Jonathan Davis: So much fun in store with Safeway

For those involved in the bid for Safeway, the fun has only just begun. Three competing bidders already and the prospect of a referral to the Competition Commission make this a potential saga that the fee-hungry investment bankers and lawyers will be drooling over, like mangy dogs who have been living off scraps for months. The odds are that whoever wins the day in these circumstances will end up paying a full (and possibly more than full) price for the privilege.

For this column, however, the significance of the flurry of bids lies mainly in the fact that it threatens to tie up another of the loose ends in the high-yield, safety-first portfolio whose performance I highlighted here in the autumn. Safeway was one of only two shares in the eight-stock contrarian's portfolio, originally selected by Jim Slater in late 1998, that has so far failed to produce much in the way of fireworks.

I said at the time that the great rationale for investing in this kind of stock, assuming that the dividend is well-backed by cash, as the initial selection criteria required, is that it offers a reasonably secure annual return in the shape of the yield, while also retaining the underlying promise that if the company fails to perform consistently for several years, as Safeway has certainly done, it is likely to end up being taken over at a price that will give shareholders something extra in the form of a capital gain as well.

That is what happened to another of the original selections, the cement company Blue Circle Industries (which was bought by its French rival Lafarge, probably at too high a price, judging by the veiled profits warning which the latter put out this week). Now it is Safeway's turn to go from stock market pariah to corporate favourite overnight. It provides a further modest justification for the original stock selection methodology.

The initial value of the bid made by the splendidly politically incorrect folk at Morrisons (no remuneration committee, no non-executive directors, but a big owners' shareholding, hurrah for them) was little higher than the price – 283p – at which the stock was trading when it was included in the initial 1998 portfolio. Given that the shares have now risen to around 300p in the expectation of a higher final bid, it looks as if shareholders may still secure a modest capital gain to sit alongside the 48p of dividends that they will have received since November 1998. (Safeway did cut their dividend along the way, which is not meant to happen with this methodology, it has to be admitted). A total return of, say, 60p on the original purchase price of 283p (a gain of some 25 per cent over four and a bit years), would not, of course, be any great shakes in absolute terms. But when you consider what has happened to the market as a whole over the period – down about a quarter – it certainly will not be a bad outcome for those with the patience to have waited for it.

It will have beaten the return on cash and will lift the overall return from the portfolio to a compound annual return of some 8 per cent per annum. Given inflation at 2 per cent, by a neat coincidence this happens to be roughly equivalent to the well-established long-term return on equities, which is between 6 and 7 per cent in real terms. Given that Safeway's shares were as low as 184p just a few weeks ago, it does, however, serve to underline the fact that you have to be prepared to be patient with this kind of investment. More importantly, unless you have faith in the validity of the original discipline, and are genuinely prepared to wait five years for the results, the risk is that disappointment will shake you out of the shares far too early. Many people who like to think of themselves as medium to long-term investors turn out to be anything but in practice.

AN INTERESTING document passes through my mailbox. It is a brochure from a firm that specialises in making a market in traded endowment policies. As most readers will know, it is often possible to secure a higher price for an endowment policy by going through one of several middlemen who trade policies than you can get as a surrender value from the company that issued the policy to you in the first place. (Whether you are right to stop making payments on the endowment is quite another matter). What caught my eye about this brochure, however, was the sales pitch that the firm makes to the IFAs at whom it is explicitly targeted.

"Maximise your earnings from your forgotten or impossible clients," is the theme of the brochure. "Don't miss these unique earnings opportunities," it goes on, listing three main sources of potential income, namely: 1. commission from clients with no cash to invest; 2. commission on up to three times the value of the capital investment; 3. commission for maximising a client's endowment policy.

And you thought that IFAs were there to give you impartial, unbiased advice about your financial welfare? The best ones are, of course, and in some cases trading in endowment policies will be a sensible thing to do. But there is no escaping the harsh economic reality that commission-based IFAs make their money from selling you financial products, and it is the job of product providers to keep the IFAs happy with a string of products that will make them money, much as doctors are besieged by drugs companies offering them solutions to patients' problems.

It is salutary to see one firm, at least, making no bones about the fact that it sees its business as being to maximise IFA earnings. In the case of Midas Securities (sic), the firm in question, some of us, I suggest, may prefer to remain "forgotten or impossible clients".

Davisbiz@aol.com