Yes, we should worry, as we don’t know if we can slow Covid 19. However, if a tidal wave can be reduced to a heavy sea we should not worry. This can happen if we self-quarantine, reduce meetings, work from home and wash our hands. Little differences now will make a massive change in the speed and volume of spread. At 10% rate 3,000 cases become 800,000 in 60 days, but 15% is over 10 million. Act now, head off.
Covid19: If we assume the ‘head off’ works, will it affect values? No. In the last slowdown of the economy in 2008/09, the credit crunch, businesses faced a protracted, ongoing storm, and no one could assess whether drops in profit were economy-driven and/or simply a bad business model. Statistically, values faltered briefly, although volumes dropped. Individual businesses that were negatively affected typically chose not to sell, and some others that were unaffected also chose not to sell on the incorrect assumption that the wider economy would affect values. Those businesses that continued to perform well achieved P/E ratios in line with those previously seen.
One might even argue that a business continuing to perform well and grow in a difficult economic climate could be worth more, as it is outperforming its competition by a greater margin than in buoyant economic times. It is also worth noting that we have not seen any material drop in values due to Brexit. The average P/E ratio based on the last full year’s earnings has averaged 6.9 over the last two years (to June 2019). This is the highest maintained average so far this century.
Covid 19 impacts should be traceable and entirely demonstrable as ‘extraordinary’ adjustments, so investors or buyers should make allowances which will therefore not affect values.
Entrepreneurs’ Relief: Entrepreneurs’ relief costs the Government some £2bn a year and changes were expected. The Chancellor announced a reduction in the lifetime limit from £10m to £1m. so the first £1 million per 5% shareholder is 10%; thereafter Capital Gains Tax rates remain at 20% for sales of companies, so the position is still very beneficial compared to Income Tax. For many, the headline is the driver as the net is often a lifestyle number and the increased tax won’t impact on whether they fly first class or not. Assuming we get back to flying quickly!
Valuations: This is all pretty straightforward and others are saying similar, however, a much more interesting question now is: could values go up? The Chancellor’s plan to raise investment levels to almost unprecedented heights on infrastructure spending is a radical departure from austerity, but arguably with productivity in the doldrums, austerity to repay the balance sheet has stifled growth which might have been equally effective at achieving the same result. The principle is that with the spectre of deflation, almost zero interest and excess capital reducing debt to arbitrary self-appointed levels is unnecessary – therefore spend to create growth. Whilst, not an economist, this makes sense to me. With an ageing population that needs social support, we have an underlying drag – so boom and inflation are unlikely.
Low-cost debt is the new normal and with low cost debt and excess capital, yields in traditional assets also remain low. From property to stocks a 5% yield looks increasingly promising. Arguably therefore with smaller cap companies often available for acquisition at 15-25% yield they become increasingly attractive. In principle, therefore, valuations could actually creep up.
M&A activity and volumes will also continue. If anything, Covid 19 will remind sellers there is more to life than money and with some balance sheets being weaker after the impact there will be opportunity to continue consolidation. It’s conjecture but our argument is valuations and deal volumes will remain robust.