Valuing old and new like jelly wrestling

By HAMISH MCRAE

If ever we wanted a week that would illustrate the markets' struggle to price different types of companies, this has surely been it.

Plunging prices of high-tech stocks; a bit of a run into "value" - that is, old economy - companies, but a pretty shaky one; and a move into US treasury securities on the grounds that in a low-inflation world, maybe the cult of equity has become a bit overblown.

The trouble with all this is that valuing both the old and new economies is like wrestling with jelly. Whenever the market thinks it has found some helpful measure, something damages its usefulness.

With the new dot.coms, the most frequently noted valuation - market capitalisation per customer - has been undermined because the communications revolution is developing differently on either side of the Atlantic.

Customers have differing degrees of loyalty. In the US, where there is stronger brand identification and people pay for internet access (but not for phone calls), customers tend to be loyal to one service provider.

In Britain and on the Continent, where brand identification is less established and internet service providers are now becoming free (but people pay for the phone calls), customers are more promiscuous.

This sort of confusion is excusable. Markets have no historical basis for valuing companies that have never made a profit. Less excusable is the difficulty valuing established companies.

So a new paper on valuing the different sectors, by Goldman Sachs, deserves a special welcome. It looks at the annual return that will be needed to justify the present market value of the various sectors.

Goldman uses its own measure of economic value added, which makes sense as investors seem happy to see returns ploughed back into the companies themselves rather than shown in profits or handed back in dividends.

On this measure, the highest-rated sectors are IT, media and telecoms. Not only does the market expect these sectors to deliver returns of 27 to 18 per cent over the next decade, but this implied future growth is faster than the growth these industries have experienced over the past 10 years.

True, there is some sort of step change that has taken place, but the market is clearly making an enormous bet on the new economy delivering a decade of immense prosperity to the companies most closely involved.

What about the other sectors? As a whole they, too, are overvalued: the market - aside from IT, media and telecoms - is rated to deliver a 10 per cent return on capital over the next 10 years, as opposed to an actual 9 per cent over the last.

However, there are several sectors where the implied returns are lower than those achieved in the past. Both food and beverages are expected to produce lower returns and paper, cars and non-cyclical consumer goods are expected to do worse than they did over the past five years.

The great advantage of having these numbers is that investors can then make a rational judgment as to whether both the bullish view of the new-economy companies and the bearish view of the old-economy ones are right.

Here are some observations. Three of the four top-rated sectors sell intangible products - software, a phone call, information - while the remaining one sells computer hardware. Three of the four lowly rated ones sell things you can touch - drinks, cars, paper - while the other one, retailing, provides the mechanism to sell physical objects.

So the market is saying not only that a large part of the growth of our spending over the next decade will be on intangibles (which is probably right) but that margins will remain high on intangibles (which may well turn out to be wrong).

- INDEPENDENT