Pete Wargent blogspot

Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

Invest in Sydney/Brisbane property markets, or for media/public speaking requests, email pete@allenwargent.com

Sunday, 6 October 2013

Sensitivity

When investors take a detailed read of company accounts they are often trying to assess an entity's earning power, both present and future.

In the past, companies were able to 'strip' out extraordinary items or exceptional items in their P&L accounts (income statements) in order to present a net profit figure which would in theory show a realistic picture of ongoing profits. Thus the costs of closing an unprofitable subsidiary or the windfall receipts from the sale of a business might be disclosed separately as exceptional.

Bean-counters love these kind of loopholes and we ended up with a ridiculous situation where companies argued that 'good news' - e.g. cash from the sale of a profitable business - should be presented as 'exceptional items' (above the line) and 'bad news' - such as factory closure and related redundancy costs - as 'extraordinary items' (below the line).

The accounting authorities were wise enough to the window-dressing. In the UK the standards board introduced a new accounting standard (FRS 3) which effectively put a stop to all that nonsense by demanding that all such one-off items were treated as exceptional and were to be disclosed above the line - that is, they had to be subtracted before arriving at the net profit and earnings per share (EPS) figures. 

As if...

Not that any of this actually put a stop to questionable disclosures, of course. Far from it - for years companies have reported headline 'normalised' profits leading sceptics to refer to "as if earnings". As in..."this is how our accounts would look as if nothing bad had happened".

Around the time of the global financial crisis, accounting authorities upped the ante further and introduced a huge raft of financial instruments disclosures (in Australia we called the regulation AASB 7) to listed company financials.

This was a huge pain in the backside for those of us who wrote listed company Annual Reports for the accounting standards now demanded that we include pages and pages of information to show the potential impact of changing financial conditions. For example, companies now have to perform and disclose a sensitivity analysis the potential impact on reported profit of percentage changes in interest rates, exchange rates, commodity prices, and so on.

The problem, said the sceptics (including myself - because it meant I had more work to do), was that although the sensitivity analysis was superficially sensible and useful, it only actually served any purpose if it was (a) prepared properly and, (b) if anyone actually bothered to read through to note 50 of the financials.

However, there's no doubt that for banks and other key financial entities, the new disclosures when used properly do help management and analysts to better understand risk.

Sensitivity

The reason that all of this sprung to mind is that in the last couple of weeks I have seen property buyers at auction being outbid by cash buyers - Baby Boomers downsizing into apartments for retirement and using equity from their former larger house with which to buy.

Cash buyers with ample equity only have to worry about future interest rate movements to the extent that monetary policy has an impact on their future income streams from fixed interest investments.

Homebuyers and investors who are buying using a mortgage, however, need to be very wary of entering into bidding wars and paying too much.

In particular, borrowers should conduct some sensitivity analysis of their own.

Mortgage repayments are very affordable today because we have the lowest interest rates in a generation. 

But buyers need to consider how their financial profile would look if the cash rate reverts to 5%? And what about 7.5%? Or even 10%?

Listed companies on the ASX do something very similar with their own financials. They look at balance sheet gearing ratios such as debt to equity, which is the equivalent of a loan to value (LVR) ratio for a property investor.

Companies also look at profitability ratios as interest cover: what percentage of their net profit is used to pay loan interest to banks and financiers? How many times over do the profits cover the interest payments? And what would happen if interest rates revert higher?

Property buyers using variable mortgage rates should be doing exactly the same thing at this stage in the interest rate cycle - how easily would you be able to service mortgage debt in the event of a string of interest rate rises?