Member Article

Why share prices can be misleading

When Durham based mining and transport group, Hargreaves Services issued a profit warning recently, following problems at its Maltby Colliery in South Yorkshire, it was a reminder that the same published financial information can be interpreted in many different ways.

The charts shown compare our rating of the Company’s financial health, using the H- Score® system, which assesses various key financial ratios, with the movement in its share price.

As the first of chart shows, our financial risk rating for Hargreaves Services after their results for the six months to November 2011 was 18 out of a maximum of 100, putting the company firmly into our warning area for those businesses with scores of 25 or below. The negative factors we have identified are relatively poor liquidity, stretching of working capital resources, over-reliance on current liabilities and the level of debt, most of which is short term.

Looking back 14 years, one in four of companies with H-Scores in the warning area go on to file for insolvency or undergo some form of restructuring. An H-Score of 18 does not of course mean the Hargreaves Services will fail, just that its financial profile suggests it is vulnerable and management would do well to take action to improve the financial position of the company. Unfortunately, the problem at Maltby and the consequential reduction in profits of between £12m and £16m must inevitably lower the rating and increase the vulnerability.

The Company has been here before, having had an H-Score of 22 after the publication of its May 2009 accounts. Management took action then to correct the situation and are no doubt working hard to put things right once more.

But look at the behaviour of the share price and a completely different profile appears. When the May 2009 figures would have been known to the stock market, the share price was under 500p. Fast forward to when the November 2011 figures were in the public domain and the share price was almost 1,100p, an increase of well over 100%. By comparison, the net worth of the balance sheet only increased by 69% over the same period. Neither chart shows the impact of this week’s profit warning yet. The shares fell by around a third after the announcement.

Share price movements are typically driven by the market’s view of a company’s future, which in turn reflects many non-financial factors, including future prospects, the state of the economy and the sector in which a company operates, perceptions of management’s skills and the usual interplay between supply and demand for the shares. As many wise observers have commented, stock markets can sometimes seem more like casinos than serious share trading platforms.

Never the less, these charts are in stark contrast, one sounding alarm bells & asking questions, the other moving resolutely upwards, give or take the volatility which is now a feature of stock markets the world over. Investors and stakeholders in any business must always carry out regular financial risk assessments, rather than just relying on monitoring its share price.

This was posted in Bdaily's Members' News section by Nick Hood .