Qualiport

Fool Sells
Monday, 19 October 1998

A Confession - We got it wrong.

Welcome to today's Monday Qualiport special. Veteran Fools will know that the Qualiport update is featured every Wednesday and Friday, so an article today is something out of the ordinary.

Today marks a piece of Qualiport history. No, it's not the confession that we got something wrong. We've made errors in the past, and we'll no doubt make them in the future. The monumental announcement is that we're selling!

What the...? The Fool is selling so soon after buying? Have we lost our bottle? Are we running scared? Has our strategy investment strategy changed?

At the outset, the Qualiport's aim was to invest real money into a basket of companies, with the objective of assembling a market beating portfolio. Over the past 10 months, we've invested a total of £4,000 each (plus costs) into 4 large UK companies, known around Fooldom as the Qualiport Quartet.

All investors should own a portfolio of companies spread across various industries and sectors. Diversification is the name of the game. It is inevitable that, over time, you will have some big winners in your portfolio and some big losers. By diversifying, you are also spreading the risk. A one share portfolio is a risky portfolio. If the company doesn't progress as you expected, you could be left nursing a sizeable loss.

Like investment strategies, we could debate the merits of diversification until the cows come home. Some people feel comfortable with a small number of companies in their portfolio. When you consider the amount of money he has invested, Warren Buffett has a relatively small number of companies in his portfolio. When he buys, however, he buys big, taking large positions in companies he considers have outstanding prospects. At the end of 1987, his company Berkshire Hathaway had a share portfolio of US$2 billion -- and it consisted of holdings in just 3 companies! Buffett says that truly great companies are rare, and when you find one available at an attractive price, you should buy up big.

Some people like to own shares in many different companies. I know of some people who hold shares in about 30 or 40 companies. These people are certainly well diversified! However, studies have shown that a portfolio with more than about 15 companies in it actually increases the risk factor. With a portfolio that size, it is also very difficult to follow the progress of each and every company.

Here at the Qualiport, we feel comfortable with a portfolio of between 8 and 12 companies. To us, a portfolio of just four companies, such as we've got at the moment, is not sufficiently diversified. So, over the next few weeks, we'll aim to build it up. We've recently identified a couple of companies that we will possibly add to the Qualiport. Before we can consider that, though, here comes our confession....

We Was Wrong

This is a real money portfolio. That means we've spent over £16,000 of our own money buying 4 shares.

We've run out of cash.

Although we'd like to be able to add another £16,000 to the portfolio so that we can buy shares in another 4 companies, we just haven't got that sort of money. We therefore need to raise some cash from our current portfolio. But which company are we going to sell?

Should we take profits in Rentokil Initial, our biggest position? Should we dump EMAP, until today (up another 48p to 973p -- see today's numbers below) our worst performing company in terms of its share price? Our what about Marks & Spencer? They seem to have recently lost the plot a little, and the share price is in the doldrums. We have acknowledged we overpaid for Unilever, so should they be sacrificed? Second quarter results were a little disappointing, and they are exposed to the troubled emerging markets.

Fool Sells

We're selling them all. Every single company in our portfolio. Rentokil Initial, EMAP, Marks & Spencer and Unilever -- they're all out, out, out.

But....

We're not selling our full holdings -- we're selling exactly half the number of shares we own in each of our four companies.

Here's the reasoning. Given our own personal financial situations, we should have started out by buying £2,000 (plus costs) worth of shares in each company. Instead, we splurged and bought double the amount. As time has gone on, we've realised we can't keep adding £4,000 when we want to buy shares in a different company. At the outset, when we bought 1565 shares in Rentokil Initial at 255p for a total cost including charges of £4,040.63, we got it wrong. We should have been planning ahead and thinking about the exact problem we now find ourselves with. But, being new and eager Fools, excited about making our first purchase, we didn't think ahead.

We got it wrong.

There were other cash raising options open to us. We never borrow money to finance a share purchase, so that option was out. And besides, investing borrowed money costing 15% and above is not going to get anyone anywhere fast. You'd be very lucky to breakeven.

We could have realigned the portfolio by raising the approximately £7,600 cash by selling each of our four companies in proportion to their weight in the portfolio. However, we rejected that idea because it involves us cutting the percentage weighting of our only winner -- Rentokil Initial. Over time, we will find our portfolio has relatively few big winners that will propel its returns over and above that of the market (we hope!). To cut one of them (our only one) now would be to potentially forgo that additional appreciation over time.

By selling half our positions, we are effectively saying that we think we can put our money to better use. Whether we will be successful, only time will tell.

Sometime over the next 5 days, in accordance with the Fool's trading rules, we will make the following trades:

Sell -- 782 shares in Rentokil Initial
Sell -- 368 shares in Marks & Spencer
Sell -- 297 shares in Unilever
Sell -- 178 shares in EMAP

When you think about the brokerage charges that this little exercise will cost us, we made an expensive mistake. The additional charges will also hold back our returns in the short term.

If we were able to sell half our holdings tonight, after the market closed, the actual percentage returns and cash loss would be completely unchanged, apart from the selling costs involved. But, once we have a portion of our portfolio sitting in cash, we could either under- or overperform the market. However, we don't envisage sitting on the cash for too long.

This is not a market timing decision. We will be taking a loss on 3 of our 4 holdings, but that isn't influencing our decision one little bit. This is a business decision.

Moving Forward

Having learnt our lesson, we have done a bit of forward planning and come up with a portfolio strategy for the future.

The £7,600 odd raised will be split into 4 equal portions with the intention of adding 4 new companies to the portfolio. This is the next phase for the Qualiport, and we will move towards having an 8 share portfolio in the next couple of weeks.

On April 1st every year (appropriately All Fool's Day) we will add £2,000 cash to the Qualiport. Then, 6 months later, on October 1st, we will add another £2,000. The intention will be to invest this money into the share market soon after those dates.

We will not be buying shares in a different company every 6 months. As I said earlier, I see the maximum number of companies needed to have a sufficiently diversified portfolio as being about 12. Also, if the current Qualiport Quartet are four of the best companies out there, why invest money in our 20th choice?

That therefore means that we will be adding to our existing holdings. For example, if we were adding new cash now, we might decide that Marks & Spencer would be the recipient of a chunk of the funds, because we consider them to offer good value at their current price. We wouldn't always add money to our losers, and we may consider a company that is already outperforming the market still offers value.

We will still not be averse to selling our full holding in a company. This conceivably would happen if:

-- the story about the company had changed for the worse.
-- we felt we could invest the money elsewhere and achieve better returns.
-- we need the money, but that will probably be in about 30 years' time.

At the moment, we are happy with the underlying performance of our Qualiport Quartet. The share prices of a few of them may be struggling, but the companies themselves are performing adequately. We have seen no reason to be worried about the long-term attractiveness of them as an investment.

So that's it, Fools. Today is a monumental day in the history of the Qualiport. We believe we've made the right decision and are eagerly looking forward to the future. We'd be pleased to hear your views, and the Qualiport message board is the place to tell us what you think of our decision.

See you on Wednesday.

Bruce Jackson (TMF Googly)

Qualiport Numbers

                     19/10/98 Close

                     Company   Change    Bid
                     EMA       0.48      9.73
                     MKS      -0.11      4.23
                     RTO       0.03      3.52
                     ULVR      0.02      5.58 

Qualiport Stocks

Last Rec'd Total #  Company   In At Current Change
 19/12/97     1565    RTO     2.55  3.52     38.0% 
 17/07/98      595    ULVR    6.72  5.58    (17.0%)
 17/04/98      337    EMA     11.85 9.73    (17.9%)
 11/05/98      736    MKS     5.54  4.23    (23.6%)


Last Rec'd Total # Company  In At    Value   Change
 19/12/97     1565    RTO   4040.63 5508.80  1468.17 
 17/07/98      595    ULVR  4048.38 3320.10  (728.28)
 17/04/98      337    EMA   4043.37 3279.01  (764.36)
 11/05/98      736    MKS   4052.24 3113.28  (938.96)


Cash:                         £67.82
Current Total :               £15,289.01

Total Invested:               £16,184.62
Profit/(Loss) :              (£895.61)

Value Per Share

                   Day   Month    Year   History
Qualiport          0.92% 1.45%   23.67%  26.45% 
FTSE 100          -1.08% 0.26%   (1.13%) 1.14%
FTSE All Share    -0.79% 0.14%   (2.61%) (0.56%)

For an explanation of Value Per Share accounting, please click here.