A punt at the best of times

Trouble at CBA and Telstra shows how hard it is for investors to get it right

If the first rule of investing is to not lose money, and the second rule is the same as the first, then why do so many of us keep breaking the rules?

Hands up, if after the past few months of publicity and controversy, you’ve wondered if you should sell your Commonwealth Bank or Telstra shares? Just about every person who owns them, I’ll bet.

Notwithstanding CBA CEO Ian Narev announcing his departure in 15 months, a 20% pay cut for the board and short-term bonuses suspended for senior executives over allegations by government agency Austrac that the bank’s systems failed to report around 53,700 potentially suspicious transactions, nothing much happened to the Commonwealth share price.

Yet each breach attracts a maximum penalty of $18 million – a total worth many times more than the bank at $966 billion. Tabcorp earlier this year settled for $45 million after being accused of 236 similar breaches. That’s more than $190,000 per breach. Apply that to the Commonwealth’s 53,000 and you come to around $10 billion – a year’s profit. Put another way, it’s around 7% of the company’s market value.

Can shareholders afford that? Well, yes. Should something like that normally dent the share price? Yes. So why have the shares barely moved? Well, that’s because the Commonwealth’s argument is that it committed just one breach (that was repeated more than 53,000 times). One breach is $18 million, which is a far cry from $10 billion or so.

So how does a CBA shareholder work that one out? You’re not a legal expert who understands the vagaries of the Federal Court. All you can do is follow the crowd and hope like hell the smart money is right in not marking down the shares. In other words, for all the analysis and smarts that go into company research, there’s still a punt at the bottom of it, even in the largest of all companies.

So we go to Telstra shares. Here you perhaps should have got a whiff of something in the past 12 months. They hit a 13½-year high price of $6.61 in mid-2015 – four years after hitting all-time lows around $2.60. It rode off the back of its $11 billion settlement with the government on the NBN rollout and soaring dividends. The company was so awash with cash that it, unusually, distributed 100% of its profit as a dividend.

Well, the past year has been anything but impressive, with the shares falling all the way back to around $3.80 as I write, based on worries about its future growth and a cut in its dividend policy.

Telstra CEO Andy Penn, while announcing the company profit, said that in the current financial year the payout ratio will fall from close to 100% to between 70% and 90% of the profit. The shares fell 10% on the spot. As with Commonwealth Bank, many people receiving low deposit rates from their bank had piled into Telstra to chase those higher income returns. Yields of 7%-9% fully franked were enticing but ultimately illusory.

Now a Telstra shareholder must work out how much the dividend will be cut by (there will undoubtedly be guidance for shareholders throughout the year but until then it’s a guessing game). But for that income-based investor – already staring down a 30% cut in their income, with the possible capital loss – it’s an unenviable decision. What was that first rule of investing? Don’t lose money?

For many investors, the decision is to hang in there and ride it out. And if you have enough time, that might work. All the bad news might be in the market already. Or it might not. You can’t be quite sure. Telstra’s big problem is that, having sold off its customer base and copper wires to the NBN for a reported $11 billion, it means it also sold off between $2 billion and $3 billion worth of profit.

It says it will give three-quarters of that money back to shareholders and will invest the rest into fresh businesses to try to replenish the profit. Some big shareholders are saying “which businesses?” and “let’s hope they pick the right ones”. And that adds risk to the share price.

Just a final one: the real way to judge companies is to look at their return on shareholders’ capital employed. In the case of CBA it’s 16% (down from 18% in recent years) and for Telstra it’s 14.7%. That’s not dividends, that’s the profit generated on the capital shareholders have put in. Neither is shabby though others are growing more strongly.

But if two of the most popular companies in Australia have so many questions to be answered, heaven help you trying to sort through your portfolio – and fulfilling the first and second rule of investment.

Ross Greenwood is Channel 9’s finance editor and Radio 2GB’s Money News host.