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APRA close scrutiny continues - Column

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Making investment terminology simple is a personal obsession, as I have learned in more than 40 years of investment and financial journalism just how difficult this exercise can be. One reason is the risk of over simplification.
Making investment terminology simple is a personal obsession, as I have learned in more than 40 years of investment and financial journalism just how difficult this exercise can be. One reason is the risk of over simplification.

When I began writing, I was told to write for 10 year olds.

When I began to employ investment analysts for my investment newsletter, I told them to write for eight year olds.

I asked if they had read Ernest Hemingway's Old Man and The Sea, not because of my love of fishing in beautiful places, but because it is the supreme example of writing simply. Active tense, few adjectives. Words speak for themselves, uncluttered.

Why eight year olds?

It is not our age. The busy mind needs to absorb information quickly. Simple expression is vital. Every field has its jargon so the meaning has to be used, not the jargon.

Sounds easy?

Some years ago I asked my journalist wife her opinion of an investment company annual report I had written. She had then lived with me and investment for at least 35 years.

I was amazed my simple statements were question marks to her. Three weeks later with many rewrites, I had some success.

So that annual report cover began: "Dear Patricia".

I discussed the net tangible asset backing per share of an investment company specialising in Australian equities.

First what does that mean? That's the value of the equity portfolio plus cash less any tax that has to be actually paid less any bills due plus any monies due at that date.

Tangible? Equities fit as they can be sold at the price quoted on the stock exchange each day.

I explain what per share means - in this case we divide net assets by the number of shares on issue. Why? Because this is the cornerstone of equity investment. We buy shares in a business, and to gain a better understanding of this unit we reduce all financial matters to a per share basis. Earnings per share, dividend per share, assets per share.

This company then had options to take up shares, so I discussed why their exercise could dilute the value of existing shares as it meant shares would be bought at less than the current share price.

There was more on tax. The company has to account for deferred tax on unrealised profits as well as tax now due to be paid on profits actually realised.

So deferred tax will only be paid on the company's share holdings should they be sold in the future, however distant that future. The company does not pay that money this year or probably for many years to come. So it is somewhat silly to deduct that tax, as the investment company has the use of the money to invest for years.

These are all relatively simple issues with a straightforward company with no debt. Most companies are far more complex, and just to illustrate this point the varied financial press will often report a different headline profit for the same company, each report right in a particular context, but very confusing to the lay investor.

The conversation then ran to three propositions:

1. Just count the dividends you are paid, per share each year, and just see how much they go up over time. That will tell you the worth of your company. Dividends don't lie and they are far easier to understand than option dilutions, modern accounting, indeed almost any accounting.

2. The attraction of an equity over fixed interest income is that dividends can go up, fixed interest can't. You want the yield, just divide the dividend per share by the share price, and you have your yield and, oh, add a fair whack for the value of franking - where you are credited with the tax already paid by company, and don't have to pay it again. That makes franked dividends and their low rate of tax in your hands absolutely marvellous.

3. And just think about that deferred tax. If we only buy really good companies that we never have to sell, then we always have that invested money working for us. For we will not have to pay tax on the profit from sales. We just need to select good companies that don't have terminal stumbles.

I sincerely hope you enjoy the conversational conclusions of how complicated making investment terms simple can be.

And perhaps next time you are talking clients through the investment process you'll keep this in mind.

 

APRA close scrutiny continues - Column
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