Qualiport

Quick & dirty Glaxo valuation

By Bruce Jackson (TMF Googly)

Melbourne, Australia -- On page 212 of the Motley Fool UK Investment Guide, and reprinted in the Gardner brothers excellent new book Rule Breakers, Rule Makers, we suggest the following:

"When you've decided what strategy you might like to follow, then immediately do nothing."

It takes time to decide your investment strategy. Much depends on your temperament, investing time scale and risk profile. I actually think that temperament is the most important of these -- keeping control of your emotions, making rational decisions and sticking to your strategy through good times and, particularly, bad times, will set you apart from the crowd.

The investment strategy of the Qualiport has been largely fixed from day one -- to buy part interests in quality companies at attractive prices. It took us a while to put down in cyberspace the ten criteria of our ideal Qualiport company. In hindsight, we should have done this before considering parting with a penny. As we've said on previous occasions, we arguably overpaid for a couple of our current holdings -- Unilever (ULVR) and EMAP (EMA) spring to mind. At the time of purchase, neither passed our valuation hurdle of a 15% return per annum. That's not to say they won't achieve that now or in the future, but at the time of purchase that wasn't the case. For the record, we still remain happy with our part ownership in those companies.

One of the things we suggest, in the "do nothing" stage of your strategy development, is to run a paper portfolio. That is far easier said than done. Imagine the scenarios.

1. Your paper portfolio is winning -- and winning big time. Are you euphoric, seeing it as the rubber stamping of your investment strategy? Or are you feeling a little sick, thinking of all that money that you could have made but didn't? My betting is that it is the latter.

2. Your paper portfolio is losing -- and losing big time. Are you relieved, thinking of all that money that you've saved by not investing your hard earned cash? Or are you thinking that you are actually glad that the portfolio is losing money, because you'll be able to pick up the shares in your companies at cheaper prices? My betting is that you'll certainly be relieved, but feeling confident because of the cheaper prices on offer.

Both scenarios involve you taking control of your emotions. A paper portfolio allows you to take many more risks than perhaps you'd do if you were putting your own money on the line. A paper portfolio may include smaller companies with highly volatile share prices. For example:

If you included Colt Telecom (CTM) or Psion (PON) in your paper portfolio throughout 1998, you'd have done quite well for yourself. But could you have held all the way through the year if your real money was on the line? Colt Telecom started the year at 154p, and even then many pundits were saying that the upstart communications company was overvalued. But that didn't stop the shares rising all the way to 897p, and at each stage of their ascent, they surely must have been looking and feeling more and more overvalued. Could you have held all the way through? What about when the shares dropped from 831p on 16th July 1998 to 398p on 5th October 1998? Would you have been tempted to lock in profits as they fell?

What about Psion? Starting 1998 at 453p, the shares slumped to a low point of 205p as the stock market feared (and probably rightly so) that their staple hand held computer product would continue to lose market share. This was in the wake of competition from the Windows powered products of consumer goods giants like Hewlett Packard, Philips and 3Com. Could you have held on when it looked as if the walls around little Psion were collapsing? The Symbian joint venture changed everything -- not to mention the share price, which rocketed from 205p to 723p in the space of days. Once the initial excitement had worn off, though, the share price slumped back to as low as 343p on 12th October 1998. Would you have lost interest and considered a sale? With the shares recently topping 900p, you'd have been doing yourself a disservice.

Those two examples show just how hard it is to buy and hold shares, especially when your own money is involved. We do advocate the use of paper portfolios, but you should be aware that reality can be harder to deal with than the pretend world. The scout motto is appropriate here -- be prepared.

Qualiwatch

I've had a quick look at the valuation of Glaxo Wellcome (GLXO). Here's a quick snapshot.

Recent Share Price 2050p

1997 EPS 52.0p actual
1998 EPS 49.0p estimate
1999 EPS 56.0p estimate

1997 P/E 39 actual
1998 P/E 42 estimate
1999 P/E 37 estimate

If you assume a long-term growth rate of 14% per annum, 2008 earnings per share (EPS) will be 182.1p. Dividend growth rate assumption is 11% per annum.

2008 EPS 182.1p * price to earnings ratio (P/E) 35 = share price 6374p. Total dividends 1998 to 2008 = 705p. Total return = 7079p, which is 245% appreciation from the recent share price of 2050p. That sounds quite attractive, but over a ten year time period it works out at a rather more sobering 13.2% compounded annual growth rate (CAGR).

I think this is a rather optimistic valuation. In 1995 and 1996, Glaxo traded on an average P/E of about 18. If this was the case in 2008, the total CAGR would work out at a mere 6.9%.

We are looking for a CAGR of 15% per annum, so our first (optimistic) valuation doesn't quite jump that hurdle. Of course, it is entirely possible that Glaxo will trade on a P/E of 50 in 2008, in which case the CAGR would be 16.9%. I think that is doubtful.

There is more than one way to skin a cat (what a horrible saying that is!), and this is a quick and dirty indication of Glaxo's valuation. At this early stage, the shares would have to drop to 1750p to jump our hurdle of 15% CAGR, using the optimistic valuation scenario. Time is on our side. I'll have a look at Glaxo's cash generation next week.

In closing, here's something to consider. If Glaxo doesn't pass our 15% CAGR hurdle, yet has a higher CAGR than one of our existing holdings, should we make the switch? Our selling rule of thumb is applicable if we find a better investment opportunity. An interesting conundrum. The Qualiport message board beckons.

Have a great weekend, Fools. PizzaExpress (PIZ) are due to report interim results on Monday. Here's hoping for positive like for like sales growth.

                    05/02/99 Close

                   Company   Change   Bid
                    DELL    -$5.50  $102.00 
                    EMA      -0.50    12.35
                    IIG       0.00     2.30 
                    MKS      +0.02     3.61
                    PIZ      -0.08     7.50 
                    RTO      -0.11     4.44
                    ULVR     -0.07     5.61

Qualiport Stocks

Last Rec'd Total # Company  In At  Current  Change
 19/12/97    783     RTO     2.55    4.44    74.1%
 27/01/99     37     DELL  $89.25 $102.00    14.3%
 17/04/98    169     EMA    11.85   12.35     4.2%
 04/11/98    245     PIZ     7.93    7.50    (5.4%)
 27/10/98    755     IIG     2.58    2.30   (10.9%)
 17/07/98    298     ULVR    6.72    5.61   (16.5%)
 11/05/98    368     MKS     5.54    3.61   (34.8%)

Last Rec'd Total # Company  In At     Value     Change
 19/12/97   783      RTO   2046.53   3476.52  1429.99
 27/01/99    37      DELL  2007.42   2287.27   279.85
 17/04/98   169      EMA   2052.57   2087.15    34.58
 04/11/98   245      PIZ   1966.34   1837.50  (128.84)
 27/10/98   755      IIG   1972.64   1736.50  (236.14)
 17/07/98   298      ULVR  2052.54   1671.78  (380.76)
 11/05/98   368      MKS   2054.11   1328.48  (725.63)


Cash:                              £2,000.18
Current Total :                   £16,425.38

Total Invested:                   £16,184.62
Profit/(Loss) :                     £ 240.76 


Value Per Share

                    Day      Month      Year      
Qualiport         -1.95%    -0.43%     -2.29%
FTSE 100          -1.42%    -0.69%     -0.46%
FTSE All Share    -1.19%     0.17%      0.99%

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