Martin Hawes: Astute investors go back to basics

The next few years will be a bear market for both shares and property.

There will be cyclical rises and falls for short-term traders and speculators, but the overall pattern will see little capital gain for long-term investors.

Investments therefore need to produce enough income, or yield, to stack up without factoring-in capital growth.

Calculating investment value solely on income produced will be a big change for many investors - a back-to-basics approach where investments that do not produce enough yield will be shunned.

The "bigger fool" theory no longer applies. This says if you buy a poor quality investment, don't worry, a bigger fool will come along and buy your mistake at a higher price.

It works in boom times - but not at this stage of the cycle, where markets are driven by fear. Hot markets develop their own momentum, losing touch with the fundamentals of value and income.

A boom in which investment income bears little relation to the prices is called a "bubble", and such bubbles almost always continue to inflate far beyond what anyone would expect.

In the speculative binge of a bubble, investors forget that yield should always be the first and foremost component of returns, whether on shares, bonds or property.

An investor must always ask whether the yield on offer is enough.

Net yield is calculated by taking away the annual costs from the annual rent, and then dividing this figure by the property value. On average they are now still too low at about 4 per cent.
Earnings yields on shares are calculated by dividing the earnings, or profits, per share by the share price and multiplying by 100 to get a percentage.

While earnings yields for shares are better than for property, many investors doubt companies can maintain their profits so are waiting until their profitability is clearer.

Yields being offered on corporate bonds are well advertised.

While better than bank deposits, many would say most present bond offerings promise a yield that is too low, given the twin risks of company failure and future inflation.

The quality of an investment is not simply the amount of income that will accrue to it, but also the income's sustainability and growth prospects.

An astute investor will pay more for income that is very secure and/or growing.

"Investing" on any other basis is speculation.

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