The rules of attraction

The City has never really liked businesses where the assets go up and down like the lift each morning. The City prefers high margin growth businesses where there is a dream of potential explosive growth.

In the past, advertising agencies were the butt of this dislike, and mines in far away places were the beneficiaries.

Distance is no impediment if you have a few billion dollars of ore under the ground. The human element is fungible. A few million tons of zinc ore can’t flounce over the road and set up in competition against you while stealing your customers.

On the surface, computer software companies can look quite like accountants and ad agencies – but look under the hood and there is a dense web of intellectual property that can’t be stolen or spirited away.

An auditor or consultant is much more easily replaced than the software or network that makes a company tick.

While practitioners might disagree vehemently, from a City perspective accountancy is a commodity business too – which gives it yet another black mark. To top it all, one bad customer can sink even the biggest accountancy firm in a huge Enron-style implosion and everyone knows accounting scandals are simply a function of the passing of time.

These points are, of course, wild generalisations, yet that is exactly how the City operates. City folk and investors don’t have the time or inclination to bother trying to get a detailed picture of businesses they invest in. They enjoy snapshots of an investment, and the simpler the better. This is why everything is clumped into sectors.

The ‘efficient market hypothesis’ and the resultant practice of diversification support a general sloth. Because the market is theoretically always right, and therefore impossible to outperform, the only way to protection is to diversify. Attention to detail is replaced by the need to spread the risk. Thus when a sector rises, by and large all the companies in it (both good and bad) rise along on the tide. Likewise when the market tanks, it’s a very lucky company indeed that is unaffected by the crash.

Accountants are clumped into the ‘specialty & other finance’ sector, which contains a hodgepodge of companies from spreadbetters to the London Stock Exchange itself, not to mention the likes of Vantis, Tenon and Numerica.

As a grouping, accountancy companies’ income is shared out along the lines of a Peano distribution, that is to say like the rich of the world. A handful of companies take the lion’s share of business. The top four companies, all private, generate nigh on 75% of the business amongst the top 50, as published by Accountancy Age. None of the listed companies is in that group, with Tenon making a mere 5% in fees of the biggest player.

Against this backdrop, it is not surprising that accountants haven’t done particularly well on the market.

Since the turn of the millennium, the market has had three phases: crash, rally and correction. Tenon floated at the cusp between boom and crash and fared badly in its first three years, but has followed the general trend of the market, from hero to zero then back up again. If you bought the stock when the allies were rolling into Baghdad, you would still be sitting on a nice profit. But then again you could say that about pretty much any small cap stock over this period.

While the FTSE100 has languished, the small cap and fledgling indices have experienced a historic rally up until the second quarter. Small listed companies, good and bad, have risen like corks until the spring of 2004 saw the end of the bounce.

Vantis’s share price took off along with the market at this time, yet while it corrected this spring, it has surged ahead once more. It is by far the most highly rated of the group including Tenon and Numerica, enjoying a healthy rating of a market cap twice sales as opposed to Numerica’s 0.4 and Tenon’s 0.6.

Yet the accountancy arena is a confusing picture for the investor. Where does accountancy end and consultancy begin, when does accountancy end and corporate finance begin? This complex picture is always going to drag on valuations.

What can be seen is the huge quantities of intangibles in the balance sheets. Numerica has a whopping 60% of its assets classed as intangibles, while Tenon and Vantis each have intangibles in the 50% range.

Investors have long since discovered a dislike for intangible assets. While accountants may enjoy them, investors have become used to them disappearing and instinctively know that you can’t buy lunch with an intangible £10 note. Intangibles, of course, link neatly into the assets that go up and down in the lift everyday, so it is little wonder that the listed accountants tend to be unloved.

It has always been an open question whether service industries should be listed at all, yet the point is moot – they are.

During the recent rally, two more accountants have come to market – Stepquick and Frenkel. Contrary to the suggestions of old fashioned purists, there are more reasons to be listed than merely letting the public partake. Profile for marketing purposes, liquidity for owners and paper for acquisitions are all sound reasons to get a listing.

Meanwhile as the market is being ‘perfectly efficient’, fashions come and go.

In this way, one day, accountants will no longer appear as asset free, intangible heavy, litigation vulnerable businesses, but will be looked at as IP heavy, virtual, high margin, new economy businesses. That of course will be the time to sell.

Clem Chambers is chief executive of stocks and shares website ADVFN

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