Shares that Grow

Author: Kevin Arthur O'Brien

Book Synopsis (provided by the author)

Shares that Grow introduces a new index for quick evaluation of relative value of investment grade quoted shares. The data that it uses is based on current media publication of ratios etc. The author is a former Chartered Accountant, Foundation Manager of the Samoa National Provident Fund and educated at Victoria University of Wellington NZ. Gx shows, by inference, that the economist’s, model rational person, invests in shares in stable companies using a measurable, intrinsic value. The price paid varies with earnings, absolute size of company, industrial activity group and ability to pay. It proves that for the same sized companies with the same earnings expectations the aggregate value should be the same. It flushes out potential bonus issues and the implications of takeovers or share splits. The affects of an acquisition on share price is also determinable. Gx yielded a price which newspapers confirmed daily and worked on prior years data too. These claims have remained hidden as they verge on incredible but now I'm 82 I've opened them up to the world to update. The formula was tested over 40 years in New Zealand and Australia. It has also been tested in the USA market and picked up an IBM bonus issue before announcement. The principles are universal and the invitation is now to extended to further it's use internationally by computing the key parameters from the model shown. This will be of interest to economists and academics teaching classes on marketable share valuation. The work has been laid out as a primer and may be freely downloaded and used as it has been released by the Author to the Public Domain. Examples from the author's original work papers are included.

1. Rational Share Investment

This work grew out of asking the simple question of “how do I rank shares amongst themselves as a best buy at a given date?” A simple question, with the implications that if there was a best buy, there was the second, third, fourth etc. if they could be so ranked. A unique way of ranking, Gx, (Growth Factor) has been developed by the author with implications for valuation and pricing of shares. If the shares are only to be held for quick trading, ranking may still be relevant to pinpoint undervaluation and potential bonus rights issues. It may be not relevant if buy/sell decisions are made on the basis of price pressures or charting. The implications of Gx flow through to valuations resulting from corporate activity such as takeovers and mergers and new offerings of securities by many companies.

Only the pricing of shares traded on securities exchanges or stock markets is dealt with. It is not about pricing bonds, options or the host of other financial offerings that brokers (sales personnel) attempt to trade. Returns on long term bonds are referred  to under index forecasting.

This research is primarily about investment-grade shares, not necessarily those that might be included in indices.

Companies both big and small qualify—known as ‘stable’ companies from here on.

Some relationships between speculative and stable companies will be looked at too.

The research on which this publication is based started while the author found himself with time on his hands while working in Samoa.  He was freshly qualified as an accountant and already an experienced share valuer with an interest in valuation theory. So armed with slide rule, log tables and a Facit hand-cranked calculator which he found in the lagoon, he set to work to try and figure out what might be a best buy. All this was done BE, before Excel. It makes the research even more interesting that the author is not an investor by temperament. The newspapers gave a lot of statistics and Equity Investment published a summary of balance sheet data so information was freely available to New Zealand and Australian investors.

 The formula developed worked both for future and historical pricing over a period of about 40 years. For a stable company one could, using only published data, plug in the numbers and obtain an expected price that its common shares should be trading at on a given day. This was precise, often to the cent. Changes occurred when New Zealand opened up its economy. I have revisited this research from time to time over the years.

A test of the application to the USA in 1999 revealed a situation in IBM through comparison with Intel that would require a bonus share issue to adjust the price to what I had determined to be market. The stock split duly happened on May 26 1999 in agreement with the formula. The principles to be shown are timeless and not limited to location. Substantial movements in the economy may require periodic updates. Some elements of pricing are local, but the data for those should be readily available or calculable by example.

Ultimately it shows, by inference, that the economist’s model rational person invests in shares in stable companies using a measurable, intrinsic value. The price paid varies with earnings, absolute size of company, industrial activity group and ability to pay. It proves that for the same sized companies with the same earnings expectations the aggregate value should be the same.

This work has been hidden for many years as, frankly, I didn’t know what to do with it. It’s hard to claim that one can tell prices of shares without others expressing more than disbelief and just saying ‘prove it’. To reveal it is to destroy its personal economic value. Others have had the benefit of advice based on the formula but this publication reveals it and justifies it for the first time. The original working papers are still in my possession to prove the originality of this work. Some extracts of these appear here, so all can be tested and further developed as wished. I wish I could give more examples than included but age no longer readily allows that. So I am releasing the whole of this publication to the Public Domain.

This should prove of value to all investors, economists, analysts, business finance students and corporate finance officers. The mathematics are mostly at the level investors deal with in looking at ratios and the more advanced can be left to those who can develop it. I am persuaded now to publish this work because it speaks of the essential nature and valuation of shares and at the end of this season of speculation sanity needs a voice. We need to return to basic principles of valuation. There will still be long term returns on investment. The lesson that income drives value needs to be re-learned. Perhaps a corollary is that borrowing drives loss.

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