Qualiport

Qualiwatch goes pharmaceutical

A week is a long time in politics, but 3 days is even longer in the sometimes volatile world of the stock market. All we can be thankful for is that we don't measure our investing successes or failures over such a short period of time. We prefer to look 3, 5 and 10 years, not days, into the future.

Having said that, it is virtually impossible not to look at the short-term movements in share prices. This is especially so when we are updating our returns on a daily basis. Last Friday, the Qualiport moved back into the black. We weren't rejoicing or shouting this from the rooftops, but clearly we felt better about showing a profit than a loss.

Well, just 3 trading days later, we are well are truly back in the red again. I don't need to remind you here that the market has taken a turn for the worse over the past few days. We cover this every day in the Daily Fool, up on the site by 8pm each market day. As the market has fallen, so has the Qualiport. When there is a mass sell off, as we saw in yesterday's 200 point fall in the Footsie, virtually all share prices get caught up in the panic.

It's at times like these that we remind Fools to look beyond the share price and concentrate on the underlying company. Nothing at all has changed about our companies in the last 3 trading days. Basically, the market is freaking because of the threat of lower domestic growth and even a possible recession. Sure, the macro situation has some effect on all companies. But has the prospect of low growth just been recognised? I think back to October 1997, when the Asian financial crisis first hit the headlines. It was at that moment that the slowing of world growth should have been first recognised.

Yet what did the market do? It first panicked, falling precipitously in October 1997. Then it went on a buying binge, which peaked in a fit of gluttony in July this year. That was followed by more panic selling, down again to a low point in October this year. Then, as we have seen over the past 7 weeks, the FTSE 100 has risen back up again. Is this rational?

Back to the Qualiport companies, not the share prices. I've said in this space before, and I'll say it again, that I'm not best impressed with the performance of Marks & Spencer (MKS) since we made our purchase back in May this year. There have been board room arguments, a possible change in their expansion strategy and worst of all, a sharp fall in their interim profits. It is therefore not surprising to see the share price of this giant retailer fall to around the 400p mark.

There were yet more woes for the whole sector today after a profit warning from Arcadia Group (AG.). This is the company that used to be called Burton Group, before it demerged the Debenhams (DEB) business. Although it will be of no consolation to shareholders in Arcadia, it is perhaps a little reassuring that not only M&S is feeling the High Street pinch. Nevertheless, there's no hiding from the fact that M&S has been a poor investment for us.

We'll look a little further into this on Friday.

Qualiwatch -- Pharmaceutical sector

In our search for some of the best companies in the world, we switch our attention to the pharmaceutical sector. As is the case with many companies we've already identified in the growth sectors of technology, internet and telecommunications, I suspect we'll find that most of the following companies are trading on traditionally high valuations. But, for the time being anyway, we're not that bothered with that. We want to first identify the great companies, then set a price at which we may like to consider purchasing them.

Like the telecommunications sector, UK based pharmaceutical companies can compete on a global scale. This is not the case in the technology or internet sectors, where US companies are dominant. If at all possible, I would like to consider UK based companies ahead of their international counterparts. It is much easier to get a handle on their progress and their competitors. Also, you don't have to worry about the differences between the UK and international accounting standards. Although the underlying company is exactly the same, the way accountants add up the numbers can show a significant difference in important valuation numbers such as return on equity and earnings per share (EPS). Of course, the way to circumnavigate this anomaly is to concentrate purely on cash earnings.

I'm going to quickly narrow down my pharmaceutical watch list to just two companies. There are so many great pharmaceutical companies out there, but we can't have 'em all. Here are the ones that made it onto my personal shortlist but will ultimately be rejected. Most of this stuff is based on my own personal gut feeling. Although this is not the best stock selection criteria in the world, I think you've got to feel comfortable about investing in any company, and you can't do that if your heart is not in it.

SmithKline Beecham (SKB) -- Head man Jan Leschley makes news headlines reasonably regularly, but usually for the wrong reasons. For right or wrong, he came out looking the bad egg when the planned merger of his company with Glaxo Wellcome fell through. He has also been criticised because of his enormous pay package, making him the fattest of the UK fat cats.

Back in 1994, SmithKline Beecham traded on an average price to earnings ratio (P/E) of just 14. These days the P/E is closer to 38. You would think that perhaps the intervening years would have seen explosive profit growth in order for that rating to be justified. How does a compounded annual growth rate (CAGR) of just 7.8% sound? Not too great in my books.

Zeneca (ZEN) -- I just can't get excited about Zeneca. The patents on a few of their important drugs expire in the next few years, and from all accounts their pipeline of new drugs needs building. Also, the agrochemical business is low margin and capital intensive, although the company has now put it up for sale. The bottom line is that I think there are better pharmaceutical companies than Zeneca.

And now, on to the two contenders:

Glaxo Wellcome (GLXO) -- the biggest company by market capitalisation in the UK. They produced and profited from one of the very few real blockbusting drugs ever -- Zantac. Now that drug has gone off patent, but Glaxo are moving forward and into the post Zantac era with great gusto.

I'm no expert on this, but apparently Glaxo has one of the best drug pipelines. However, that is not the be all and end all. Many of those drugs will never make it to the market, and anyway we want to be looking 10 years down the track when assessing these companies. The drugs that will grow profits in 2008 haven't even been thought of yet.

Similarly to SmithKline Beecham, amazingly Glaxo traded at a P/E of under 15 in 1994. That P/E has moved up to 36 whilst profits have hardly surged. This is largely due to the run off in Zantac's profits as its patent expired.

Why choose Glaxo Wellcome over SmithKline Beecham? Gut feel, I guess, and the strength of the visible pipeline.

Pfizer (NYSE: PFE) -- the US giant famous for its male impotency drug Viagra. These companies produce very few blockbusters, and like Zantac, this drug is one of the them. At the moment Pfizer is a leader in cardiovascular drugs, which is a major source of cash for the company. Right now, Viagra is actually a very small part of revenue and earnings, but it won't stay that way for too much longer, given the explosive growth of the drug. Of the US drug companies, this one stands above the others.

That's it. The pharmaceutical sector narrowed down to just 2 companies in one fell swoop. I could be completely wide of the mark and too dismissive of the above two companies, plus other US and European drug companies. Stock selection is a very subjective thing, and you have to draw the line somewhere.

What do you think? That's the beauty of the Internet -- you can tell us which company, if any, is your favourite in the pharmaceutical sector. Post a message on the Qualiport message board.

See you Friday, Fools.

Bruce Jackson (TMF Googly)

                    2/12/98 Close

               Company  Change    Bid
                 EMA    +0.25    11.45
                 IIG    +0.03     2.15 
                 MKS    -0.15     3.98
                 PIZ    -0.05     8.45 
                 RTO    -0.01     3.77
                 ULVR   -0.17     5.85

Qualiport Stocks

Last Rec'd Total # Company  In At Current Change
 19/12/97    783     RTO     2.55   3.77   47.8%
 04/11/98    245     PIZ     7.93   8.45    6.6%
 17/04/98    169     EMA    11.85  11.45   (3.4%)
 17/07/98    298     ULVR    6.72   5.85  (12.9%)
 11/05/98    368     MKS     5.54   3.98  (28.1%)
 27/10/98    755     IIG     2.58   2.15  (16.7%)

Last Rec'd Total # Company  In At    Value    Change
 19/12/97    783     RTO   2046.53  2951.91   905.38
 04/11/98    245     PIZ   1966.34  2070.25   103.92
 17/04/98    169     EMA   2052.57  1935.05  (117.52)
 17/07/98    298     ULVR  2052.54  1743.30  (309.24)
 11/05/98    368     MKS   2054.11  1464.64  (589.47)
 27/10/98    755     IIG   1972.64  1623.25  (349.39)

Cash:                             £3,975.57
Current Total :                  £15,763.57

Total Invested:                  £16,184.62
Profit/(Loss) :                   (£ 420.65)

Value Per Share

                   Day     Month    Year    History
Qualiport        -0.51%   -1.98%   29.89%   32.81% 
FTSE 100         -0.55%   -4.12%    7.24%    9.70%
FTSE All Share   -0.50%   -3.66%    4.97%    7.18%

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