The real kings of shareholder value; “When we long for life without difficulties, remind ourselves that oaks grow strong in contrary winds and diamonds are made under pressure.”

November 8, 2013 7:08 pm

The real kings of shareholder value

By Nigel Thomas

Some managers are delivering excellent returns

Investors often see the term “shareholder value” bandied about. Company managers are very fond of using it. But what exactly does it mean – and in an era of low growth and rock-bottom interest rates, how can we be sure that managers are committed to generating it? Shareholder value originally rose to prominence to solve what Adam Smith called the “agency problem”. This relates to the age-old temptation for managers or executives of a company potentially to follow a course of action that was favourable to them as a group but detrimental, in the long-run, to the company’s beneficial owners – the shareholders.The recent problems of the banks, before and after the credit crunch, illustrate this well. An asymmetrical risk existed between ever greater risk-taking by executives to inflate their annual bonuses, versus the shareholders’ long-term total returns. The shareholders came off worse. Capital and dividends have been lost or forgone.

The rather better news is that we are seeing more UK companies wholly embracing and aligning themselves with the concept of “total shareholder returns”. This involves dialogue with shareholders regarding the growth of earnings and how best to share that growth with investors through regular dividends, special dividends and share buybacks. Some paragons of virtue in this regard are Next, Wolseley, ITV, Dunelm, St James’s Place,Rotork, Vodafone, WPP, Elementis and Rightmove.

Take Next as an example. The clothing retailer has retired 54 per cent of its equity over the past 11 years through share buybacks. It has kept its debt roughly constant at £500m in order to do this. But it has been worth it – earnings and dividends have risen well above profits despite a tough retail environment. Or there’s Rightmove, which has used its 81 per cent share of the online property search market to generate prodigious cash flow. It doesn’t need to do heavy capital expenditure or acquisitions, so that cash has gone into growing dividends well into double digits and buying back shares. Special dividends are another means of returning surplus cash; ITV paid out £135m this yearand builders’ merchant Wolseley returned £300m.

To distribute value you must first create it. And while most of the companies highlighted above are in what one might term “traditional” sectors, fast-growing and innovative companies can also generate great returns. A great example is Xaar, a Cambridge-based company that designs and manufactures digital ink-jet printing heads. These are being used to reshape manufacturing processes in a wide variety of applications including labels, packaging, decoration of ceramic tiles and laminates and outer case coding.

Xaar’s “direct to shape” printing heads are a classic disruptive technology. They allow printing direct on to bottles and containers of any shape, rather than the traditional method of printing a label which is then stuck on to the container. A simple change – but labels are often a higher cost than the actual bottle, or even its contents, so the cost saving using Xaar printheads can be significant for the customer. Xaar is growing fast; its share price has risen by 211 per cent over the past year and it recently entered the FTSE 250.

Rightmove is another disruptive technology company. It has caused huge shrinkage in newspaper property advertising. It is now the sixth most popular website in the UK and is the biggest customer of Google Maps in the whole of Europe. Average revenue per estate agent is set to grow 13 per cent this year, because their service delivers for customers; telephone leads to agents as a result of Rightmove search results were up 80 per cent in the third quarter.

All of these companies have prospered despite a less-than-ideal economic backdrop. I don’t see conditions becoming much easier in the near future. But I’m reminded of the words of Peter Marshall, the British philosopher: “When we long for life without difficulties, remind ourselves that oaks grow strong in contrary winds and diamonds are made under pressure.” Some management teams can cope with change and reward shareholders at the same time. These are the companies that investors should seek.

Nigel Thomas is manager of the Axa Framlington UK Select Opportunities Fund