Information underload

PORTFOLIO POINT: The flow of information is a major issue for market regulators, and the consequences on share prices can be enormous.

The sharemarket is often awash with gossip, rumour and innuendo. It is the stuff that causes share prices to rise and fall in the short term.

Volatility may be concerning to long-term or sensible investors, but it is a delight for day traders, hedge funds and even the ASX. The latter entity benefits from market price volatility and particularly when it is matched by high trading volumes.

Also the market is always awash with opinions on facts and it is the pricing debate that can offer an investor an opportunity to buy, to sit with, or to sell a security. This is particularly so because of the insistence by the ASX, as operator of the market, to require that securities must trade whilst the market is open.

The recent experiences of David Jones (DJS is not in our growth portfolio) and MacMillan Shakespeare (MMS is in our growth portfolio) are worth reviewing to understand the inefficiencies and pitfalls of market pricing where information is scant. Notably, the DJS price rose by 15% and the MMS price fell by 10% during the “events” that I will cover.

In the DJS case we now know that an obscure person or group from the United Kingdom made various “highly conditional” takeover approaches to the retailer’s board. The terms of the first purported bid were so “conditional” as to render it highly dubious. With the second approach the board rightly questioned the capacity of the bidder, who had previously failed to prove their bona fides. Nothing needed to be disclosed to shareholders until newswires were alerted to a blog in the UK that mentioned the takeover approach. At that point DJS made an ASX announcement on June 29, which happened to be the last trading day of the financial year.

In my view the shares of DJS should have been immediately placed in a “trading halt” to allow the company to publicly clarify the integrity, terms, bona fides, price and capacity of the bid to occur. Anything short of that causes the market to trade on massive speculation with a clear risk of financial detriment to many investors.

At that point on June 29 there was no way that the DJS board could convey to its shareholders or the market, all of the relevant information which they deserved to receive. However, the shares were back on the market at the opening of trade on June 29, and many sell orders entered days before by unsuspecting owners were transacted. No trading halt and no time for orders to be withdrawn by private individuals operating through online discount brokers. Is that fair? Absolutely not! So why wasn’t there a trading halt, and to whose detriment was it if the shares had not traded on that last day of the financial year? Maybe the ASX or indeed ASIC can advise.

A less obscure event happened last week with one of our growth portfolio stocks, MMS. On Friday I was alerted by a broker to the following newswire:

“BRISBANE, July 6 AAP - The Queensland government’s salary sacrificing arrangements will be probed after a suspected fraud netted almost $500,000 from public servants. The alleged fraud came to light in June 2011 under the former Labor government, Public Works Minister Bruce Flegg says. Dr Flegg says RemServ, one of two providers of salary packaging services to government, engaged accounting firm BDO to investigate the matter. The investigation found the alleged fraud was down to a failure in RemServ’s internal controls, Dr Flegg said. 'I am informed that the alleged fraudulent transactions impacted the accounts of 7580 current or former Queensland government employees and totalled $492,763,’ he said. The alleged fraudulent transactions have been traced to a former RemServ employee, and police and the Director of Public Prosecutions have been informed.”

The share price of MMS had been falling for a few days before the newswire and accelerated as the wire was circulated amongst professional investors in the market. Indeed, the share price fall amounted to a $60 million decline in market value in just three days. This dramatic fall resulted from a $500,000 fraud. Not that $500,000 (actually $492,000) is trivial but a close look at the newswire shows that the fraud was actually quite small, amounting to less than $70 per aggrieved worker. If the fraud was undertaken over many years (and it was) then the actual amounts were very small indeed. Then we note the fraud had been exposed over a year earlier (old news) plus it had been uncovered and investigated by the company itself. It is arguable that the resulting investigation would improve the operations of the business, for often it is fraudulent attacks that will force or allow a business to respond and improve its systems – much like internet security.

In the above circumstance it was probably correct that MMS did not publicly respond to “old” news presented on newswires. Why should a public company need to respond to every comment or review that passes for news in this market? However, it is interesting to note that the price fall did not trigger a question to MMS from those regulators who monitor price movements. It appears that so much mindless price volatility has led to a sanguine position on behalf of market supervisors. The current position suggests that there would be far too many surveillance questions asked if a 10% price move was a trigger event. Quite sad, when you reflect upon it.

Having said that, MMS comfortably resides in our growth portfolio. Over the past five years MMS has achieved:

• An average normalised return on equity of 54.7% pa;
• Growth in net profits from $17.37 million in FY08 to $47.85 million in the 12 months to Dec 31 2012;
• Dividend growth, from $9.75 million pa to $25.91 million pa over the same period; and
• MMS has achieved this without asking shareholders for new equity, with the only substantial injection of capital being from executive option exercises.

Figure 1. Financial History and Forecast: McMillan Shakespeare Limited
Source: MyClime

Based on market consensus and the lack of any negative statement by the company, we have a valuation for MMS of $11.43 for FY12, which places it around fair value at current prices. Going forward value is forecast to grow.

Figure 2. Performance: McMillan Shakespeare Limited
Source: MyClime

Figure 3. Price Value Chart: McMillan Shakespeare Limited
Source: MyClime

At current prices, around $11, MMS is providing its owners with a grossed up dividend yield of 5.5%.

Growth Model Portfolio

-Clime Model Growth Portfolio (prices as at July 12, 2012)
Company	Code	Purchase Price	Market Price	June 2012 Value	Safety Margin	GU Yield	Total Return
BHP Billiton	BHP	35.5	30.40	46.12	51.71%	4.84%	-14.37%
Commonwealth Bank	CBA	50.78	53.51	58.93	10.14%	8.44%	5.38%
Westpac	WBC	22.02	21.87	26.49	21.12%	9.73%	3.04%
Blackmores	BKL	27.55	27.19	27.36	0.63%	0.58%	-1.31%
Woolworths	WOW	25.85	26.91	31.53	17.17%	6.42%	4.10%
Iress	IRE	6.75	6.32	7.40	17.09%	8.21%	-6.37%
The Reject Shop	TRS	12.04	9.15	12.58	37.49%	4.84%	-24.00%
Brickworks	BKW	10.45	10.14	12.33	21.60%	5.78%	-2.97%
McMillan Shakespeare	MMS	11.01	11.29	11.43	1.24%	4.68%	2.54%
Mineral Resources	MIN	11.77	8.41	13.83	64.45%	6.96%	-28.55%
Rio Tinto	RIO	66.6	54.25	83.65	54.19%	3.13%	-18.54%
OrotonGroup	ORL	8.64	7.28	9.38	28.85%	9.81%	-15.74%
* Market prices as at close July 12, 2012

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