Letters of the Week

A question of value. Linear or log? Taxi challenges.

Question of value
How do your readers make sense of stock selection advice when Montgomery/Skaffold quotes Westpac's margin at -7.3%, whereas Abernethy/Clime's is 25.2%? This huge disparity is repeated across the stocks quoted by both contributors.

– J Mort

Editor’s response: The 'safety margin’ of a stock simply refers to the discount of its current price compared to what an analyst or computer program determines to be its 'intrinsic’ value. One of the intricacies of stock selection is the identification of this value, and such a figure is dependent on many factors. Clime projects Westpac will be intrinsically worth $27.57 in June – thus it is currently trading 25.2% below its IV – whereas Skaffold finds Westpac is currently trading above its intrinsic value (by a margin of 7.3%). It is also important to recognise here that Skaffold gives a figure for expected rise in value – 4.31% – which will change this margin. Our writers provide in-depth analyses to help readers, but of course there will be divergent outlooks and opinions.

Linear or log?

On April 27, Alan Kohler published a graph entitled “Reversion to the Mean.” Included with it was the following text. “For the past 30 years the Australian All Ordinaries index mostly gained at a fairly consistent pace, until the early 2000s that is. However, since the 2009 rally, market performance appears to have returned to something broadly in line with that longer-term trend.” This highlights a mistake that is often made with long-term graphs of prices: a linear scale distorts the proportional changes which are occurring in the index. We are actually well below trend. You should have used a logarithmic price scale to compensate for the compound growth of the index. On your graph (with a linear scale) the performance looks quite steady but in fact it is steadily decreasing. If you adjust the returns for inflation, the annual compound returns for the 1980s and 1990s are actually quite consistent. The index would actually need to be around 7000 (much like it reached in 2007) to give a decade-long annual real return of 5%. (Oh, if only it were.) Investopedia gives a good explanation: Logarithmic price scales are generally accepted as the default setting for most charting services, and they're used by the majority of technical traders. Common percentage changes are represented by an equal spacing between the numbers in the scale. For example, the distance between $10 and $20 is equal to the distance between $20 and $40 because both scenarios represent a 100% increase in price. I apologise for not providing the logarithmic graph as I do not have your exact data nor the software to do a professional job for you.

– P Anderson

Taxi challenges

Not quite sure why Alan Kohler thought Allan Fels should read The Atlantic's article on taxis (Weekend briefing, April 28). Was that a momentary anachronism? The one who doesn't need to read it is Bill Moss. Remember Lime Taxis in Sydney? It was possibly the first serious failure of the Macquarie model. In every city, the taxi industry is the greatest real-world challenge to the usefulness of business school competition models. Allan Fels has no solution to the way the drivers and operators collaborate to undermine and subvert all pro-competition rules. The taxi industry is the ultimate in 'provider capture'. Ever heard of Reg Kermode? Remember the boycott of Visa cards in Sydney? The nearest to a solution is the London model where what's scarce and hard to get is the driver's licence, not the car's. I note the DC model is the same as Sydney's – ration the cars.

– G Cant

To read this week’s letters, click here.