FOOL'S EYE VIEW
Searching for Super Tech Stocks

By Maynard Paton (TMFMayn)
March 28, 2001

Carburton Street, London -- Are you on the look out for tech stock bargains? If so, then the book Super Stocks could help you. The author of the publication is Kenneth Fisher, the son of Philip Fisher. Fisher Senior wrote the legendary investment text Common Stocks and Uncommon Profits, and although Fisher Junior's book is not in the same ground-breaking league, it does present some clever stock picking ideas for the enterprising tech investor.

Kenneth Fisher is an ambitious investor. He defines a Super Stock as:

"A stock which increases 3 to 10 times in value in three to five years from its initial purchase"

In short, he looks for unloved technology companies. Fisher explains:

"The most profitable common stock investments come in the form of young, rapidly growing [technology] companies that are currently out of favour with Wall Street..."

"Young, rapidly growing companies usually grow in cycles. These cycles are tied to a number of causes. The most important is the 'product life cycle'. Usually young and unseasoned, the management of these companies can make severe mistakes, which can cause losses and even threaten the survival of the firm. Making mistakes is less of a sign of weakness than a sign of evolution. Few companies grow at rapid rates year after year without suffering from some irregularity or "glitch" resulting in unfavourable earnings or even losses"

"Time and time again, a company will be highly revered by the financial community. It will be vividly described by almost everyone as having a rosy future that deserves a high valuation... [However,] there may be a few flies on it that people don't see. When the flies start to show up, and for the first time, earnings decline, the financial community batters the stock. The 'experts' then decide that management isn't very good at all. They decide the technology is weak"

"[Usually], the company is not as bad as they think. The company was probably a very good company. The problem is simply that expectations, and the stock price, were just too high early on"

That should all sound quite familiar to anybody who has bought technology stocks over the past year or so.

Price to sales

So, how does Fisher identify a potential Super Stock? Initially, he applies two valuation ratios: the price to sales ratio (PSR) and the price to research and development ratio (PRR). Fisher disregards any earnings-based valuation, simply because his favoured companies typically have little or no profits. Fisher explains:

"It is rare to see a Super Company have a truly substantial sales decline. It is quite common to see one suffer from severe earnings reversals. The increased relative stability of sales, in relation to other financial yardsticks, allows you to use sales as an anchor to windward in the process of securities valuation."

In terms of using the PSR, Fisher suggests:

"Avoid stocks with PSRs greater than 1.5. Never ever buy any stock with a PSR greater than 3. Aggressively seek Super Companies at PSRs of 0.75 or less. Sell stock in any Super Company when the PSR rises to between 3 and 6"

Price to brains

Fisher also takes into account "the cost of a good set of brains". He believes that the future revenues of a technology company are linked to its current expenditure on R&D. In other words, comparing the market value of the company to its R&D expenditure is a rough way of gauging a long-term PSR.

In terms of using the PRR, Fisher suggests:

"Don't ever buy a Super Company selling at a PRR greater than 15. Find Super Companies with a PRR of 5 to 10"

However, Fisher does recognise the limitations with the PSR and PRR. Both are based on historic financial figures, which may not adequately reflect the future. Also, the accounting of research & development expenditure can vary between companies. 

Anyway, here are the top ten UK technology-related companies that currently fit Fisher's PSR and PRR criteria.

Company             Share      Market     PSR     PRR
                    Price      Value
                     (p)        (£m)

Eidos                217         210      1.05    4.33
Filtronic            160         117      0.49    4.13
Merant                69          92      0.43    2.64
Oxford Instruments   134          64      0.39    5.44
MTL Instruments      275          51      1.18   10.00
Plasmon              108          41      0.52    5.31
QSP                   25          23      0.36    3.00
DCS                   63          16      0.09    2.10
Telme.com             17          14      0.85    7.51
Telspec               33          13      0.25    2.41

All of the above have disappointed investors with varying degrees of profit gloom this year and last. Yet all could have the potential for material sales growth in the future.

MTL: A Super Stock?

Of course, Fisher's valuation sieves are just one half of the investment story. Just like his Dad, Fisher sets great store by judging the underlying business. His five business aspects to look for are management's orientation towards growth, marketing excellence, an unfair competitive advantage, creative personnel relations and the best in financial controls. It's this investigation that sorts out the also-rans from the Super Companies.

It's far beyond the scope of this article to review each company to the standard that Fisher would require. But after a quick perusal, the pick of the bunch could be MTL Instruments (LSE: MTI). The company claims to be a world leader in the design, manufactures and marketing of  "electronic explosion protection equipment". Recent results from MTL highlighted a downturn in profits, although ongoing sales had managed to remain firm. However, analysts are forecasting a sharp profit recovery for MTL this year (40% earnings growth), and a continuation (15% earnings growth) during the year after. Of the ten companies listed, MTL is the one with the greatest expectation of a profit turnaround.

Overall, given the present stock market malaise, Super Stocks is a very useful read for those hunting for tech stock bargains. One word of warning though. While the principles are sound, readers should be aware that the book is now twenty years old. Needless to say, technology has moved on. Fisher recalls investing in an eventual 15-bagger and described the company, Verbatim Corporation, as a "producer of flexible diskettes used in small computer systems".

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