Follow the boss

Obviously such logic has its limitations. It would not have worked out too well at US energy supplier Enron, nor – closer to home – at Independent Insurance or Versailles (remember them?), which were essentially investment scams at the heart of what could have been decent companies.

Yet you don’t necessarily have to believe the boss for the logic to come good. What really matters is how many other investors believe the gung-ho comments. If enough do, and buy the shares as a result, then you have share price momentum and a virtuous feed-back system becomes self-sustaining for a while; and plenty long enough for some fortunate investors to make wonderful profits from investing in the infamous companies just mentioned. It might even be that no one actually believes, but that each investor reckons all the others do and so each buys assuming the credulity of everyone else. That can work – for a while.

Granted, there is the complication that almost all of the time almost all bosses make confident noises; that just goes with the job. So investors have to read between the lines. There is bosses’ obligatory PR-speak, which finds bright spots in the darkest gloom. Then there are the quiet statements that say the business really is doing well; honest, no messing, no bull.

But there is a serious point here – no matter how detailed the number crunching nor how thorough the industry analysis, taking note of what a company’s boss said recently is essential, even if the aim is to eliminate shares in those companies where the latest update is disappointing.

Thus it is mildly encouraging – I know, not the strongest recommendation – that the bosses of three companies that are serious candidates for the Bearbull income portfolio most recently sounded the right note. Sure, two companies – retailer Topps Tiles (TPT) and structural engineer Severfield (SFR) – will announce first-half results for 2018-19 next week when we will hear more. The third, publisher Bloomsbury (BMY), announced its first-half figures last month when it said it was on track to hit full-year expectations, which would be earnings of about 14p, a useful advance on last year’s 12p.

That would seem to put Bloomsbury firmly back on a growth tack and City analysts – ever the optimists – see Bloomsbury’s earnings growing nice and neatly by about 2p a year out to 2020-21. It probably won’t be that smooth, but the big question about Bloomsbury is whether it should use the prodigious cash flow from its Harry Potter franchise to build a diversified publishing house?

It’s the obvious thing for management to do, but that does not make it right. After all, away from its children’s division, Bloomsbury’s other activities generate about 60 per cent of the group’s £160m-plus revenue but only about 10 per cent of its £13m operating profits. Rather than commit increasingly more capital into low-return ventures, arguably Bloomsbury’s bosses should be distributing Harry Potter’s excess returns directly to shareholders. Certainly, the combination of a low return on capital and ordinary profit margins (see the table) dull the attractions of shares in a business that looks capable of generating the cash flow to sustain a dividend comfortably higher than the 7.5p that Bloomsbury currently pays.

Severfield also labours under performance metrics as dull as Bloomsbury’s. Yet, if management’s trading update from September holds good, the company will also report acceptable first-half figures next week. If there is excitement it is likely to come from the Indian joint venture with JSW Steel where the order book in September, at £128m, was 21 per cent higher than just three months earlier. Punchy stuff, but the joint venture is not big enough to be a game changer for Severfield.

Which leaves Topps Tiles as the one whose shares I am putting into the Bearbull income portfolio (see Bearbull, 12 October). Granted, you have to be sceptical about its figures for return on capital because bookkeeping items meant Topps had a deficit on its equity account until three years ago. That said, it consistently makes good profit margins and – as you would expect of a retailer – turns over its assets briskly, which implies good use of its capital.

True, I am putting its shares into the portfolio with reservations. But that’s more to do with the wobbly state of the world’s equity markets and the precarious nature of the UK’s economy ahead of Brexit. I seriously wonder if there is a high-yield stock standing about which I would currently feel completely happy. Testing times.