Qualiport

The Qualiport goes for quality.

Last night when I told some old work colleagues that I was going to look at Marks & Spencer as a possible share to invest in, the universal cry was "boring." Most of these people have never been direct investors in shares, but assumed that to invest in the stock market meant that you wanted to buy shares that double in a year or, even better, in a month. On a regular basis, this just doesn't happen.

I started quoting Warren Buffett at them... "It's better to be certain of a good result than hopeful of a great one," but by this stage their eyes had firmly gazed over and another pint was being ordered. When I told them that 12% compounding growth over a 30 year time scale adds up to an enormous amount of money, they got a little interested again. But by that stage it was too late and the alcohol was having its desired effect. (I didn't have my scientific calculator on me last night, so couldn't throw some numbers at my friends. £5,000 compounded for 30 years at 12% per annum would leave you with £150,000 in 2028 -- not bad, and that's without adding any new money along the way.)

Anyway, enough about my social activities. If a company like Marks & Spencer can grow at 12% per annum for the next 30 years, as potential investors we'll be very happy indeed, no matter how boring the company or investment may be. We are building a model portfolio which we hope will outperform the market over a long period of time. So far, with Rentokil Initial and EMAP, we have two companies that are large and that we think are well managed. In our view, all portfolios should start with some big companies that are the bedrocks on which to build. We've got two so far and are looking to add a third.

Back in January this year, aeons ago in terms of Internet time, we analysed Marks & Spencer in terms of their Qualiportness. There were 3 articles in all (check back in the archives for all of them, and for all the stuff we've written here in Fooldom) and we concluded that good old boring Marks was a quality company with excellent management. At the time I said, "We would be willing to become part owners in this company if the price is right." That was when their share price was 600p -- it has now dropped to by 8.3% to around 550p, whilst in the same period the market has risen by 15%.

The other attraction to Marks & Spencer is their index tracking potential. They operate a single company PEP into which you can contribute amounts as and when you like, not exceeding the £3,000 limit per annum. The big catch to this is that you've only got until April 1999 to do this, as the new ISAs come in after this date. Any amount contributed to the M&S single company PEP before that date remains in the PEP until you decide to sell.

The "drip" nature of the single company PEP is something that appealed to me, as it could have substituted for dripping money into an index tracking fund. However, with that option being phased out, I don't consider this to be feasible. Still, if M&S prove to be good value at current levels, a lump sum purchase now could see them acting as an index tracker of sorts. Since 1982, the shares alone (ignoring dividends) have had a compounding annual growth rate (CAGR) of 13.1%, which is above the long term growth rate of the market.

In my original articles, I assumed that M&S would be awarded a price to earnings (P/E) ratio of between 13 and 15 in ten year's time. This was based on the company growing at rates from 7.5% per annum to 12% per annum. Looking back over the history of the company's share price, in the last 5 years the P/E has averaged almost bang on 20. At 550p, with earnings per share (EPS) for the year ended March 1998 estimated at 27.6p, that leaves M&S trading at a P/E of almost exactly 20. That would imply that today they are a fair value. As a quality company with a great brand name, one would expect that M&S would continue to trade at their average P/E of 20 for the foreseeable future. If you take any changes to the P/E out of any valuation equation, it makes things so much easier. The share price should appreciate annually by the same amount that the company's profits grow.

Marks & Spencer announced in its interim report for the period ended September 1997 that it was embarking on an "unprecedented product and footage expansion in the United Kingdom, Continental Europe and the Far East." This programme is continuing despite the economic downturn in Asia. Foolishly, M&S has firmly got its eyes set on the long term. In the next 3 years, they expect to increase their overall footage by an astonishing 33%. And you thought that a company this size had very little further growth potential! They are aiming to become the world's leading volume retailer with a global brand and global recognition.

There is no doubting that right now, in the 1998 financial year that ended on March 31st, Marks & Spencer struggled. Earnings growth is expected to be in the 3% range, and they've been hit by the strength of sterling. This will be their worst performance for quite a number of years. The 1999 financial year will not be easy either, and only 8% earnings growth is currently anticipated. However, it is from then onwards that the unprecedented expansion programme is expected to kick in, which should feed through in the form of increased profits.

The beauty of an investment in Marks & Spencer is that you don't really have to go into too much detail when looking at their numbers. Because we know they are well managed, we can therefore assume that they've got their eagle eyes on important things like stock, debtor and cash levels. We can also assume that they won't make a Next type mistake and have the wrong style of clothing in stock at the wrong time of year. M&S' stable diet is essential clothing for Mr. and Mrs. Average. This is one company that is not going to be caught out on fashion changes, unless of course they start stocking bathing trunks during winter.

Someone asked me what was it that attracted me to Marks & Spencer. I replied with the following words, which in my view sum up the company:

Quality
Management
Brand Name
Brand Recognition
Reliability
Reputation
Safe

The Decision

Fool buys! In accordance with the Fool Trading Rules, over the next 5 days we will be buying £4,000 worth of shares in Marks & Spencer. The share price closed today at 551p. Unlike previous occasions, where we have waited a few days before purchasing the shares in our companies, we are planning on buying M&S shares on Monday morning. That is because we want to be assured of picking them up at around the 550p mark. Having previously decided not to buy them at 600p, if we waited till later on in the week before buying them, at which point they may have risen up towards that mark, we would look a little foolish (small 'f').

As I have hinted throughout this report, we are not becoming part owners in M&S for the excitement factor. Over time, I fully expect them to grow, and therefore their share price to do the same, by 10 to 12% per annum. That return should be almost guaranteed, because of the size and quality of the company. Compare that with the current risk free rate of return of less than 6%, and you an see why an investment in M&S is attractive.

We see this investment as doing the job of an index tracker. Steady, hopefully quite certain, growth of 10% to 12% over a long period of time. The market has grown at about 12% per annum over time, and this is what we hope M&S and its share price can do.

In building this "Quality Portfolio" we see no better company to grace its presence than Mark & Spencer. The company's name is synonymous with the word "quality." Every portfolio should have its fair share of big, solid, dependable companies. We reckon we've now got 3 of these, and this is a very solid base on which to build. Sure, we'd love to have some excitement in the portfolio, the little companies that have got the potential to grow quickly and really make a difference to your returns. One day we hope to have some of these, but of course they come with much greater risks. That's why it is important to secure your portfolio with some big, dependable companies. We're not going to lose all our money in a hurry by investing in great companies like Rentokil Initial, EMAP and Marks & Spencer.

Despite my blasé comment about an investment in M&S being almost a guaranteed winner, reality is that they could be a loser. Because we're not investing our money in the building society, there are risks involved. That's one of the reasons why equities return more than bonds -- the risk premium inherent in them. M&S are due to report their results for the year ended March 1998 in the next 2 weeks. At that same time they will issue a trading update. As I said earlier, it is fully expected that they will be finding the current retailing environment tough going. This is old news, but may cause the share price to be depressed even further. There is also no guarantee that they will trade at a P/E of 20 ad infinitum. If Mr Market sees that they are continuing to struggle for an extended period of time, he may rightly mark the shares down to a P/E of 15. That would equate to a share price of 414p versus today's price of 551p, a drop of 25%. Ouch -- that would hurt. The P/E could go even lower.

We're banking on this not happening. History says that it won't, but that's no guarantee. However, we're happy parting with our hard earned cash to become part owner in Britain's best and most respected retailer. This is our decision, and we know exactly what we're getting ourselves into. Just because we're buying M&S for our portfolio, doesn't mean you should too. As usual, we encourage you to learn from what we are doing here, but always make your own investment decisions. Please share your thoughts about M&S in the Qualiport message board.

Welcome to the Qualiport, Marks & Spencer. Here's to the next 10, 20 or more years.

Bruce Jackson (TMF Googly)

Qualiport Numbers

Today's Numbers                   Date            08/05/98


          Change     Bid
          pence       £

RTO        0.04      3.78
EMAP       0.12     12.15


Rec'd        #     Stock      Buy      Now    % Change   £ Change

19/12/97   1565  Rentokil     2.55     3.78     48.2%       1.23 
17/04/98    337  EMAP     11.85    12.15   2.5%       0.30 


19/12/97   1565 Rentokil  4,040.63  5,915.70 46.4% 1,875.07 
17/04/98    337 EMAP   4,043.37  4,094.55    1.3%       51.18 


Total                               10,010.25 



                Day    Month    Year    History

Qualiport       1.0%   -0.8%    44.5%    47.8%
FTSE 100        0.5%    0.7%    16.2%    18.9%
FTSE All Share  0.6%    1.1%    16.9%    19.4%