Qualiport

The qualities of a great company.

The search for great Qualiport companies continues. But before we move forward and start analysing the next potential Qualiport share, I want to elaborate and expand on the criteria I see as befitting a quality company. I touched on this at the conclusion to Wednesday's report. Tonight's report will be archived (as everything we write here in Fool UK is) for posterity as "What is a Qualiport Share?" Here goes:

1. A well managed company

This is the most important factor in any company. It is also arguably the hardest to define.

People run companies. The success or failure or mediocrity of a company is all down to people. Whether it is the mad professor in the chemistry lab discovering the cure to Alzheimer's disease or the electronic genius inventing the hand held tele-conferencer, these are people who are contributing to the success or otherwise of the company they work for.

It is not, however, these "backroom" people who really make a company tick. It is all very well to have the best product on the market, but that in itself is no guarantee of success. Examples of this are littered throughout the annals of time. Apple vs Microsoft, Pepsi vs Coca-Cola, Betamax vs VHS, 5" floppy disks vs 3 1/2" floppies, and Psion vs Philips et al. The reason the latter company or product in each of the examples succeeded is arguably because they had the better management.

The management of any company starts at the very top with the Chief Executive. In two of our current Qualiport companies -- Rentokil Initial and Marks & Spencer -- the top men are admired not only throughout the company, but also across the business community. They lead from the front, and their qualities have naturally filtered down the management line.

The men are not autocratic. The companies they run are not one-person businesses. If they left tomorrow, the two companies would not fall to pieces. We would not want to be invested in companies where too much depends on too few. You could argue that Rupert Murdoch's News Corporation is just that. We wouldn't want to invest in such a company.

But how do you measure management expertise? Unlike numbers, there's no quantitative measure you can run. However, we believe there are some measures that give you a good indication of a company that is well managed. Read on...

2. Strong, and ideally increasing, margins

This, I believe, is a good indication of a quality company. Margins can give investors an idea of a company's competitive advantage. However, high margins are not necessarily the be all and end all of stock analysis. They often invite competition as other companies are attracted by the profitability of the industry. On the other hand, a company with low margins is not necessarily a poor company. They can be very profitable by selling large volumes of low margin products, just like a supermarket does. Looking at margins is just one tool in an investor's armoury when analysing companies.

Margins are where you can get some sort of measure of a company's management. If you look back over the past years of its audited results and see the operating margin has increased from 8% to 20%, you know they must be doing something right. Whether it is because they can successfully roll out a proven idea, as in the case of companies like JJB Sports or Pizza Express, or it is a company like Granada that has re-engineered itself to concentrate on higher margin businesses, it is usually the result of good management.

I like to use past results when evaluating a company's management. Conventional stock analysis says that you should always look forward when evaluating a company. You will almost always see and hear comments like "their forward P/E is 20" or their PEG (which is calculated using forward earnings estimates) is 0.7. Whilst these are important, in isolation they certainly don't give investors any feel for the quality of the company and its management. That can be gleaned by looking backwards and evaluating the company's proven results.

Each year in his letter to shareholders, Warren Buffett sets out the criteria for companies he is looking to buy for his company, Berkshire Hathaway. After point number one, which refers to the size of the company, point number two says that they are looking for companies with "demonstrated consistent earning power -- future projections are of little interest to us, nor are 'turnaround' situations."

If it's good enough for Warren, it's good enough for us.

3. Strong brand name and competitive advantage.

Companies with strong brand names automatically have a competitive advantage over the opposition. But the brand name doesn't just happen overnight. It is usually the culmination of good management, a good product and canny marketing. The best and cheapest type of marketing is the word of mouth kind.

Richard B: "I flew Virgin to Miami and it was the best flight I've ever been on. They've got these computer games in the back of every seat and you can play them all flight. You are disappointed when the flight ends."

Robert A: "How was the service?"

Richard B: "It was good. You get these little welcome packs when you get on board with a comb and toothbrush in them. Virgin think of everything."

Robert A: "How much was the flight?"

Richard B: "Oh, I'm not exactly sure. They weren't the cheapest, but it is worth paying the extra for the experience."

This could be a typical conversation between two work-mates. Richard, being so naturally enthused about these great little extras, and the Virgin band, declined to mention that the food was standard aeroplane stuff, the leg room was nothing special, and the plane was an hour late both ways. But the really important message was the fact that Richard was prepared to pay that little bit extra for what he said was a brand he enjoyed and could trust.

A strong brand and competitive advantage gives a company huge pricing power. These are the type of companies that can raise prices and yet lose very few customers. A company like British Sky Broadcasting is a good example. Once you've decided to subscribe to their service, and especially if you do it only to watch the Premier League football, and they decide to increase the monthly subscription by £2, the chances are that they will keep 98% of their customers.

Many of the biggest and best brands in the world are associated with some of the best companies in the world. Coca-Cola springs instantly to mind, and in the UK Marks & Spencer have an instantly recognisable and respected brand name.

Next Week

That's only 3 of the qualities of a great company. I will conclude this series next week, and as I said at the top of this article, this will then miraculously be whisked off to an easily accessible list box in the Qualiport area.

After that, the search for the next potential Qualiport candidate will begin. Fools must remember that although we are setting out the ideal criteria for a quality company, no company is perfect. For example, based on today's first 3 qualities, Mark & Spencer falls down on the "strong and ideally increasing margins," whereas it passes through the "well managed" and "strong brand" criteria. If the perfect company does exist, and is available to be purchased at a reasonable valuation, I'd love to know about it.

In the meantime, feel free to throw some Qualiport ideas, and potential companies to look at, onto the message boards. If you're feeling a little bashful, feel free to email me with your thoughts.

Our newest Qualiport share, Marks & Spencer, report their annual results on Tuesday. We'll be covering them extensively in the Daily Fool that evening and having a quick update in next Wednesday's Qualiport report. Analysts are expecting pre tax profits in the range of £1.11-1.15 billion, up from £1.10 billion last year. Consensus earnings per share (EPS) estimates are around the 27.6p mark.

Have a great weekend, Fools. Get out and enjoy the sun -- whilst it lasts.

Bruce Jackson (TMF Googly)

Qualiport Numbers

Today's Numbers                   Date            15/05/98


          Change     Bid
          pence       £

RTO       -0.06      3.80
EMAP       0.00     12.40
MKS        0.07      5.68         


Rec'd        #     Stock      Buy      Now    % Change   £ Change

19/12/97   1565  Rentokil     2.55     3.80     49.0%       1.25 
17/04/98    337  EMAP     11.85    12.40   4.6%       0.55 
11/05/98    722  M & S        5.535    5.68      2.6%       0.145


19/12/97   1565 Rentokil  4,040.63  5,947.00 47.2% 1,906.37 
17/04/98    337 EMAP   4,043.37  4,178.80    3.3%      135.43
11/05/98    722  M & S     4,052.24  4,100.96    1.2%       48.72

Cash                                    33.96

Total                               14,260.72 


                Day    Month    Year    History

Qualiport      -0.3%    0.6%    46.6%    49.9%
FTSE 100       -0.5%   -0.2%    15.2%    17.9%
FTSE All Share -0.4%    0.7%    16.5%    18.9%