High share prices reflection of success

In New Zealand, only a few companies have a double-digit share price. Photo / NZME.

Opinion

Stock values seen by some as expensive can be an indication of a strong track record of performance.

Earlier this month CSL, a very successful Australian healthcare company, saw its share price hit A$100 for the first time.

Some New Zealand investors would baulk at the thought of buying shares in a company as "expensive" as that, but they shouldn't. A company's share price doesn't tell us anything about whether it's expensive or cheap and, if anything, it should be taken as a sign of a strong track record of performance.

In New Zealand, only a few companies have a double-digit share price. Port of Tauranga is the highest of these with a share price of almost $18, with Xero and Mainfreight not far behind. Almost half of the top 50 have share prices below $3.

In larger markets it is commonplace for shares to trade at high prices.

Of the 30 companies in the Dow Jones index in the United States, the average share price is US$88 and the cheapest share is General Electric at US$26. Google shares are US$663 and Amazon shares are US$524.

Many local companies have conducted share splits over the years, usually when prices approach the $10 level. Ryman Healthcare did a 5-for-1 share split in 2007, which saw the price fall from $11 to around $2.

Investors didn't lose any money, as they owned five times more shares than before. This offset the share price fall and left the total value of their holding unchanged. Auckland Airport did something similar in 2005, as did Fisher & Paykel Healthcare in 2004.

Companies do this in the hope of creating additional liquidity and, as stated by Auckland Airport in 2005, "ensuring the shares remain attractive to retail investors".

You can bet that at some point Port of Tauranga and Mainfreight have had similar discussions in consideration of a share split.

Less sophisticated retail investors do seem to have a preoccupation with share prices, favouring those in the $2 to $3 range which they perceive as better value and shying away from those that trade at higher levels.

However, it shouldn't make any difference. The share price of a company doesn't tell you whether it is good value or not, unless you compare this with the share of earnings, profits or dividends you get for each share.

That's why analysts will always look at ratios, multiples or yields when comparing one company with another. This allows an apples-with-apples comparison to be made, whereas share prices alone don't.

Consider a company with a share price of $1 and one worth $10. The $1 company earns just 5c of annual earnings per share, while each share in the $10 company gives the owner $1 of earnings. The $1 company has a price-earnings ratio of 20, and on this measure is twice as expensive as the $10 company, which has a PE of just 10.

I can remember one experienced Australian retail investor telling me he only buys shares in companies that are trading above $10. This was his screening process and he reasoned that only the best companies would grow their businesses enough to see their share prices get this high. Certainly not a perfect approach, but probably a more sensible one than focusing on the other end of the spectrum in the hope of finding a bargain.

Ryman shares would be $42 today if that share split hadn't taken place in 2007, Auckland Airport would be over $20 and Fisher & Paykel Healthcare shares would be $38.

These companies have been some of the strongest performers on the local market over the last decade, so maybe the best shares are in fact the ones that sometimes look the most expensive.

Mark Lister is head of private wealth research at Craigs Investment Partners This column is general in nature and should not be regarded as specific investment advice.