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By Bruce Jackson (TMF Googly)
Baker Street, London -- First things first. It was nice to see the Qualiport jump almost 2% today.
Moving quickly on
Following on from, and concluding, last week's two articles on PizzaExpress (LSE: PIZ), I just wanted to follow up on a couple of the numbers mentioned in last Wednesday's report, and look at what I see as the current valuation range of the company.
Simply using return on equity (ROE) as the base number, you can see once again how well PizzaExpress are performing. The average company, over the longer-term, achieves an ROE of about 10-12%. The better companies see their ROE consistently at or above 15%. If that number seems low, remember that over the very-long term, competitive pressures usually drive returns back to the norm.
Warren Buffett, no less, noted that it is easy for companies to increase their earnings per share (EPS). If you just throw a load of capital at something and make some money out of it, you've increased your earnings, all things else being equal. However, by doing that, you are potentially destroying value, and almost certainly your return on equity will decline. Eventually, there will come a point where the destruction of value will show up in your (reducing) share price. The continuing woes of Marks & Spencer (LSE: MKS) are an example of a company destroying value. That's the main reason why the Qualiport sold the shares.
(As a side-issue, when the Qualiport sold M&S, I mentioned that the shares could have an intrinsic value as low as 216p per share. With the shares now about 340p, there could yet be more damage to the share price, although the rising dividend yield will place a floor under the shares.)
Back to PizzaExpress. In 1998, they had a goodwill-adjusted equity base of £82.3m, upon which normalised net profits were £17.3m, for an ROE of 21% (£17.3m / £82.3m = 0.21 or 21%). In 1999, the equity base grew to £109.7m, net profits were £22.8m, giving an ROE of 20.8%. The striking thing is that on a significantly higher investment base, PizzaExpress have still managed to keep their returns well above the average. They are value creators.
As for the rather vexed issue of valuation, I calculate the shares could be worth anything between 850p and 950p. These numbers are based on some reasonably optimistic growth rates, of about 15-18% per annum over the next 10 years, although I'd like to think they are reasonably realistic. After all, I was a conservative accountant in my former life!
The PizzaExpress share price has a habit of oscillating all over the place at various times throughout the year. That's usually the result of the two short-term drivers of individual share prices -- fear and greed. I will look to top up on the Qualiport's holding in this excellent company should the share price fall to about 730p, or roughly 15% below the 850p valuation low point. When topping up on a holding, I definitely want to do so only when I perceive a company is trading at a discount to intrinsic value.
Which nicely brings me onto part 2 of tonight's report
The Qualiport is sitting on cash balances of over £3,400. In 10 days' time, we'll be adding another £2,000 cash - we do so on April 1st and October 1st each year. We've been saving hard!
Even before then, in percentage terms 'cash' is already the biggest holding in the Qualiport. Whilst it could be considered prudent to have some cash set aside for a rainy day, so that you may take advantage of a mis-priced situation, over £5,400 out of a total Qualiport holding of about £19,000 is not an ideal scenario.
We believe the stock market to be the best vehicle in which to invest for long-term value appreciation. Since 1918, on average it has returned 12.2% compounding returns. Whichever way you cut it, that beats all other forms of investment, including property. An investment of £100 into an index tracking fund back in 1918 would now be worth over £1.25 million.
If that's the case, surely the Qualiport should be looking to get all its cash invested in the stock market, shouldn't it? With base interest rates at 5.25%, and bank interest rates a hell of a lot less than that (ever wondered how banks make so much money?), the Qualiport is potentially missing out by not being fully invested in the stock market.
So, the solution all seems rather simple -- invest the cash in the market, and do it now! Well, that is easier said than done. The Qualiport is a stock-picking portfolio, with quite strict selection criteria. The criteria are deliberately tough, because I believe that by investing in quality companies, and holding them for the long term, market beating returns can be achieved.
Having said that, there are probably quite a few companies which pass numbers 1-9 of the Qualiport criteria. Off the top of my head, Sage (LSE: SGE), Logica (LSE: LOG), CMG (LSE: CMG) and Guardian iT (LSE: GRD) all probably come pretty close. Note the theme -- all are fast-growing, IT-related shares, a sector all too sadly under-represented in the Qualiport. That's because very few companies traded on the world markets pass Qualiport criteria number 10 -- "A company which is attractively valued." And by 'attractive', we're looking for companies which can return us an average of at least 15% per annum over the next 10 years.
Now, valuation is always very subjective, an art much more than a science. Try as we might to place a value on a company, we are almost always invariably wrong, because there are so many variables to take into consideration. Sometimes it's hard to keep up with all the changes that are going on within a company on a monthly basis, let alone trying to predict what it will look like 4, 7 or 10 years from now. Even British Telecommunications (LSE: BT.A), the company only a few years ago I thought was staid, old and shrinking, is in the process of changing itself, in order to benefit from what it sees as future opportunities, especially in the high speed data delivery and wireless communication worlds.
That said, recently I've had a gut feeling that a couple of companies I follow may now, finally, be getting close to passing the valuation criteria. That excess cash could soon have a belated home! One of them is an existing Qualiport company, and the other is a company in which I'm already a part-owner. I'll look at these two companies on Wednesday, but in the meantime feel free to post suggestions on the Qualiport message board.
Company Change Bid DELL(US)+2.10 48.70 EMA +0.09 9.71 IIG +0.05 2.87 MSY +0.26 5.91 PIZ 0.00 8.45 RTO +0.04 2.40 ULVR +0.23 5.94 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 27/10/98 755 Indep Ins 2.58 2.87 11.2% 27/01/99 74 Dell (US) 44.63 48.70 9.1% 04/11/98 245 Pizza Exp 7.93 8.45 6.6% 22/04/99 347 Misys 5.76 5.91 2.6% 19/12/97 783 Rentokil 2.55 2.40 (5.9%) 17/04/98 169 EMAP 11.34 9.71 (14.4%) 17/07/98 266 Unilever 7.53 5.94 (21.1%) Last Rec'd Total # Company In At Value Change 27/10/98 755 Indep Ins 1972.64 2166.85 194.21 04/11/98 245 Pizza Exp 1966.34 2070.25 103.92 27/01/99 74 Dell (US) 2007.42 2184.12 176.70 22/04/99 347 Misys 2028.71 2050.77 22.06 19/12/97 783 Rentokil 2046.53 1879.20 (167.33) 17/04/98 169 EMAP 2341.32 1961.42 (379.90) 17/07/98 266 Unilever 2052.00 1580.04 (471.96) Cash: £3,433.46 Current Total : £17,326.11 Total Invested: £18,184.62 Profit/(Loss) : (£ 858.51) Value Per Share Day Month Year Qualiport 1.96% 2.98% -7.87% FTSE 100 0.28% -3.04% 2.96% FTSE All Share 0.23% -2.93% 6.70%