By Bruce Jackson (TMFGoogly@aol.com)
Baker Street, London -- I'm part way through reading Common Stocks and Uncommon Profits, an investment classic written by legendary investor Philip Fisher. It is truly is a remarkable book, especially given that it was written in 1956 and virtually every major point he makes is just as relevant today.
The things I want to pick up on today are Fisher's thoughts on valuation. Although he is obviously aware that valuation does matter, he very much concentrates on the quality and growth prospects of the company. Over the long-term, it is worth, he says, paying a higher price for a company with excellent, rapid and sustainable growth prospects.
Obviously very few companies fit that bill, but when you do find one, Fisher says that you should consider buying it even if the price to earnings ratio (P/E) is higher than that generally prevailing in the market. If you take the current P/E of the FTSE 100 index of 28.5, that means, for the right company, you shouldn't be afraid of paying say 50 times earnings. That's virtually exactly the rating the Qualiport is prepared to pay for Vodafone Airtouch (LSE: VOD) should it hit our target buy price of 1050p.
The same principle is borne out in this message board post from lazzylubby. What is the correct P/E for a rapidly growing quality company? Is it 50, 25 or 150? To my mind, it depends on just how long the rapid growth phase of an individual company can last. If, for example, Vodafone can keep growing earnings at 40% per annum for the next 10 years, and maintain its premium P/E rating, paying 6400p (P/E 340!) now could still see investors returning 15% per annum. Pretty amazing stuff, hey?!
Over at our US site, you can find the transcript of a radio interview between co-founding Fool Tom Gardner and Dell Computer Corporation (NASDAQ: DELL) Chief Financial Officer Tom Meredith. Things of particular interest to me were the comments made about the perceived threat (at least in the eyes of the PC industry doubters) of the free PC. Basically, in Dell's eyes, they just don't get the business model as the economics suggest a position of permanent state of break-even for the free PC companies. Heck, even the most wildly over-valued and loss-making Internet company surely has a business model that makes money some time in the future!
As for threats to Dell's business model, Meredith sees the Internet as both an opportunity and a threat. The opportunities are already clear, as US$30 million on-line sales per day says, but it also poses a threat, as "a new entrant (can) come up and chew at us from underneath and it would be potentially very disruptive." Whilst Meredith is being cautious and prudent to recognise this potential threat (he's an accountant after all), personally I think Dell will continue to thrive because of its areas of enormous competitive strength -- brand name, supreme customer service and because it's the low cost producer of PC's.
On valuation, and this links in to the first part of this article, Meredith points out that Dell trades "at a little bit more than one times its growth rate." That was a couple of weeks ago, before the shares put on a decent burst, but as of today Dell's forecast fiscal 2000 P/E is about 63 and they are growing at about 40-45% per annum. In comparison to the rest of the market, and other US technology holdings such as Cisco (NASDAQ: CSCO), Microsoft (NASDAQ: MSFT) and AOL (NASDAQ: AOL), this price earnings to growth rate ratio -- commonly known as the PEG or Fool Ratio -- indicates the shares are positively cheap! Don't tell Pyad, our value shares meister, as he'll have a fit -- he generally considers a company with a double digit P/E to be expensive!
Today marks the launch of our second real money on-line educational portfolio, christened Rule Shakers. It 'throws to the wind' traditional valuation techniques, such as those practised by the Qualiport, and looks to buy companies based on their purely qualitative aspects. I for one will be very interested to look at the portfolio's selections, because I think there may be some potential overlap with the Qualiport. I don't have any idea of the Rule Shakers plans, but if for example they were to buy Glaxo Wellcome (LSE: GLXO), it would be interesting to track the progress of the share price, given my 1300p current target buy price. Of course, over the very long-term, it's the progress of Glaxo the company that will determine its share price, and that's what I'll continue to track.
Finally, in today's Lunchbox I took a look at Guardian iT's (LSE: GRD) interim results. This is a company I first looked at some time ago on the message boards, but haven't really pursued any further. I've sort of had them on an internal (i.e. in my brain) radar for quite some time, my message board post being prompted by a sharp fall in the share price, down to 485p on the date that was posted. It's been up up and away since then for the Guardian iT share price to 645p today, meaning we've got another candidate for the Hindsight Portfolio (copyright TMF Essex).
I do like the economics of the business -- disaster recovery and business continuity -- and will keep an eye on the company and its valuation. As regards the valuation, my gut feel, with a forward P/E of almost 60, is that there's not a big margin of error were I to consider buying the shares today.
See you on Friday, and/or on the Qualiport message board.
Company Change Bid DELL(US)+2.40 48.60 EMA +0.08 9.80 IIG -0.05 2.80 MSY -0.09 5.40 PIZ -0.05 7.30 RTO +0.03 2.51 ULVR +0.04 5.89Qualiport Stocks Last Rec'd Total # Company Buy Current Change 27/10/98 755 Indep Ins 2.58 2.80 8.5% 27/01/99 74 Dell (US) 44.63 48.60 8.9% 19/12/97 783 Rentokil 2.55 2.51 (1.6%) 22/04/99 347 Misys 5.76 5.40 (6.2%) 04/11/98 245 Pizza Exp 7.93 7.30 (7.9%) 17/04/98 169 EMAP 11.34 9.80 (13.6%) 17/07/98 266 Unilever 7.53 5.89 (21.7%) Last Rec'd Total # Company In At Value Change 27/10/98 755 Indep Ins 1972.64 2114.00 141.36 27/01/99 74 Dell (US) 2007.42 2179.64 172.22 19/12/97 783 Rentokil 2046.53 1965.33 (81.20) 22/04/99 347 Misys 2028.71 1873.80 (154.91) 04/11/98 245 Pizza Exp 1966.34 1788.50 (177.84) 17/04/98 169 EMAP 2341.32 1979.60 (361.72) 17/07/98 266 Unilever 2052.00 1566.74 (485.26) Cash: £3,433.46 Current Total : £16,901.07 Total Invested: £18,184.62 Profit/(Loss) : (£1,283.55) Value Per Share Day Month Year Qualiport 0.46% 0.46% -10.13% FTSE 100 0.48% 0.48% 6.69% FTSE All Share 0.51% 0.51% 10.48%