Devil's Advocate: Preserving value in IT

Want a decent retirement fund? Maybe the experts shouldn't have been looking for the next Microsoft. Martin Brampton opines...

Last week, I argued the government could arbitrate between the generations to provide secure pensions for ageing IT people and everyone else. Unfortunately, it seems we cannot rely on government to discharge its responsibilities in this area. So can we find ways to preserve value? We can most easily understand the issues in the business we know best: information technology.

The idea is that while we are busy applying our skills to IT problems, we consume less than we produce, preserving the balance to sustain us in our dotage. All kinds of schemes have been promoted as stores of value for this purpose. Art works, antiques or wine have all been advocated at some time. The trouble is their value is inclined to fluctuate quite violently and keeping them safe can become costly. Worse still, they are markets where there is usually little liquidity. That is, there is not much cash ready at hand when large numbers of sellers appear.

Because of such difficulties, attention has usually been focussed on putting savings into company shares. That way we get to own a slice of a company, which we will suppose is in the IT business. The simple theory is that shareholders' funds are used to buy assets and raw materials, to recruit staff and to provide working capital. The hope is that the trading activities of the company will increase its assets and also provide dividends to the shareholders.

Valuing a company is difficult. One way to value it is simply to look at the net value of all the things owned by the company. A puzzling argument is often introduced here. It is easy to see why manufacturing companies need assets such as factories and machinery. Services, in which one might well include the creation of software, are said to need much less capital. However, there is no evidence to support this view, and it seems all companies need assets roughly proportionate to their size to operate successfully.

In the long term, it looks very much as if the stock market value of the corporate sector does line up with the total assets of the sector, a figure that grows slowly but steadily. The long term here is very long though, too long for the average IT worker hoping to build up a pension fund. Other ways of looking at the value of company shares tend to dominate in the short term.

Another way to value a company is to tot up all the future dividends that will ever be paid, discounting them to take account of how long the shareholder will have to wait for each one. Of course, in the short term, estimates of the future profits to be made by a company can fluctuate violently. During periods of optimism, there is a strong belief that innovative companies will generate large revenue streams in the future. So in the dot-com boom, we saw a flood of new companies formed that achieved huge stock market valuations on the belief that they had a golden future.

There was much talk of latching on to the next Microsoft, the next company that would spring from next to nothing to become a giant of the economy. Advice was plentiful on where to put money. Unfortunately, most investment advice is little more useful than the suggestions of lottery winners on how to pick numbers. The dot-coms had not really found a magic way to increase the return on investment and as the painful reality became clear, share prices plunged. It became clear that the enthusiasm for technology shares had spurred the creation of companies that had no real prospect of survival, let alone success.

So it looks as though company shares have only a very limited ability to preserve value for us. And next week I will look at the threat to ordinary shareholders from company executives.

** Martin Brampton is a director and founder of Black Sheep Research (www.black-sheep-research.co.uk ), an independent consultancy providing research, writing and speaking services on a wide range of business and technology subjects. Martin was previously a director at Bloor Research, and has worked with IT as a user and analyst for over 20 years. He has been a frequent contributor to silicon.com's Behind the Headlines TV programme and can be contacted at silicon@black-sheep-research.co.uk .