But what's happened to PizzaExpress?
The last three Qualiport updates have been devoted to analysing PizzaExpress. For those new Fools, and we have many newcomers every day, if you are interested in learning more about the company, I urge you to check the archives. Everything we publish here in Fooldom miraculously gets whisked off to the archives, where it stays until posterity, or until the backbone of the Internet explodes due to a lack of capacity. The link is at the top of every web page.
PizzaExpress passed just about every one of our ten criteria of a quality company. In Friday's update, we looked at some possible valuations of the company. The range of possibilities, looked at from a 10 year investment perspective, gave differing potential compounded annual growth rates (CAGR). The low point, using the price to sales ratio (PSR), was 5.4% rising to a high point of 19.7% using a return on equity (ROE) valuation method. Each method involved many widely differing assumptions.
You will note that we have not used a cash flow based valuation method on PizzaExpress. Discounted cash flow analysis works best on mature companies, especially ones that throw off a lot of free cash flow. PizzaExpress is still very much in the growing phase, and all the cash it generates is being invested back into the business. As we saw in the earlier reports, their cash earnings exceed their accounting earnings, which is usually a good sign that profits are real and not something conjured up by devious accountants. As PizzaExpress are earning 24% on average equity, it makes perfect sense for them to reinvest their cash back into the business. Why leave it sitting in the bank account earning 7% interest, when they can use it to expand the business at an average rate of 24%?
Are they a Foolish buy at 690p? Based on the first nine of the Qualiport criteria, the answer is a resounding yes. Based on number 10, valuation, the answer is also yes. But....
We're not buying them. Yet. For the time being, PizzaExpress will go onto the Qualiwatch list, of which they are the only current member. Veteran Fools will remember this is what we did before our purchase of Marks & Spencer. However, the reasoning this time is quite different.
At 600p, when we did our original analysis of M&S, we thought an investment in them didn't represent particularly good value. Again, check the archives. When the shares dropped to 550p, we pounced, figuring the fall in the share price presented us with a buying opportunity. At the time, it looked a good decision, as soon after our purchase the shares spurted up to 580p. Now, with them hovering around the 440p mark, we're not feeling so clever. Luckily we're long-term investors, and the long-term M&S story is largely unchanged from earlier this year.
We're putting PizzaExpress on the Qualiwatch list, but not because of any of the following reasons:
We are putting PizzaExpress on the Qualiwatch list because we need to raise some money before we can buy them. It's as simple as that. This is a real money portfolio, and we've invested more than £16,000 into it over the last 10 months. We're now all out of cash. In the next couple of weeks, we are planning on freeing up some money, so that we may work towards building the Qualiport into a portfolio of about 8 companies. At that same time, we will announce a new money management policy, whereby we will be adding new money to the Qualiport.
In the meantime, will press on with our search for great companies to join the portfolio for the next 10 years. Please keep talking about and analysing PizzaExpress on the Qualiport message board. Of course, now that we've placed PizzaExpress on the Qualiwatch list, we're hoping their share price will be irrationally marked down over the next few weeks. We are also risking not picking up any shares in them at all if they rise to a level above which we consider them to offer value. That would be disappointing, but market forces have a habit of throwing up buying opportunities sometime in the future. Patience is a virtue.
As a disclaimer, I already own shares in this company, having bought them in April this year. In another piece of fantastic market timing, I picked the peak and am currently sitting on a rather large paper loss. But, enough of my personal portfolio's problems....
The Qualiport is run completely separately from any personal investments I have. If we do decide to make an investment in Independent Insurance, it won't be because I want to average down on my existing holding. It will be because it passes most of the Qualiport criteria. Finally, just because Independent Insurance is in my portfolio, it doesn't mean that this company will be a definite buy and that the research and analysis that follows is irrelevant. Sure, I did some research before I bought my original holding in the company, but nothing as extensive as what follows. The beauty of my job is that it forces me to do my homework before buying shares for the Qualiport.
On with the show.
Independent Insurance is one of the UK's most successful and innovative insurers. They specialise in providing commercial property and liability cover, together with non-standard and specialist personal lines cover.
The company was floated in 1993 at the equivalent of 45p per share. They currently trade at around 250p, meaning that since floatation they've grown at a compound annual rate of over 40%. In anyone's language, that's pretty good going.
Insurance companies are very different beasts to your average company. They do not make or sell products, as a manufacturer or retailer would. They don't have sales income in the traditional sense of the word, nor do they have operating margins. But they are, of course, in this world to make money. I see them essentially as investment vehicles that raise funds for investment purposes through insurance underwriting activities.
Insurance companies cover people and businesses against the risk of loss arising from certain events. Take motor car insurance, for example. The insurer quotes you a premium to cover you in case of loss or damage to your car. The quote is dependent on many things, such as the value of the car, your age, your claims record, your driving record, where the car is garaged... the list seems almost endless. All this information is used by the insurer to calculate a suitable premium. If you accept, you reluctantly hand over your money, and off you drive into the distance.
Even if your car is stolen the minute your cheque is cashed, it will be some months before the insurance company pays out on your claim. In that time, the insurer has got the use of your money. Whilst acknowledging the need to eventually pay your claim, in the ensuing months the insurance company will invest your money with the express intention of having it earn as much income as possible. Now do you perhaps know why insurance companies take so long to settle your claims?
(At this point, I must tell you about an extraordinary experience I had. My bicycle was recently stolen, but luckily it was insured, so I made a claim. I received my settlement cheque for the replacement value -- which exceeded the cost -- just 10 days after submitting the claim, no questions asked. I'm claiming this as a world record, and will contact Diageo to see if I will feature in next year's Guinness Book Of Records. Thankfully, the underwriter was not Independent Insurance.)
As I said earlier, insurance companies are essentially investment vehicles. As savers and stock market investors, we are a sort of investment vehicle. I raise money to invest in the stock market by selling my services to my employer. In return, my employer pays me a monthly fee. The cost to me of those funds is my valuable time. Insurance companies raise their investment income from underwriting activities.
The beauty of a good insurance company is that over the long term it can raise its investment funds (from here on to be known as "float") at no cost to shareholders. The really good insurance companies can actually have a negative float cost. The traditional manufacturing company raises money through recourse to its shareholders or the debt market. Each of these courses of action has a cost involved. Raising funds through underwriting activities is usually cheaper than conventional methods of loan finance. If you obtain your float for free and use that to generate above average investment returns, you're onto a winner.
You will note we haven't looked that closely at Independent Insurance the company yet. It is first important to understand the mechanics of an insurance company and how it makes money. We will continue this process on Friday before getting down to the nitty gritty of Independent Insurance.
In the meantime, we have an individual web message board set up for Independent Insurance. The last time I looked at it, poor old Mehmet (TMF Coffee) was having a conversation with himself, pleading for Foolish input. Help out this Fool and give your opinions on Independent Insurance, other insurance companies, and thoughts about the sector. Are they a Qualiport company?
Bruce Jackson (TMF Googly)
7/10/98 Close Company Change Bid EMA -0.03 8.50 MKS -0.07 4.35 RTO -0.03 3.05 ULVR -0.03 5.14 Qualiport Stocks Last Rec'd Total # Company In At Current Change 19/12/97 1565 RTO 2.55 3.05 18.13% 11/05/98 736 MKS 5.54 4.35 (22.37%) 17/07/98 595 ULVR 6.72 5.14 (24.46%) 17/04/98 337 EMA 11.85 8.50 (29.16%) Last Rec'd Total # Company In At Value Change 19/12/97 1565 RTO 4040.63 4773.25 732.62 11/05/98 736 MKS 4052.24 3201.60 (850.64) 17/07/98 595 ULVR 4048.38 3058.30 (990.08) 17/04/98 337 EMA 4043.37 2864.50 (1178.87) Cash: £67.82 Current Total : £13,965.47 Total Invested: £16,184.62 Profit/(Loss) : (£2,219.15) Value Per Share Day Month Year History Qualiport (0.90%) (7.34%) 12.96% 15.50% FTSE 100 (0.52%) (4.65%) (5.97%) (3.81%) FTSE All Shares (0.46%) (4.63%) (7.24%) (5.29%)For an explanation of Value Per Share accounting, please click here.