50
F Price per share £60
G 5 D/F Dividend yield 2.5%
Jerry explained how they picked their companies. ‘Any rm
offering a high dividend yield is perfect for our clients. Anything
that has a very low dividend yield – a start-up company or a
company that is growing rapidly – we avoid like the plague.’
Jerry’s strategy had been extremely successful for many years. I
asked him what other companies he avoided and he told me the
fund never considered a small company.
‘What is your denition of small?’
‘A company where the market capitalisation is less than £200
million. The market cap is the value of the company on the stock
exchange. It’s the number of shares multiplied by the share price.’
Welcome to the jungle66
Market capitalisation
B Number of shares 4,000
F Price per share £60
H 5 B 3 F Market cap £240,000
‘My next investment criterion was to nd companies that
appeared to be unloved or forgotten by the stock market. I delib-
erately launched my fund as a clear alternative to the highly
volatile technology funds that were popular at the time. I concen-
trate on highly protable organisations which provide a stable
rate of return. My boring carthorses are the diametric opposite of
start-ups, which are volatile and normally loss-making.’
The P/E ratio tells us what investors think about different
companies
‘My nal fund selection technique is to analyse the relationship
between a company’s share price and its EPS. This is captured in
the P/E ratio, which is the ratio of share price to EPS. For example,
our company has a share price of £60 and the earnings per share
are £2.50. This means that investors in the market are willing to
pay twenty-four times the earnings to buy the share.’
P/E ratio
F Price per share £60
C Earnings per share £2.50
I 5 F/C P/E ratio 24x
‘A high P/E ratio usually means that investors believe a company’s
earnings are going to rocket. The higher the P/E, the higher
the premium investors are prepared to pay for the stock. Do
you remember those factors we talked about: new product,
demographic change, regulation? If a company benets from
these, its P/E will rise.
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