Qualiport

We're in the Black
Friday, 27 November 1998

Pharmaceuticals introduced

We're in the black again. On an investment of over £16,000, we're up £37.85. That's nothing to get very excited about, so we won't.

Our biggest and most successful holding, Rentokil Initial (RTO), soared over the 400p mark today. See the numbers on this page to see what price it actually closed at. The last time it was as high as that was way back on July 27th. The shares reached a high point of 457p on July 8th this year, and dipped to as low as 285p on September 18th. They started the year at 267p.

The movement of Rentokil's share price is an interesting case study. From Jan 1st 1998 to their high point of the year, the shares appreciated by an amazing 71%. Is that rational, considering nothing much has really changed about the company in the past 12 months? In fact, you could say that the outlook for the company has worsened a little, as they missed their stated 20% growth objective at the interim stage. Yet the share price oscillates all over the place for no apparent reason. That's market forces for you.

Rentokil are a boringly consistent company. Their earnings have increased by at least 20% per annum for the past 16 years in a row. That past record in itself means the shares deserve to trade on a premium rating. But how much of a premium?

Rentokil Initial now trade on a forward forecast 1998 price to earnings ratio (P/E) of about 33. Is that a fair valuation for a consistent growth company? Right this instant, with the FTSE 100 up around the 5850 mark, it seems reasonable. On October 5th, when the Footsie was languishing around the 4650 mark, a P/E of 33 looked remarkably high. Again, though, I will remind you that nothing about the underlying company has really changed that much. This shows you why you should always concentrate on the individual companies, not the market, and never let emotions dictate your portfolio strategy.

I've done a quick and dirty valuation for Rentokil Initial based simply on earnings per share growth. The assumptions used were:

-- current share price of 410p
-- 1998 EPS 12.4p, growth of 20% over 1997
-- 1999 EPS growth of 20%
-- 2000 EPS growth of 18%
-- from 2001 to 2008, EPS and dividend growth rate of 15% per annum
-- 2003 and 2008 P/E of 20

Over the next 5 years, the basic model spits out a total (including dividends) compounded annual growth rate (CAGR) of 6.7%. Hardly earth shattering stuff. Over 10 years, the total CAGR increases to 11.0%. That is close to the average appreciation of the stock market over the long term, but short of our stated aim of 15% per annum growth. Should we therefore be selling?

The Qualiport is a long-term portfolio. We only intend to sell if we think we can invest the money better elsewhere, or if the story about the company has changed. At the moment, I don't know of a better investment than Rentokil. That's not to say one doesn't exist somewhere out there, it's just that I haven't identified it. And, by the way, it would have to be a darn good company to be better than Rentokil. The story about Rentokil hasn't changed, so that is no reason to sell, either. So we're happy to hang onto our holding, but we appreciate that the share price is looking a little on the high side.

I guess many Fools are wondering whether we made a mistake with our purchase of Independent Insurance (IIG). We've lost almost 20% of our investment in just one month. At this rate, the company will be out of business by the middle of next year! (Only joking.)

There is no doubt that the timing of our investment wasn't great. But we don't attempt to time the market or the share price of an individual company. Independent issued a trading statement a couple of weeks ago saying that it had been hit by further flood damage, and that it wasn't proceeding with a possible move into the financial services area. Whilst the flood damage loss is hardly good news, it is equally hardly unexpected.

The market hates bad news, and the shares were immediately marked down and have since fallen further. The company itself remains a well managed insurance company, however. One of the risks of investing in an insurance company is that earnings are lumpy. An unexpected loss in one year can wipe out large proportions of the company's profits. Just as likely, though, the company could go 3 years in a row without having any serious underwriting losses. That's just the nature of the business.

When we bought Independent Insurance, I thought the valuation left us with a large margin for error. Given that the company has had a setback in 1998, it is just as well, too. I still have confidence in the company and its management. The chief executive and driving force behind the company, Michael Bright, bought 35,000 shares immediately after the trading update. He obviously still has confidence in the company's long-term future.

I haven't done the homework yet, but I wouldn't completely discount adding to our holding in Independent Insurance. We have almost £4000 sitting in the bank, waiting to be reinvested back into the market. Rather than looking for a new company, we may be better off ploughing that cash into one of our existing ones. Of the current 6, at first glances Independent Insurance looks as if it could be top of the list of candidates.

Of course, this opens up a whole new debate. Some people say that you should never average down your holdings. They say that the share price has fallen for a reason, and that it may fall further. Others will say that if nothing has changed about the company, and it offers even more value than it previously did, why not add to your holding? What's your view? The Qualiport message board is ready and waiting to hear from you.

I'm not saying that we will buy some more Independent Insurance shares, but I think it is worth a look.

Qualiwatch

The Qualiwatch series now moves onto its fourth growth sector. We have already briefly covered the Technology, Internet and Telecommunications sectors. We will be coming back to them in future reports, but I now want to move onto the next sector.

Pharmaceutical companies are already among the biggest and most successful in the world. Glaxo Wellcome (GLXO) is the biggest company by market capitalisation in the UK. As the population ages, drug companies will continue to grow. The medical advances we have seen since mankind began have been nothing short of a miracle. Yet many diseases remain uncured. The world's best minds still cannot find a cure for the common cold!

The biggest killer in the UK remains heart disease. Cancer is not far behind. Then you've got horrible diseases like AIDS, Alzheimer's, Parkinson's and diabetes. There is no definitive cure for any of these.

We all want and expect to live longer. The average age of death has been rising since day 1 of mankind, thanks mostly to medical advances. As we get older, we will require drugs to keep us going as the natural body functions start to pack up. It's all very morbid stuff, but reality, I'm afraid.

Next week, we shall look at our shortlist of pharmaceutical companies. No guesses for picking the UK based contenders (there's only 3 of them), but we will be looking abroad, too. Again, all suggestions and thoughts to the Qualiport message board.

Have a great Ashes weekend, Fools. See you next Wednesday.

Bruce Jackson (TMF Googly)

Qualiport Numbers

                    27/11/98 Close

              Company   Change    Bid
                 EMA    +0.01    11.73
                 IIG     0.00     2.10 
                 MKS    +0.03     4.22
                 PIZ    +0.10     8.25 
                 RTO    +0.15     4.08
                 ULVR   +0.02     6.41

Qualiport Stocks

Last Rec'd Total # Company  In At Current Change
 19/12/97   783      RTO     2.55   4.08   60.0%
 04/11/98   245      PIZ     7.93   8.25    4.1%
 17/04/98   169      EMA    11.85  11.73   (1.0%)
 17/07/98   298      ULVR    6.72   6.41   (4.6%)
 11/05/98   368      MKS     5.54   4.22  (23.8%)
 27/10/98   755      IIG     2.58   2.10  (18.6%)

Last Rec'd Total # Company  In At    Value     Change
 19/12/97   783      RTO   2046.53  3194.64  1148.11
 04/11/98   245      PIZ   1966.34  2021.25    54.92
 17/04/98   169      EMA   2052.57  1982.37   (70.20)
 17/07/98   298      ULVR  2052.54  1910.18   (142.36)
 11/05/98   368      MKS   2054.11  1552.96  (501.15)
 27/10/98   755      IIG   1972.64  1585.50  (387.14)

Cash:                                   £3,975.57
Current Total :                        £16,222.47

Total Invested:                        £16,184.62
Profit/(Loss) :                          £  37.85

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