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OPINION

Living in the past

Living in the past
June 18, 2015
Living in the past
820p

Of course, it's not that simple. As the great Bob Marley observed - and countless others have said as much - "If you know your history, then you will know where you're coming from". This is another way of saying that the past - including investment's past - is a useful guide. Sure, old-man river is not precisely the same each time we wade in it. But, for the most part, it just keeps rolling along, so those using its waters can be confident that the knowledge which served them well last week will be useful next week, next year even. It's only very occasionally that one of Nassim Nicholas Taleb's metaphorical Black Swans glides along, bringing a tsunami in its wake. But such events are beyond analysis so can only be countered by always wearing a life jacket (even in the shallows) and refusing to wade where the currents are tricky.

Okay, let's ground this discussion in the practicalities of investment. What we are really asking is whether it's better to make investment decisions giving greater stress to the future or to the past. Which works better, Heraclitus's forward-looking investment model or Bob Marley's backward-looking one?

Results this week from Latchways (LTC), whose shares are in the Bearbull Income Portfolio, prompt these thoughts. Both profits and cash flow fell sharply in the year to end March. So, on the face of it, Latchways, which makes safety equipment for people working at heights, is less valuable than a year ago. Indeed, the latest results underscore the notion that the group's value is waning since this is the second year running that profits - both of the accounting and the cash variety - have fallen and they are now at their lowest since 2005.

The reasons behind the 28 per cent drop in operating profits to £4.92m (£6.83m) are familiar enough - a mixture of the macro-economic and the company specific. By its nature, Latchways has much going for it; in particular, a growing body of health-and-safety regulations, which means that customers have no choice but to use its products. Whether workers are high on the roof of Manchester City's Etihad Stadium, on the wings of an Air France Airbus or 100 meters up the columns that support the North Sea's biggest wind turbines, they all need fall-arrest equipment.

That said, Latchways generates much revenue from construction projects. So when macro-economic factors delay or even stop these, the company suffers. Nor does it help that Latchways has found its sales force wanting in the US, where revenues fell 38 per cent in 2014-15. That drop was even steeper than the fall in sickly Europe where fewer construction projects meant revenues fell 30 per cent.

All of which means that on the backward-looking investment model there is a small but distinct drop in the value of Latchways shares. How much? Two bad years in the lifetime of a company isn't that significant, but if you are using average profits to derive a company's value - the sort of figure that a company can produce in an average year over the business cycle - then it has an effect. Two good years fall out of the reckoning and are replaced with the poor ones. Thus, a year ago I crunched valuation guesstimates for Latchways and got 'installed' value - ie, a proxy figure for the net present value of all the projects in place - of about 790p per share. Today that figure has dropped to 765p.

Yet the share price has recently bounced to 820p. That's because investors - in Heraclitus mode - are disregarding the past and gazing towards Latchways' future, which is brighter than for a while. Certainly, its bosses talk bullishly. They are beefing up the sales force - especially in the US - and hope to see progress in the first half of 2015-16. In addition, deferred projects are coming on stream, activity in wind-farm projects remains high and UK construction is starting to recover. It points to a lively bounce in profits this year. Operating profits might even challenge the figures the group made four or five years ago - £9m plus. Assume that level is the new norm on which valuations can be based and installed value moves ahead of the share price.

That might be risky, but there is also an even fuzzier guesstimate for the value that Latchways - with its strong position in a regulation-driven market - might create in the future. Thus a year ago my all-in value for Latchways - installed value plus this 'franchise' value that could be created from the group's strengths - was about 920p per share. Even if I trimmed 25p off that, it would still be well ahead of the share price, which indicates that the shares are still worth buying.

But the point is that this judgement is largely based on the backward-looking investment model. That's odd to the extent that the future must shape a company's value rather than the past. Yet the sensible use of past data is arguably more useful than forecast data that may well prove useless. One up to Bob Marley, perhaps.