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FOOL'S EYE VIEW
By
Our best-selling UK Investment Guide contains a chapter with the title 'Obviously Great Investments'. The title was intended to reflect the simplicity of the stock picking approach but, we realise now of course, the catchy moniker was just asking for trouble. The original selection of ten companies was made five years ago. So it seems like a good time to review how the portfolio has performed as five years is often cited as the minimum length of time needed to invest in shares. We looked at the progress in January 2002 and found that they were breaking even, whereas the FTSE All-Share had fallen 11%. We also looked at the portfolio's progress in the third edition of the book, which was published last autumn. Here's a quick recap of the six tests used to select the companies. 1. Have they built a strong brand? 2. Are they the best in their business? 3. Is their position easily defended? 4. Are they making a lot of money for their efforts? 5. Are they up to their eyebrows in debt? 6. Have they been a success up until now? The Performance Following these criteria, the companies that were chosen as fitting the bill for the first edition of the book were: In the second and third editions of the book, we revisited our original selections. M&S, Rentokil and Ericsson were given the boot (PizzaExpress looks to be on the way out too, considering that it is shortly to be taken back into private ownership). Diageo (LSE: DGE), ARM Holdings (LSE: ARM), Sage (LSE: SGE) and HSBC (LSE:HSBA) were all considered to be worthy replacements. So, if we were starting again today, the line-up would be: Like all our strategies, remember that this portfolio is all about Education, Not Recommendation. This list is not intended to be a series of tips and you should always do your own research before buying any share. The Verdict Although the performance of the original portfolio has been disappointing, it has not been a disaster considering the harsh stock market conditions of the last five years. Investing in shares is not a one-way bet and cash has provided a better return than shares in around one-fifth of all the five-year periods since 1918. However, you would have been hard pushed to find a worse time to start such a portfolio. There has only been one other five-year period since 1918 when shares have lost more than 10% (1969-1974 if you're curious). While your money would have done much better in a savings account, matching the market means the portfolio, with no effort expended after the initial selection, has beaten over three-quarters of the unit trusts in the UK All Companies sector. So, despite the losses to date, I don't believe it's fair to say the strategy has been discredited. It hasn't been proven either of course. It was designed to be held for 15-20 years so it will be some time yet before a final verdict can be reached. The performance to date does show the benefits of diversifying your portfolio over a broad spread of sectors, even if we did get a bit carried away in that we picked three drug companies! It also shows you don't need to make dozens of investments in order to build a decent long-term portfolio and to get one that is fairly close to an index tracker. Of course, the whole point of the exercise was to pick a selection that had the potential to outperform the market over the long term, even if only by a small margin. It is failing to do that at the moment, having lost its early lead over the FTSE All-Share. The biggest lesson to be learnt, in my opinion at least, is the danger of overpaying for your shares. We were undoubtedly guilty of falling for the hype and buying a number of companies that were flavour of the moment five years ago and which were therefore too richly priced. Currently, the revised line-up seems to be a lot more fairly valued. Check out our full range of books in the Fool Shop | The Fool Turns Five
'[A strong brand]...gives the company the opportunity to sell more of the product at the same price as less well-branded competitors. Alternatively, it means the company can charge more and still sell the same amount.'
'Does...[our company]...have competitors that are doing a better job? If it does then we may be looking at the wrong company.'
'For a company to sustain its growth over the long term, it needs to have some form of sustainable advantage....a company's brand is about the most important protective moat that a company can build around itself...[but]...there are other factors that can keep the competition at bay.'
'What we want to see is a company that makes good profits relative to its sales.... Sales basically corresponds to the money that comes in to a company through the front door. Of course, all the time there is a lot of money leaving the a company through the back door (that is, the company's costs). What we want to know is how much money stays in the company relative to how much is coming in. This is called the margin.'
'What we really don't want is to find a great company that can't then sustain its position because it is having to spend all its cash paying interest on a large pile of debt.'
'As we have said before, business success, over the long term, will translate into share price success. If we have found an Obviously Great Investment, then it should, almost always, have a good track record of long-term share price growth... Start by looking at the share price performance over the last 10 years or even longer.'Company Share Share
Price Price
at at Change
1/6/98 28/5/03 %
AstraZeneca (LSE: AZN) 2545p 2529p -1
Ericsson (Nasdaq: ERICY) 4233p 620p -85
GlaxoSmithKline (LSE: GSK) 1638p 1252p -24
Marks & Spencer (LSE: MKS) * 479p 295p -38
Microsoft (Nasdaq: MSFT) 1291p 1493p +16
PizzaExpress (LSE: PIZ) 855p 386p -55
Rentokil (LSE: RTO) 418.5p 194p -54
SmithKline Beecham ** 655p 570p -13
(now part of GlaxoSmithKline)
Unilever (LSE: ULVR) *** 604.4p 561.5p -7
Vodafone (LSE: VOD) 137.6p 126.75p -8Average -27
FTSE All-Share 2789 1974 -29
* The purchase price of M&S has been adjusted to reflect last year's
special dividend of 70p. ** The price of SmithKline Beecham shares has been adjusted to reflect
their conversion into 0.4552 shares of GlaxoSmithKline. *** The purchase price of Unilever has been adjusted to reflect the
At first sight, the table makes for rather grim reading. The lead over the All-Share has been trimmed and only one of the shares selected, Microsoft, is ahead over the five-year period.
Note that none of the above figures include annual dividends. The companies selected have paid out slightly lower dividends than the market as a whole. Once these are taken into account, both the All-Share and the original selection are down by around 20% over the five-year period. Ouch! But considering that most of the selections are large blue chip companies, the portfolio's return was always likely to be closely correlated to the market.
special dividend of 66p paid in 1999.