Derek Pain: Looking for recruits but we're too close to the market's peak

No Pain, No Gain
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The Independent Online

With the no pain, no gain portfolio below strength I have, on a number of occasions, asserted that I am actively looking to enlist a couple of newcomers. But any recruits have been conspicuous by their absence. Why? Quite simply I have experienced difficulty alighting on any additional constituents and I have been a little disconcerted by the strength of the stock market so far this year.

Greece may have achieved its bailout but will almost certainly need further cash injections. Some other eurozone countries are still suffering acute difficulties and will require help. In addition, the world economy, although showing encouraging signs of improving, is still relatively sluggish. I know the stock market likes to anticipate events but I cannot help wondering whether it has got uncomfortably ahead in the recovery game. I am, therefore, worried that this year's advance is too far, too soon.

The desperate and unyielding crunch on interest rates, with savers stripped of much of their expected income, has obviously helped high-paying shares. Many of the more generous dividend payers are constituents of the FTSE 350 index. Surprisingly around 50 per cent of payouts come from just nine companies. Last year total payments increased by approaching 20 per cent although, as Rob Burgeman at stockbroker Brewin Dolphin points out, special dividends, which formed a chunk of the distributed cash, are really a return of capital.

There are a number of ways companies can reward shareholders when distributing cash to them. Dividends are one method. Buying in shares through stock-market purchases is another. But the merits of share buybacks have been questioned and it seems only City institutions and other professional investors can benefit. Although buybacks help earnings per share calculations there is little evidence they improve share prices; so small investors are, again, left out in the cold.

Tender offers are an often overlooked way of distributing cash. Yet all shareholders benefit, even the smallest, and the earnings per share sums are again influenced. Why more companies do not adopt such an equitable cash distribution process is a mystery.

Two of the companies I have examined have recently adopted the tender approach. James Halstead, a family-run floor coverings group, and PSG Solutions, with property services and electronic surveillance interests, have successfully used tenders in the past year. Mind you the companies, although highly rated, are chalk and cheese. Halstead is capitalised at around £521m and PSG at £26.4m. The floor coverer started life nearly 100 years ago as a maker of weatherproof materials whereas PSG is a comparatively recent creation.

The Halstead record is outstanding. Pre-tax profits should top £40m this year and another dividend increase, making 36 consecutive years of progress, is expected. And the cash-rich group returned cash through a tender in December. Not surprisingly the shares are near their peak; hence my hesitation to recruit them. I like to invest in shares when they are underappreciated but, there is, I must admit, a temptation to ignore my long-standing prejudice.

It's more or less the same story with PSG. The shares are a little below their peak. In the past year they have risen from 20p to 120p; as I write they are 102.5p. A profits explosion has done the trick. At the half year pre-tax profits were £3.9m against a £315,000 loss. Government contracts have helped. Westminster-inspired interest coincided with a dramatic advance in the performance of the electronics operation.

I contemplated adding PSG to the portfolio in 2008. Then it seemed destined to score from the ill-considered and since abandoned Housing Information Packs. Following the HIPs débâcle entrepreneur Bob Morton and PSG chairman Jonathan Mervis bid 17.125p a share. Their joint interests are now around 50 per cent.

Although Halstead and PSG would make fine constituents, I eventually hate getting in at or near the top. So for now I am holding off. Who knows? Perhaps the shares of these two excellent companies will get nearer a more tempting level.

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