Qualiport

Avoid wasting your valuable time

By Bruce Jackson (TMF Googly)

Kilburn, London -- Gut feel plays a big part in any investment decision. In fact, it plays a significant part in life itself. If something doesn't quite feel right, how often does it turn out not to be right?

Proper security analysis takes a hell of a long time. In the past, I've spent many hours plugging numbers into a spreadsheet only to find out that there's something I don't like about what I'm seeing -- things like the operating margin, or the lack of free cash flow, or a low return on equity.

My investment strategy has evolved over the past 10 years. I was one of those "Sids," my first purchase being Yorkshire Water (YW.) back in 1989. Day one saw all the privatised water companies surge to a decent premium (was it about 25%?), and I was hooked. I was, however, a very unsophisticated and naïve investor and made many mistakes. Some involved penny shares and the lure of a quick profit. Despite the Fool's tenet of "buy and hold," I suspect many other readers have, at one time or another, dabbled in penny shares. I also suspect most of us lost money. Speculating in penny shares is a relatively easy mistake to make. Those of us who've tried have usually learned a harsh and expensive lesson.

The next mistake I made was buying companies because they appeared cheap. At that stage I didn't really know what "cheap" meant, because if a company traded on a price to earnings ratio (P/E) of 15 and was forecast to grow 30% in the next year, in my eyes it was automatically a buy. This was my very crude attempt at calculating the PEG, or Fool ratio, and at that stage I thought it was the be all and end all of share analysis.

Virtually by pure luck, the PEG led me to good long-term investments such as Lloyds TSB (LLOY) and Metal Bulletin (MTLB), but gave me an absolute shocker in Powerscreen International (PSI). It also led me to sell Glaxo Wellcome (GLXO) at 869p in March 1996 because their PEG had risen over some arbitrary figure I'd set for it. With the shares well over 2000p less than three years later, you can easily see that bad selling decisions are just as bad as bad buying decisions.

It was only after reading lots of investment books that it finally dawned on me that the quality of the company was the number one priority. It was also priority number 2, 3, 4 and 5. I'm of the belief that valuation matters, but it doesn't matter when you're looking at a poor company. Buying a poor company because it looks cheap relies a lot more on market timing and luck than anything else.

Good people run good companies. Defining good people is very difficult and very much a subjective assessment. It may be that you've heard the top man is solid, or you've read an article about the person, or you admire what the person has achieved. Before we made our investment in Rentokil Initial (RTO) we knew that Sir Clive Thompson was well respected in the business world. The company's slogan is/was "Management Is Success." They were voted Britain's most admired company and plastered that down the sides of their delivery vans. The gut feel was good.

In my view, on the other side of the fence stands MSB International (MSB). They are a recruitment and employment agency specialising in the Information Technology sector. In the four years since fiscal 1994 they have grown their earnings per share (EPS) by a compounded rate of 100% per annum. Admittedly, they were starting from a small base, but this is purely phenomenal growth. The company was floated in mid 1996, and from a low point in that year of 220p, the shares hit a high of 1048p last year. They now stand back around the 250p level -- click over to the quote page to see their up to date share price.

A company growing that fast grabbed my attention. I managed to get hold of a copy of the placing document, which is much more comprehensive than any annual report. If you are looking at a company that has recently floated, ask them to send you a copy of this document. It looks at the company's competitive threats and gives detailed information about the directors.

It was the director fine print that gave me a bad feeling about MSB International. I remember reading about at least one director who had been involved in a company that went into liquidation. That immediately sent the wrong vibes -- a gut feeling that didn't sit correctly. That, coupled with a quick glance of the numbers, was enough to put me off an investment in MSB International. Anyone considering investing in them now, despite the fact that they trade on a January 99 P/E of just 6, would do well to have a look at the company's cash position. Rising debtors can strangle the long-term growth of recruitment companies.

My mistakes and evolving investment strategy have hopefully led to me spending less wasteful time on valuation work for companies that are poor and ones where the gut feel isn't quite right. I recently skimmed through the 1998 annual report of information technology company Misys (MSY). From the word go, I got a good feeling about the company. It started on page one, where the only two sentences are:

"The Group's philosophy is based on enhancing shareholder value, measured by growth and stability of long-term cash flows. Misys' progress has been achieved through committed and experienced management, proven financial controls, substantial ongoing investment in product development and selective investment in well positioned businesses."

There are no colour pictures of smiling directors, the operations review is comprehensive, margins are high and free cash flow (before acquisitions) easily exceeds reported accounting earnings. I want to find out more about this company.

Qualiwatch

I'm going to tackle the valuation of Glaxo Wellcome next, ahead of Vodafone (VOD). We'll start looking at that next Wednesday.

Today I placed the order to purchase 37 shares in Dell Computer Corporation. The price paid was US$89 1/4 per share. The commission was a mere US$10, and stamp duty was zero. What a treat!

When I first started looking at this company the share price was around US$70. We will update the Qualiport numbers to reflect our new purchase by next Wednesday. After the EMAP (EMA) rights issue and the Dell trade, we have about £1,700 in the bank. That gives us enough money to make another purchase should the opportunity arise, although it will have a slightly smaller base investment than our other 7 companies. We'll deal with that if and when the situation arises.

It would have been great to get the 28.5% Dell appreciation behind us, but that's life. We had a similar case regarding our purchase of PizzaExpress (PIZ), where the share price went up significantly whilst we were doing our homework. Whilst it is a little galling to buy at the peak, over the course of the next 10 years the few percent appreciation missed now should hopefully be relatively insignificant.

The debate and suggestions are raging on on the Qualiport message board. Inevitably, they surround Marks & Spencer (MKS). Courtesy of its 35% share price fall, it is now our smallest holding, worth almost as third as much as our investment in Rentokil Initial. In theory, we should therefore give it very little cyberspace in comparison to the other companies in the Qualiport. But everyone has an opinion on M&S. It is the greatest brand name on the High Street, but its sales are deteriorating before our very eyes. Most of us can relate very closely to the company, because most British people have purchased something from them at sometime in the past. A strategy of "buy what you know" is often a good one. At least we got that much of our investment in M&S right!

See you Friday, where the report will be filed from Melbourne, Australia.

                    27/1/99 Close

                    Company   Change    Bid
                      EMA     +0.40    11.95
                      IIG     +0.03     2.43 
                      MKS     +0.04     3.51
                      PIZ     +0.02     7.52 
                      RTO     -0.19     4.32
                      ULVR    +0.16     6.07

Qualiport Stocks

Last Rec'd  Total # Company  In At  Current  Change
 19/12/97    783      RTO     2.55    4.32   69.4%
 04/11/98    245      PIZ     7.93    7.52   (5.1%)
 17/04/98    169      EMA    11.85   11.95    0.8%
 27/10/98    755      IIG     2.58    2.43   (5.8%)
 17/07/98    298      ULVR    6.72    6.07   (9.7%)
 11/05/98    368      MKS     5.54    3.51  (36.6%)

Last Rec'd  Total #  Company   In At    Value    Change
 19/12/97    783       RTO    2046.53  3382.56  1336.03
 17/04/98    169       EMA    2052.57  2019.55   (33.02)
 04/11/98    245       PIZ    1966.34  1842.40  (123.94)
 27/10/98    755       IIG    1972.64  1834.65  (137.99)
 17/07/98    298       ULVR   2052.54  1808.86  (243.68)
 11/05/98    368       MKS    2054.11  1291.68  (762.43)

Cash:                                £4,007.60
Current Total :                     £16,187.30

Total Invested:                     £16,184.62
Profit/(Loss) :                         £ 2.68 


Value Per Share

                    Day      Month      Year      
Qualiport          0.05%    -3.70%     -3.70%
FTSE 100          -0.16%    -0.11%     -0.11%
FTSE All Share     0.03%     0.13%      0.13%

Click here for the latest Qualiport share price quotes.

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