Martin Hawes: On scent of good buys

A Queen St high-rise is not necessarily more expensive than a Penrose warehouse. Photo / The Aucklander

Writing in a woman's magazine more than 60 years ago, Ben Graham said you should buy your investments as you would your groceries, not your perfume.

Graham was assuming for a woman the purchase of perfume is an emotional decision where price is an inconsequential factor but that in buying groceries, the price is the most critical factor.

In the same way, buying investments means asking "how much?" At some price point an investment is a screaming buy. It does not matter what it is, as long as it is cheap enough.

The converse is also true - it does not matter how good a company or a property is, if it's too expensive you should sell it. But, how do you judge what's cheap and expensive?

It has nothing to do with absolute price: Fletcher Building is currently trading on the market at about $8.17 and Auckland International Airport at $1.87 but in investment terms that does not make the airport cheaper.

Neither is a high-rise building on Queen St which is valued at $100 million more expensive than a $10 million warehouse in Penrose.

Instead, "expensive" or "cheap" for investors refers to the amount of income which flows from them. This is true whether the stream of earning is profits from a company, interest from a bond or rent from a property.

Investors do not really buy companies or buildings - they buy income. And investors are continually considering the price they will pay for ongoing income.

Assuming the income is established and all else is equal, a cheaper price for the investment will give a higher yield. The higher the yield (which is a percentage) the less you are paying for same income.

Of course, all else is seldom equal. The quality of the income is also important: is it in cash? Is the income sustainable? And is it likely to grow? These quality issues determine the amount of yield which is reasonable.

You may not care what you pay for a bottle of perfume, but as an investor you would never get to the checkout without looking at the yield you are likely to get.

* Martin Hawes is a financial adviser. His disclosure statement can be found at www.martinhawes.com