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By Rob Davies (TMFEssex)
Bruce is still enjoying the finest products of the German brewing industry so it has fallen on my broad shoulders to defend the portfolio against a scurrilous attack by TMF Tiger. Just in case Fools are too idle to click through to his article I will repeat the central thesis and data of his argument here.
Stock Bought P/E then P/E now Price P/E Earnings
change change change
IIG Oct 98 15.0 17.2 +11.2% +14.6% -2.9%
DELL Jan 99 124.0 84.0 +9.1% -32.3% +61.1%
PIZ Nov 98 29.7 25.1 +6.6% -15.6% +26.2%
MSY Apr 99 36.5 35.4 +2.6% -2.9% +5.7%
RTO Dec 97 27.2 18.8 -5.9% -31.0% +36.3%
EMA Apr 98 26.2 19.9 -14.4% -23.9% +12.5%
ULVR Jul 98 29.5 22.2 -21.1% -24.7% +4.7%
Average 41.2 31.8 -2.4% -16.5% +20.5%
The price change column tells us what we already know. The Qualiport's returns so far have not been that impressive. Overall, four Qualiport stocks are up and three are down. Despite the fact there are more ups than downs, significant losses on both EMAP (LSE: EMA) and Unilever (LSE: ULVR) have dragged the portfolio into an overall loss.
But a different picture emerges when we break down the price increase into the change in P/E and the change in earnings since the stock was bought. Six out of the seven Qualiport stocks have shown an increase in earnings but a decrease in P/E since they were included in the portfolio. Perversely the stock with the biggest price gain, Independent Insurance (LSE: IIG), is the only company which has seen a decrease in its earnings and an increase in its P/E.
Overall the average rating of the Qualiport has fallen by 16.5%, and the rating of two stocks has fallen by more than 30%! So is this poor stock selection or unfortunate timing? Personally I think it's more a case of the latter, especially in the case of EMAP and Unilever. Other Fools will no doubt have their own opinions! There is little doubt that all the Qualiport stocks are well-run companies. They have the track records to prove it. The average entry P/E, at over 40, is pretty high by most peoples' standards. Dell (NASDAQ: DELL) distorts matters somewhat but even excluding it, the average entry P/E is about 27.
Such high initial P/Es do run the risk of disappointing returns in the short term. The Qualiport has been unlucky six times out of seven.
What Stuart is saying is of course a key element in value investing. Buy anything cheaply enough and you can survive a lot of bad news. But, if you pay too much, no matter how good the company is it can be hard to get a good return on your investment.
To be fair, when these companies were purchased they were all demonstrably sound businesses. Nothing in the business history of Marks & Spencer (LSE: MKS) gave the slightest clue that they would so dramatically misread the fashion last year. A similar tale applies to Rentokil (LSE: RTO). It had always delivered 20% annual growth, why should it stop now? The problem lies with one of those smart-alec investment phrases. "The trend is your friend -- until the bend at the end".
What has happened is that the UK economy has turned a bend. It has changed from an economy where the producer, or service provider, held power, i.e. a situation where there was more demand than supply. Now the reverse is true. Power lies with the consumer and, as Jack Welch of GE says, everything is in oversupply. The numerical backing for this can be seen in the inflation data. According to the Economist magazine UK inflation is now only 1.3%, less even than that of the US where it 2.1%. Prices are soft everywhere and no business area feels that more than the retail sector. Over the last 6 months the FT All Share General Retail Index is the worst-performing sector with a fall of 15.9%.
Despite this weakness, interest rates are on the way up. Steady Eddie at the Bank of England is determined that inflation will not reappear on his watch. The problem with this strategy is that it is pushing the pound up, mostly against its European counterparts. Not that anyone looks at it any more, but one pound will now buy 3.08 Deutschmarks.
That might be good news for holidaymakers, but it is bad news for companies with overseas earnings. The Qualiport has no manufacturers and should not suffer too much from a strengthening pound. Nevertheless, I thought it would be interesting to see just how dependent the portfolio is on foreign earnings.
Stock % profit from outside UK Dell 74.0% (ex Europe) IIG 11.6% PIZ 0.0% MSY 74.0% RTO 53.0% EMA 29.6% ULVR 47.0% (ex Europe) Weighted Average 41%
Unilever (LSE: ULVR), good European that it is, does not separate UK sales from the rest of Europe, and neither does Dell (NASDAQ: DELL), so the project cannot be completely executed. Nevertheless, we get the general flavour. Overseas earnings are very important to the portfolio and constitute at least 41% of the mix. If sterling goes up it will hurt the portfolio but probably by only the same amount as the rest of the UK market.
Like so much about investing these days, it is so different from the experience of the last few decades. For most of that time investors were actively seeking foreign exchange earners to try and escape the ravages of a consistently falling exchange rate. As with so many things these days, someone has changed the rules. They have put a bend in the trend. Now we need to think of portfolios that will do well out of an appreciating sterling. Which shares should we buy if we knew sterling was going to continue appreciating for the next 10 years? Tell us on the Qualiport message board.
Company Change Bid DELL(US) 0.00 43.00 EMA -0.18 9.07 IIG -0.08 2.57 MSY +0.24 5.86 PIZ +0.12 8.12 RTO -0.03 2.17 ULVR +0.12 5.94 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 04/11/98 245 Pizza Exp 7.93 8.12 2.5% 22/04/99 347 Misys 5.76 5.86 1.7% 27/10/98 755 Indep Ins 2.58 2.57 (0.4%) 27/01/99 74 Dell (US) 44.63 43.00 (3.6%) 19/12/97 783 Rentokil 2.55 2.17 (14.9%) 17/04/98 169 EMAP 11.34 9.07 (20.0%) 17/07/98 266 Unilever 7.53 5.94 (21.1%) Last Rec'd Total # Company In At Value Change 04/11/98 245 Pizza Exp 1966.34 1989.40 23.06 22/04/99 347 Misys 2028.71 2033.42 4.71 27/10/98 755 Indep Ins 1972.64 1940.35 (32.29) 27/01/99 74 Dell (US) 2007.42 1928.48 (78.93) 19/12/97 783 Rentokil 2046.53 1699.11 (347.42) 17/07/98 266 Unilever 2052.00 1580.04 (471.96) 17/04/98 169 EMAP 2341.32 1832.14 (509.18) Cash: £3,433.46 Current Total : £16,436.41 Total Invested: £18,184.62 Profit/(Loss) : (£ 1,748.21) Value Per Share Day Month Year Qualiport 0.15% -2.31% -12.60% FTSE 100 2.37% -2.69% 3.33% FTSE All Share 2.00% -3.18% 6.42%