Nine steps to economic recovery
Decade of financial stability? ACCA reveals wish list for the new decade
The financial and regulatory world in 2020 will be much stronger, but only if nine fundamental principles are followed at the start of this new decade, says ACCA (the Association of Chartered Certified Accountants) in a policy paper entitled Nine Steps to Financial Stability 2020.
1. A separation of retail – or at the very least deposit taking – from investment banking and a return of distressed banks to the private sector in a profitable way.
The banking sector undoubtedly played a role in the financial crisis, with corporate and investment banking, bringing both significant profits but ultimately also billions of pounds in toxic debt and trillions in banking bailouts around the world. Steps need to be taken to ensure that this issue is addressed and specifically, that retail banking activities, which have long accounted for much of the profit of many banks and which focus on deposits and supporting consumers, are protected.
2. A return to a savings over debt culture combined with decent State post-retirement provision
The last decades have been marked by a combination of low savings rates and high debt levels, especially in the US and UK, which both have economies largely based on consumption, the housing market and the expansion of personal debt. The time has come to rebuild the savings culture – to reject the credit card in favour of the piggy bank, and it is for the Government to cultivate an environment that encourages this. This should be addressed urgently through the reform of pensions and benefit systems in order to restore the social and economic benefits of a low time preference culture.
3. An effective transition to the low carbon economy
Recent projections from the Intergovernmental Panel on Climate Change (IPCC) warn that that unless action is taken to cut greenhouse gas emissions, global warming will exceed the danger level of a 2°C increase. According to the IPCC’s worst-case scenario, climate change could reach dangerous levels as early as 2050. Current assessments show that this is likely to happen. Unprecedented action is required nationally, regionally, and internationally to address this. For pessimists, the current economic downturn has substantially delayed green economy plans, with governments now pre-occupied with the recession and focusing on fiscal stimulus measures. However, the trillion dollar banking sector bailout is proof that governments can work together, quickly, to help resolve global catastrophes. These difficult economic times, which could actually provide a golden opportunity to encourage investment in a low-carbon economy, specifically in energy-efficient technologies and renewable energy and in creating lower-carbon growth and green jobs.
4. Full and effective governmental support for small business by ‘thinking small first’
At a time when the Government’s finances are becoming increasingly tight and small businesses are facing mounting pressures, we must not lose sight of the fact that small businesses are the growth engine of economies around the world. During the worst of the recession, one in every five net jobs lost in the UK was replaced by a self-employed person, demonstrating that the role of entrepreneurs during economic downturns is crucial. Not only do they introduce new economic activity when existing businesses tend to reduce theirs, but through this process they create new employment, paving the way towards economic recovery. In fact, some of the most innovative and fastest growing companies were started during recessions such as Wal-Mart (1962), Starbucks (1971), Microsoft (1975) and Virgin Atlantic (1982). “Thinking small first” does not mean subsidising smaller businesses at every opportunity. It means making sure that, in complying with government’s requirements and accessing its support network, a business’ size, resources and administrative capacity do not confer an implicit subsidy.
5. A permanent secretariat for the G20 group of nations
The G20 was established in 1999 in the wake of the Asian financial crisis as a forum for cooperation and consultation on matters relating to the international financial system. A G20 summit represents a pragmatic approach to finding effective solutions to key global challenges such as financial instability and the need to reform the global financial institutions. Representing the world’s 20 leading industrialised and emerging economies, and accounting for 90% of the world’s GDP, it is a more representative and inclusive global steering committee than the Group of Eight (G8). It is clear that the financial crisis and other issues such as climate change, are too big for individual nations to tackle on their own. ACCA believes that there should be a formal agreement to make the G20 feature a long-term feature of global governance.
6. A stable, transparent, fair and certain system of taxation
It has been argued by the International Monetary Fund (IMF) that the global financial crisis has been exacerbated (though not caused) by tax policies which fuelled the credit boom that preceded the economic downturn. The IMF proposes that governments should consider changing the rules that have encouraged companies to seek finance using debt rather than equity, and allowed individuals to take out larger mortgages. Many tax regimes allow companies to deduct interest payments against tax but not against returns on equity; this has resulted in an increase both in leveraged buy-outs by private equity organisations and in the holding of debt rather than equity by other financial institutions. The IMF argues that ‘corporate level tax biases favouring debt finance including in the financial sector are pervasive, often large and hard to justify given the potential impact on financial stability.’
7. The effective adoption of International Financial Reporting Standards
The financial crisis and the current focus on accounting standards provide a unique opportunity to simplify, improve and clarify accounting standards. IFRS is helping to make financial information more transparent and comparable across countries, industry sectors and companies. In doing so, it improves investor information, comparability and investment choice.
8. Safe payments and consumer protection against bribery, money laundering, fraud and corruption
The increasing availability of the Internet and digital TV means that is becoming easier and quicker for consumers to shop without leaving home. Shopping is also becoming a truly global experience, with more and more consumers turning to their computers to buy goods such as software and CDs, higher priced items such as cars and holidays, as well as services such as insurance. Taken alone, the UK’s Internet shopping market is worth more than £21.4 billion, with more than 20 million people buying online in 2008 . Online shopping has become a multi billion pound business, but online fraud has also increased exponentially. However, online fraud is not the only risk facing those who do online shopping. There are also company insolvencies and unethical business practices to negotiate.
9. Effective corporate governance in both the public, private and third sectors.
Underlying much of the credit crunch has been a fundamental failure in corporate governance. While the financial institutions involved may have been in compliance with local requirements and codes, they have ignored the key point – good corporate governance is about boards directing and controlling the organizations so they operate in their shareholders’ interests. Boards should be answerable to company owners, to account properly for their stewardship and to ensure both sound internal control and the ethical health of the organizations. The use of overly-complex financial products, which thwarted effective supervisory control, and the unethical advancement, at the point of sale, of loans to people with little realistic hope of repaying them shows a lack of basic corporate governance. All of these issues need addressing in order to prevent a further financial crisis in the short-term.
UK Recent Economic Data
BASE RATE:
2009
Mar 5 down 0.50%
Feb 5 down 1.00%
Jan 8 down 1.50%
2008
Dec 4 down 2.00%
Nov 6 down 3.00%
Oct 8 down 4.50%
Apr 10 down 5.00%
Feb 7 down 5.25%
2007
Dec 6 down 5.50%
Jul 5 up 5.75%
May 10 up 5.50%
Jan 11 up 5.25%
2006
Nov 9 up 5.00%
Aug 3 up 4.75%
2005
Aug 4 dn 4.50%
2004
Aug 5 up 4.75%
Jun 10 up 4.50%
May 6 up 4.25%
Feb 5 up 4.00%
2003
Nov 6 up 3.75%
Jul 10 down 3.50%
Feb 6 down 3.75%
GROSS DOMESTIC PRODUCT:
quarterly % change yearly % change
2009
4Q +0.1 -3.2
3Q -0.2 (R) -5.1 (R)
2Q -0.6 (R) -5.5
1Q -2.4 (R) -4.9 (R)
2008
4Q -1.6 (R) -2.0 (R)
3Q -0.5 +0.3
2Q 0.0 (R) +1.4 (R)
1Q +0.3 (R) +2.3 (R)
2007
4Q +0.6 +2.9
3Q +0.7 (R) +3.3 (R)
2Q +0.8 +3.1 (R)
1Q +0.7 +3.0 (R)
2006
4Q +0.7 (R) +3.0
3Q +0.7 +2.9 (R)
2Q +0.7 (R) +2.6
1Q +0.7 (R) +2.3 (R)
2005
4Q +0.6 +1.8
3Q +0.4 +1.7 (R)
2Q +0.5 (R) +1.5 (R)
1Q +0.4 (R) +2.1 (R)
2004
4Q +0.7 +2.9
3Q +0.5 (R) +3.2 (R)
2Q +0.9 +3.6 (R)
1Q +0.7 +3.4
2003
4Q +0.9 +2.8 (R)
3Q +0.8 (R) +2.1 (R)
2Q +0.6 (R) +2.0 (R)
1Q +0.1 (R) +2.1 (R)
CONSUMER PRICES INDEX:
monthly % change yearly % change
2009
Dec +0.6 +2.9
Nov +0.3 +1.9
Oct +0.2 +1.5
Sep 0.0 +1.1
Aug +0.4 +1.6
Jul +0.3 +1.8
Jun +0.3 +1.8
May +0.6 +2.2
Apr +0.2 +2.3
Mar +0.2 +2.9
Feb +0.9 +3.2
Jan -0.7 +3.0
2008
Dec -0.4 +3.1
Nov -0.1 +4.1
Oct -0.2 +4.5
Sep +0.5 +5.2
Aug +0.6 +4.7
Jul +0.7 +4.4
Jun +0.7 +3.8
May +0.6 +3.3
Apr +0.8 +3.0
Mar +0.4 +2.5
Feb +0.7 +2.5
Jan -0.7 +2.2
2007
Dec +0.6 +2.1
Nov +0.3 +2.1
Oct +0.5 +2.1
Sep +0.1 +1.8
Aug +0.4 +1.8
Jul -0.6 +1.9
Jun +0.2 +2.4
May +0.3 +2.6
Apr +0.3 +2.8
Mar +0.5 +3.1
Feb +0.4 +2.8
Jan -0.8 +2.7
2006
Dec +0.6 +3.0
Nov +0.3 +2.7
Oct +0.2 +2.4
Sep +0.1 +2.4
Aug +0.4 +2.5
Jul -0.1 +2.4
Jun +0.3 +2.5
May +0.5 +2.2
Apr +0.6 +2.0
Mar +0.2 +1.8
Feb +0.3 +2.0
Jan -0.5 +1.9
2005
Dec +0.3 +1.9
Nov 0.0 +2.1
Oct +0.1 +2.3
Sep +0.2 +2.5
Aug +0.4 +2.4
Jul +0.1 +2.3
Jun 0.0 +2.0
May +0.4 +1.9
Apr +0.4 +1.9
Mar +0.4 +1.9
Feb +0.3 +1.6
Jan -0.5 +1.6
2004
Dec +0.5 +1.6
Nov +0.2 +1.5
Oct +0.3 +1.2
Sep +0.1 +1.1
Aug +0.3 +1.3
Jul -0.3 +1.4
Jun -0.1 +1.6
May +0.4 +1.5
Apr +0.4 +1.2
Mar +0.2 +1.1
Feb +0.3 +1.3
Jan -0.5 +1.4
2003
Dec +0.4 +1.3
Nov -0.1 +1.3
Oct +0.2 +1.4
Sep +0.3 +1.4
Aug N/A +1.4
Jul N/A +1.3
Jun N/A +1.1
May N/A +1.2
Apr N/A +1.5
Mar N/A +1.6
Feb N/A +1.6
Jan N/A +1.4
RETAIL SALES:
monthly % change yearly % change
2009
Dec +0.3 +2.1
Nov -0.3 +3.1 (R)
Oct +0.6 (R) +3.7 (R)
Sep +0.0 +2.9 (R)
Aug +0.0 +2.2 (R)
Jul +0.2 (R) +2.9
Jun +1.3 +3.1
May -0.6 -1.6
Apr +0.9 +2.6
Mar +1.5 (R) +0.9 (R)
Feb -2.0 (R) +0.4
Jan +0.7 +3.8 (R)
2008
Dec +1.7 (R) +4.3 (R)
Nov +0.3 +1.3 (R)
Oct -0.1 +1.9
Sep -0.5 (R) +1.7 (R)
Aug +1.2 +3.3
Jul +0.9 (R) +2.0 (R)
Jun -3.9 +2.2
May +3.5 +8.1
Apr -0.2 +4.2
Mar -0.2 +4.6
Feb +1.1
Jan +0.8 +5.7
2007
Dec -0.2 (R) +2.8 (R)
Nov +0.4 +4.2 (R)
Oct 0.0 (R) +4.2 (R)
Sep +0.3 (R) +6.0 (R)
Aug +0.7 (R) +4.8 (R)
Jul +0.7 +4.4
Jun +0.4 (R) +3.7 (R)
May +0.4 +3.9
Apr -0.1 +4.2
Mar +0.3 +4.8
Feb +1.6 (R) +5.1 (R)
Jan -1.8 +1.1
2006
Dec +1.1 +4.0 (R)
Nov +0.3 +3.2
Oct +1.0 (R) +3.9
Sep -0.4 +3.0 (R)
Aug +0.3 +4.3
Jul 0.0 (R) +4.3 (R)
Jun +0.7 (R) +3.6 (R)
May +0.5 +4.0
Apr +0.7 (R) +3.0
Mar +0.9 (R) +2.8 (R)
Feb +0.3 (R) +1.6 (R)
Jan -1.6 (R) +1.2 (R)
2005
Dec +0.4 +4.3 (R)
Nov +0.9 (R) +2.1
Oct +0.4 (R) +1.5
Sep +0.6 (R) +0.7
Aug +0.2 (R) +1.0 (R)
Jul -0.6 (R) +1.3 (R)
Jun +1.2 (R) +1.2 (R)
May +0.1 +1.2 (R)
Apr +0.5 +2.0 (R)
Mar -0.1 +2.4 (R)
Feb +0.3 (R) +3.6
Jan +0.7 (R) +3.5 (R)
2004
Dec -1.1 (R) +3.2
Nov +0.6 +5.9 (R)
Oct -0.5 (R) +5.6 (R)
Sep +1.1 (R) +7.0 (R)
Aug +1.1 (R) +7.0 (R)
Jul -0.6 (R) +6.4 (R)
Jun +1.0 (R) +7.0 (R)
May +0.7 (R) +7.5 (R)
Apr +0.3 +5.8 (R)
Mar +0.8 (R) +6.5 (R)
Feb 0.0 +6.5
Jan +1.2 (R) +6.9 (R)
2003
Dec +0.9 +4.0
Nov +0.4 (R) +4.2 (R)
Oct +0.6 +3.7
Sep +0.6 +3.9
Aug +0.5 (R) +3.4 (R)
Jul -0.4 +4.4
Jun +1.9 +6.0
May -0.2 (R) +3.1
Apr +0.4 (R) +2.7
Mar +0.6 +4.6
Feb +0.3 (R) +3.4 (R)
Jan -1.0 +4.2
JOBLESS CLAIMANTS:
Total (m) 3mth average earns (%)
2009
Dec 1.61
Nov 1.63 +1.6
Oct 1.64 +1.5
Sep 1.63 +1.7 (R)
Aug 1.61 +1.6
Jul 1.58 +2.2
Jun 1.56 +2.5
May 1.54 +2.6
Apr 1.51 +0.9 (R)
Mar 1.46 +3.2
Feb 1.39 +3.0
Jan 1.23 +3.4
2008
Dec 1.1600 +3.6
Nov 0.9910 +3.6
Oct 0.9809 +3.6
Sep 0.9399 +3.6
Aug 0.9049 +3.6
Jul 0.9001 +3.7
Jun 0.8401 +3.4
May 0.8248 +3.8
Apr 0.8015 +3.9
Mar 0.7943 +3.8
Feb 0.7941 +3.8
Jan 0.7969 +3.7
2007
Dec 0.8077 +3.8
Nov 0.8130 +4.0
Oct 0.8248 +4.0
Sep 0.8358 +4.1
Aug 0.8529 +3.7
Jul 0.8553 +3.5
Jun 0.8641 +3.4 (R)
May 0.8804 +3.5
Apr 0.8897 +4.1 (R)
Mar 0.9108 +4.4 (R)
Feb 0.9200 +4.6
Jan 0.9231 +4.2
2006
Dec 0.9391 +4.0
Nov 0.9472 +4.1
Oct 0.9551 +4.1
Sep 0.9567 +3.9
Aug 0.9533 +4.2
Jul 0.9551 +4.4
Jun 0.9552 +4.3
May 0.9519 +4.1
Apr 0.9471 +4.3
Mar 0.9388 +4.1
Feb 0.9264 +4.0
Jan 0.9109 +3.6
2005
Dec 0.9084 +3.7
Nov 0.9005 +3.5
Oct 0.8874 +3.7
Sep 0.8758 +4.2
Aug 0.8683 +4.2
Jul 0.8657 +4.2
Jun 0.8614 +4.0
May 0.8540 +4.1
Apr 0.8397 +4.5
Mar 0.8320 +4.5
How to value stocks: Earnings based valuations
Its very normal to value a company via its earnings, often referred to as net income or net profit. Essentially earnings are the money left after all the bills are paid. To compare companies like-for-like investors measure earnings with an earnings per share (EPS) formula.
EPS
To find the EPS of a company you divide the amount of earnings of a company (in currency) by the number of shares the company has outstanding. We will use good old XZY PLC for our examples:
XYZ PLC produced $1 million earnings in the last 12 months and has 1 million shares outstanding; our EPS formula would produce an EPS of $1.
$1mil earnings /1mil shares = $1 EPS
P/E
Unfortunately the EPS tells us nothing about the companies shares fair value, we need something to compare relative to its share price. Many investors use another formula, the price/earnings ration. P/E looks at the share price and divides it by the last four quarters worth of earnings. XYZ PLC volunteers yet again; the current share price of XYZ PLC is at $10 a share:
$10 share price / $1 in EPS = 10 P/E
Sometimes called a multiple the P/E is often compared to the current rate of growth in the EPS, if both are approximately equal then fair value could be argued, this assumes that the P/E ratio at 10 is roughly inline with the companies current growth rate of lets say 11% for XYZ PLC, this would make P/E relative to current earnings growth a more sensible measurement, if on the other hand a companies growth decreases then P/E would not make sense as a measurement tool.
Both of these methods produce a “trailing” ratio, in other words the methods are based on historical data and benchmark what has happened. Quite a few investors I have meet stop here and use this data for their “informed” decision on a stock, frankly I feel this is a leap of faith and alike driving car while firmly fixed on the rear view mirror.
Since XYZ PLC has a current growth rate of 11% we can extend the use of P/E, I don’t want to look at the past for a decision, I want to forecast into the future. For this we can use two simple methods, these are the “P/E & Growth” (PEG) and the “year ahead P/E & Growth” (YPEG).
PEG
To use PEG we expand the growth rate out into the future and then compare it to its trailing P/E.
10 Trailing P/E / 11% projected EPS growth rate = 0.90 PEG
The lower PEG ratio the more of a bargain the companies’ price is. As you can see the 1% increase in current growth compared to its trailing valuation of 10% growth shows up in our analysis using PEG.
YPEG
YPEG uses the same assumption but uses different data. Instead of using trailing earnings data YPEG looks at the price to earning estimates for the coming year, then we apply 5 year growth rates estimates found at many quote sources.
So, if the forward P/E is 10 and we expect the company growth at 20% over 5 years, the YPEG is equal to 0.5.
We should not use PEG or YPEG in isolation, they make excellent measures if viewed with other methods, they do not provide one-stop-shop magic numbers.
The Yen fundamental forecast
Last week, Hirohisa Fujii the out spoken Yen commentator and finances minister of Japan resigned sending ripples through the forex markets. Replacement Deputy Prime Minister Naoto Kan was expected to be more consistent than Fujii, quickly disappointing me.
Mr. Kan managed to contradict himself repeatedly within days of his new post, on Jan 6 he said it would be nice to see the Yen weaken going as far as to earmark 95 Yen to the US dollar. The next day saying the market should in fact determine the yen, “If currency levels deviate sharply from estimates, that could have effects on the economy”, later to be rebuked by Prime Minister Yukio Hatoyama who noted that the government should not talk to reporters about forex. He also went on to tell US treasury secretary that forex levels should be stable, in short, the Japanese official governmental position on the yen remains muddled, will it or will it not intervene.
Fortunately they may not have too, the Yen still remains more then 5% off the record highs of November, also economic and financial forces are uniting that could send the Yen downward. Regardless of a recovery in exports the Japanese economy remains tired, having the recently contracted to its lowest level since 1991 as a member of the fall of the largest economies.
The Nikkei standing 44.3% below its stance at the end of 1999 and 72.9% below its 1989 peak, after the economic collapse in 1990 Japanese consumers became notoriously tight, domestic markets still unable to recover. Meanwhile the bond market has been the mirror image rallying 78% since 1990.
What are the government doing about this, nothing? They continue to spend like crazy compounding its fiscal state and pushing closer to insolvent state in an attempt to prime the pump and avoid deflation digging its heels in deeper.
For the Yen, I feel we should see it hover over the near-term period s price stability and strong credit rating don’t signal immediate catastrophe. Japan’s economic problems are long-term, meaning we should see some time pass before manifestation.
Rob Lee -Senior Analyst Arriba Capital