Qualiport

Bruce (TMFGoogly) looks at the growth potential of the shortlist of media companies.

Rentokil Initial Update

Eureka. After the rumours of Rentokil taking over Denmark's ISS or the UK's Compass, we have some concrete news from the company. Yesterday, they announced to the market that they had made 12 acquisitions and completed 5 disposals in recent months. With all that corporate activity going on, no-one could accuse the management of twiddling their thumbs whilst waiting for the annual results to be released in just 2 weeks time.

The biggest of the acquisitions was a Belgian textile services company called Euroblan. They were bought for £15.4m in cash, which is exactly the same amount as their turnover. Chairman Sir Clive Thompson's comments sum up Rentokil's policy to these acquisitions. "These bolt-on acquisitions and disposals reinforce the company's strategy of concentrating on high growth and quality driven services using the strengths of the 'Rentokil' and 'Initial' brand names." Whilst many may ask why Rentokil would bother with these relative tiny acquisitions, an old accounting phrase springs to mind. "If you look after the pennies, the pounds will look after themselves."

The Media Sector

Last week, we started by reducing the 121 media companies to 13 based on their past records of growth. The reasoning used was that a good past record gives a reasonably good indication of strong management, and that it can't be argued with since it is based on audited numbers. Another important criterion was a company with strong operating margins, as this usually indicates a company with a strong competitive position.

This is far from the be all and end all of stock analysis. There are probably many companies in the media sector that are well managed but their growth period is still well ahead of them. I don't know much about them at all, but Chrysalis and Flextech may well be two of them. The latter company is growing its sales rapidly, and has signed important partnership agreements with companies like the BBC. There's also a company like Freepages Group, which is investing heavily in the Internet in the hope of future growth from that medium.

Over time, we are trying to build up a Quality Portfolio, with the firm emphasis being on finding and holding quality companies. The 13 that made our shortlist certainly have a past record that suggests they pass the QP test. Many others, including the companies mentioned above, may have potential -- but we are looking for more than that. We want concrete evidence of past performance and growth, believing that it they've done it before, they can do it again.

In the first instance, I managed to reduce the 13 chosen media stocks down to what I considered the four companies worth looking at more closely. The other 9 had some sort of slight blemish on their past records, whether it be slow sales growth, high debt, decreasing margins or low margins. Let me reiterate that of those 9, only one (Daily Mail & General Trust) is completely out of contention. One other, Pearson, is regrettably on double secret probation. I say regrettably, because they are the publishers of what I consider to be the best newspaper in the world, The Financial Times. There are obviously other strings to their bow, and they may not be as good as their flagship newspaper.

Valuation

I need not remind everyone that the stock market is at an all-time high. There's nothing wrong with that, and in fact it would seem perfectly normal given that over the years the market has been the best place to earn above average returns. However, at these levels, investors need to become wary that they don't over pay for a company. You may think this is relatively unimportant, since we are going to buy and hold the Qualiport companies for a long period of time, but even over a period of 10 years there is a danger of your investment giving mediocre returns. Equity investments are inherently risky, some more so than others. Since you are putting your money at risk, you deserve to make an above average return. Therefore, if over a 10 year time frame you find yourself looking at a 5% per annum average return, you're better off opening a building society account and playing the carpetbag game.

There are two recognised ways of progressing the stock selection analysis from here. The first is to learn as much as you can about a company by looking at its past record, analysing the last annual report, and looking to the future. Basically you want to feel comfortable that you know what the company does, who its competitors are, and how it intends to grow in the future. Having done that, if it passes your strict criteria, you can then go on to look at its valuation. This way, in theory, you choose the best company in which to invest your hard earned money.

The other way, and the method I am going to use here, starts by looking at the valuation of a company, and uses that to decide whether to go forward and find out more about it. The reasoning is that it would be disappointing to have done all that evaluation and homework, only for the company to fall at the last hurdle -- valuation. I feel this particular method has more merit to it in a strong market, the likes of which we are currently experiencing. It is far from fail proof, however, and we must be careful not to select a company simply based on its valuation. We still want a quality company.

Each method has its merits. However, having decided that we want to invest our money in the stock market, valuation plays an important part of that decision. Using the first method, the danger is that your selected company may never be at a price you think provides value or gives you a sufficient return above the risk free rate. Then, you could in theory stay out of the stock market forever. A nice little stock market correction would be handy for those us with some money waiting to invest in the market. A few bargains may easily arise.

[I'd be interested to hear other Fool's views about these 2 stock selection criteria. We can discuss and debate it in the Investment Strategies message boards.]

The Shortlist

              Long Term Growth  Yr 10 P/E   Annualised
                                           10 Yr Growth

Capital Radio      15%             18          14.6%
Southnews          14%             16          12.2%
EMAP               16%             20          11.8%
Reuters            12%             15           9.3% 

*Based on closing share prices on February 24, 1998.

This table is by far the most subjective thing I've done to date. I have tried to be as fair and as rational as possible, but reality will ultimately be very different to the above scenarios. On my Media spreadsheet, I can tinker as much as I like to get the numbers to suit, should I wish to. There is an undoubted amount of bias in my assumptions, and someone else would come up with quite different long term growth figures dependent on their optimism, pessimism or prevailing mood.

I feel the long term growth assumptions are reasonably realistic. Over the last 5 years, each company in question has grown its earnings per share by an amount far in excess of the forward rates I've quoted in the above table. Each of the companies has a reasonable forward growth rate, without setting the world on fire. However, if my growth assumptions turn out to be on the pessimistic side (and remember I'm a prudent accountant by trade), the returns could look a lot better.

The one company that is looking on slightly shaky ground is Reuters. We've had some excellent posts on the AOL Qualiport message board about this giant of a news provider. It seems they may have some good products, but may be having trouble selling them. Also, they seem to be losing market share to their great rival Bloomberg, and their customer base is shrinking. Plenty of doubts seem to surround the company's immediate future growth. However, they've done it before, and who's to say they may not come up with great products in the future, which they can sell to a new customer base? However, I have yet to be convinced. Should Reuters be unceremoniously dumped from Qualiport contention already? Views please to the Qualiport message board.

The Next Step

Oh no, you may be thinking. Another week is about to go by and we're not much closer to buying a share for the Qualiport. I make no apologies for this delay. Proper stock analysis takes time. Our own money is at risk here, and we want to make sure we are investing it in a company we feel is solid and has good future growth potential. Harking back to an earlier point, most companies in this market are trading at historically high levels. That is also a factor as to why we're not in a rush to invest.

We will start by having a closer look at the company at the top of our growth list -- Capital Radio. Londoners will be very familiar with this brand name, as they are the most popular commercial radio station in the city. But, as we shall find out, there's a little bit more to Capital than a London radio station. In my quest to find out more about the radio industry (EMAP also has radio interests), I came across The Radio Advertising Bureau's site. There's some interesting information there.

To yet further delay this Qualiport selection process, I will be having a week off next week. Nigel or David, or both, or neither, will be doing the update. And the week after that, it's Rentokil Initial's results day. In the meantime, however, I'll be doing some background work, getting to know the four shortlisted companies a little better. As with the Reuters information, don't be afraid to share your own findings about the media companies in the Qualiport message board.

Keep Fooling.

Bruce Jackson (TMFGoogly)

Qualiport Numbers

This Week's Numbers          Week Ending 25/02/98

          Change     Bid
          pence       £

RTO       +0.04      2.94


Rec'd       #    Stock      Buy      Now  % Change  £ Change

19/12/97  1565  Rentokil     2.55     2.94  15.3%      0.39
19/12/97  1565  Rentokil  4040.63  4601.10  13.9%    560.47


                    Week          Year          History

Qualiport           1.4%         11.4%            13.9%
FTSE 100            0.4%         11.9%            14.4%
FTSE All Share      0.5%         10.4%            12.8%