Do share prices reflect company performance?

Press, Volume CXI, Issue 32565, 26 March 1971, Page 18

Do share prices reflect company performance?

(By the commercial editor) Although the supply of a commodity may permanently increase, thus bringing about a lower average of prices for it, these lower prices usually prevent the supply from expanding too rapidly maintaining a reasonable balance of supply and demand.

But there is no such check on the issue of shares. If a company, say because it is expanding strongly (through take-overs or otherwise), issues more shares, the price of these shares will tend to fall provided that the demand for the shares remains as it was before. Often the demand will rise, of course, because investors are attracted to such a fast expanding company, which is obviously doing well. Then the underlying weakness of the shares is not immediately obvious. But once the demand is satisfied, the weakness becomes immediately apparent. A typical example of this is Dominion Breweries. On its take-over spree it paid for its expansion mainly in shares. Most of these shares went to hoteliers, who had worked for many years long hours in their hotels. A substantial number of them may have decided that they were now due for a world trip. But they could only take it by selling the Dominion Breweries shares they had received in exchange for their holdings.

Brokers’ adroitness The weight of selling must depress the price. In this case the weakness was not immediately apparent for two reasons: first, because the shares were thought by many investors to be good buying at about 125 c and second, because of the skill of the brokers who handled this distributive proThe latter point should not be underestimated. The price of the shares remained remarkably constant for almost five months, a fact which excited my admiration at the time, as under the circumstances. this was a real achievement. But the shares could not hold this price,..and fell in the span of about five weeks to 110 c, which illustrates my argument. New markets tapped This fall had little connection with the fact that the market was Weak during the period, but must be regarded as the inevitable outcome of the technical factors involved. After the first flood of shares on the market had all found new owners at relatively constant prices, the shares failed to find further support at that level, and prices had to come down. But when they reached 110 c, the shares began to look cheap to a new segment of the market. We may now expect further distribution of the shares

at around this level, although the support may be less strong and of shorter duration. It will be interesting to watch this process work itself out. The closer the shares get to par value, the more resistance they might be expected to show. Now all this has nothing to do with the value of Domin-

ion Breweries shares, or with the performance of the company. Dominion Breweries is doing as well as it has ever done, and the take-overs have of course strengthened the company considerably. And another paradox is that the balance sheet must actually have become much stronger, because the shares in the take-overs were issued at a premium. This means that shareholders’ funds rose much faster than issued capital, thus automatically creating huge reserves.

Not that investors should confuse the financial strength of a company, as revealed in the balance sheet, with earning power. That is another chapter, as the walrus said. But with Dominion Breweries there is no worry about eamings, either. Not the only one Any fundamentalist would say that the shares were worth more than 113 c. But the fact is that, for technical reasons and quite irrespective of the present market weakness, you could not expect the shares to rise until the distributive processes had worked themselves out. Dominion Breweries is not the only share in this category. Anybody who has been watching the behaviour of U.E.B. shares during the last five years, say since the takeover of Ross and Glendining, would observe similar processes at work.

A great number of Ross and Glendining shareholders were, a little unhappy about this take-over, and sold their shares as soon as they could. Even some of U.E.B.’s own shareholders were doubtful about the move wrongly, as. it turned out and sold at first. The upshot of it all was that it took U.E.B. shares about three years to come “right” again, although investtors who stuck with the shares did very well. U.E.B. is another company which has expanded strongly in the last five years, and before.

In the first half of the last decade expansion could only benefit the price of the shares: relative to the demand for scrip the total number of

I shares, of al! companies, on the New Zealand sharemar•ket was small.

Lately, however, many, ‘more companies have issued! much more scrip, with the re-1 suit that if anything there is' la surfeit of scrip. This makes it much trick-! jier for a company to issue i more of its own shares. It; ‘then becomes possible to con-1 tinuously increase the supply lin such a way that the mar-i ket cannot catch up. Although the company is flourishing, and going from strength to strength, the purely technical factor of supply outrunning demand keeps the price of the shares down. This would be reinforced if, some of the new shareholders from the take-overs were to be less interested in the new company than in their own, the identity of which had now merged. It would appear that U.E.B. shares suffered from this in the last two years. The fact that the directors of U.E.B. made a few private placements last year suggests that they are aware of this process.

But again, it must be emphasised that there is nothing wrong with the prospects of U.E.B. Technical factors are responsible for the low price of the shares. The examples of U.E.B. and Dominion Breweries should not lead investors to think that only the shares of companies involved in takeovers will behave in this manner.

The shares of any company with a large share capital which is widely held are technically potentially weak. The shares of New Zealand Steel are a case in point.

Whenever portfolios are being culled, you might expect those shares to hit the market that there are most of. N.Z.M.C. case With regard to the shares of the New Zealand Motor Corporation, the divergence of value and price mentioned by the chairman is probably the result of a combination of factors. Technical factors, such as those discussed above no doubt play a large part. Even before the public issue was made, just about a year ago, there was already strong selling of the shares. The only shares outstanding at that time had been issued in exchange for the companies which were to make up the corporation—all interests closely associated with the board. This selling depressed the pri ce of the share and did

not do its image .any good. Other reasons for N.Z.M.C.’s weakness in the market are ! probably non-technical. It must regrettably be said I that the company’s public | relations are not conducted I well. Also, a number of inIvestors are probably worried about the company’s relationj ship with British Leyland, (which is rumoured to be a I little difficult at. present. CONCLUDED.

Thi s is the third and final of three articles on some aspects of the long-term behaviour of share prices. The first two articles appeared on Monday and Tuesday.