COMMENT
Operational Gearing And 100% Returns

When I managed the Fool's old Qualiport portfolio, I described the London Stock Exchange (LSE: LSE) as 'Britain's best business'. I liked the fact the firm enjoyed a near monopoly status and enjoyed substantial barriers to entry.

Something I also liked about the Exchange was its 'operational gearing'. Generally speaking, the LSE has a fixed cost base. So, any increase in turnover (from listing fees, trading charges and the sale of price data) translates into a greater increase in profits. The phenomenon was demonstrated within some recent LSE results.

The figures showed underlying nine-month turnover up from £181m to £212m, an increase of 17%. However, underlying operating profits jumped from £63m to £83m, an increase of 32%. I calculate for every extra £1 of turnover the Exchange generated, a massive 65p was translated into extra profit! Of course, this sort of 'geared' profit growth has not gone unnoticed by investors and potential bidders. The shares have surged 100% since the Qualiport last bought.

Paypoint

Another share that appears to enjoy high operational gearing is Paypoint (LSE: PAY). This £400m company owns payment terminals located within 14,000 small retailers and takes a slice of each utility bill payment or mobile phone top-up made through its network. Paypoint's latest (interim) results showed turnover up from £40m to £54m, an increase of 35%. But operating profits zoomed from £4.7m to £8.2m, an increase of 75%. The largely fixed cost of Paypoint's network converts £1 of extra turnover into a very worthwhile 25p of profit.

A well as rising customer numbers, a contract to allow money transfers via Western Union and three deals to sell bus tickets should help improve Paypoint's future revenues. Not surprisingly, investors have been drawn to the firm as they hope the new arrangements will accelerate earnings growth ever further. Paypoint's shares have rallied 100% in the last three months!

What now?

I'm always searching for companies that enjoy favourable operational gearing for Champion Shares. Indeed, I'd like to think my very first recommendation for the service will benefit from having a fixed cost base. The company in question is in the final stages of establishing a network and, once in full operation, additional sales should attract little extra cost.

Sadly, I must admit this Champion Share recommendation has not put in an LSE or Paypoint-type 100% return just yet! But I'm reassured how the shares of the LSE and Paypoint had been stagnant for at least a year before the market (and potential bidders!) finally woke up to their fixed cost bases, operational gearing and the possibility of superior earnings growth. I'm now waiting for the market to wake up to my recommendation. This 30-day free trial reveals all.

Maynard recommends at least one share every month for members of the Champion Shares service. The 30-day trial costs nothing and can be cancelled anytime. Maynard also owns shares in the London Stock Exchange.