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By Bruce Jackson (TMF Googly)
Baker Street, London -- The market continues on its determined march forward, despite the falls seen in the last couple of days. In the whole scheme of things, these falls are relatively insignificant. As a value investor, I actually look forward to market falls, as they often present buying opportunities, especially when the market is at its most irrational.
I'm guessing a little here, but I suspect many buy-and-hold value investors have had a poor 1999. We've seen big advances in what I see as recovery shares -- the oil and mining sectors -- and continued gains in the broad technology and telecommunications sectors. The small-cap sector has recovered in 1999 after a horror 1998. Basically if you've not been fully invested in these areas, you're going to be struggling.
Many of the existing Qualiport companies fall outside of this range. The Great Rentokil Initial (LSE: RTO) Disaster of 1999 (451p down to 212p) is a classic example, although that company obviously deserves some re-rating following on from the dropping of its 20% per annum growth rate objective.
I'm not trying to defend the Qualiport's 1999 returns. There's no doubt this real-money portfolio has been toasted. I'd have been much better throwing valuation techniques to the wind and buying those companies which are operating in the high growth industries. In the UK, that would mean pretty much anything to do with mobile phones. In the US, it's anything to do with the Internet.
I very much admire what some (but not all) of these companies have achieved. Vodafone AirTouch (LSE: VOD), for example, is going from strength to strength. I placed a split-adjusted buy price of 210p on the biggest mobile phone operator in the world. With the shares now trading at 300p, I'm now a long way out of the game, although at one stage not too long ago the shares flirted with my buy price.
Despite all that, I still believe valuation does matter. I admit that some of the better companies are perennially over-valued, and therefore are never buys, despite their share price rocketing up over the years. Microsoft (Nasdaq: MSFT) is a classic example in the US, as are Colt Telecom (LSE: COLT) in the UK. However, from the relatively few huge long-term winners in this category, there are very many more losers. JJB Sports (LSE: JJB) at 819p in 1998 (now 441.5p, up 60p today) and British Biotech (LSE: BBG) at 326p in 1996 (now 31p) are classic examples. In their time, both companies were flavour of the moment, as are the sectors mentioned above in today's markets.
In hindsight, picking the winners looks easy, but in reality, when you're putting your money on the line, it's not quite so easy. I'll return to this theme in future reports.
Independent Insurance (LSE: IIG) dropped almost 6% yesterday, primarily on a general analyst downgrade of the insurance sector. This came on the back of Royal & Sun Alliance's (LSE: RSA) statement that their exposure to catastrophe losses is estimated to be £42m. At the same time, an analyst from Wise broker Warburg Dillon Read cut his IIG 1999 pre-tax profit forecast from £67m to £65m. These two factors, and a weaker overall market, were seemingly instrumental in IIG's share price fall.
Today I spoke to Andy Hawkes, Executive Marketing Manager of IIG. He confirmed that the company has some exposure in the Bahamas, which was hit by Hurricane Floyd, although courtesy of their re-insurance cover, IIG's losses are capped at US$3m. Hawkes said he doubted whether their losses would even reach that level. That sort of loss is hardly catastrophic for IIG. Sad as it is for the people who were hit by the hurricane, as far as a company like IIG is concerned, this is very much a routine event. In November last year, IIG released a trading statement reporting £18.5m catastrophe losses, which puts the US$3m losses in perspective.
Hawkes also told me that overall insurance premium rates are continuing to firm, although at the moment, re-insurance rates are yet to follow higher. This is consistent with the statements made by the company with the release of interim results back in August. IIG also continues to take business from the merged composite insurers -- meaning CGU (LSE: CGU) and Royal & Sun Alliance -- mainly because those competitors are concentrating on integrating systems and cutting costs at the expense of running the real business.
Hawkes also said IIG remained comfortable with the pre-tax profit estimates of house broker HSBC Securities of £66m. The £66m is the profit the company expects to make from its insurance underwriting plus investment income, called trading profit by IIG. However, I believe operating profit is a better judge of how the overall business is progressing. The difference between operating profit and trading profit basically comes down to gains or losses on investments. In 1998, IIG made gains of over £40m in this area, but in the first half of 1999 lost £1.3m. That's partly because the stock market has been weak this year, but mainly because the bond market has had a down year.
That means that although IIG will report a trading profit increase (the comparative number in 1998 was £55.2m), overall profits will be down. However, insurance companies are usually judged on their net asset value, and because IIG will report an overall profit in 1999, this will increase. As at June 30th, net asset value was 124p, meaning with the share price at about 260p, it trades on a price to book ratio of just over 2. That's one of the higher ratings in the sector, but well deserved. Most insurance companies are making losses on the underwriting portion of their business, hoping to make up the deficit on their investment income. But, with low interest rates combined with the weak bond and equities markets, this is easier said than done.
I need to update my IIG valuation spreadsheet to reflect the 1999 interim results, and my increased knowledge of the company. The longer you follow a company, the more you learn, enabling you to get a better fix on its valuation. Also, in the past year I've learnt a lot more about company valuations in general, and this knowledge needs to be factored into my calculations. If the shares fall too much further, we could be looking at yet another top-up opportunity.
On Monday, I mentioned that I wanted to have a closer look at Yahoo! (Nasdaq: YHOO). I'm running a bit over today, so that will have to wait until next week. So-called Internet companies are said to be difficult to value, and that is because their earnings stream is not predictable. However, I believe Yahoo has one of the more predictable long-term earnings streams, courtesy of its global and dominant brand name.
Rob's back on Friday. In the meantime, the Qualiport message board remains open for business.
Company Change Bid DELL(US) 0.00 45.40 EMA +0.07 8.30 IIG 0.00 2.60 MSY -0.10 5.12 PIZ -0.03 8.22 RTO -0.01 2.10 ULVR -0.06 5.44 LLOY +0.03 7.78 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 04/11/98 245 Pizza Exp 7.93 8.22 3.7% 29/09/99 356 Lloyds TSB 7.56 7.78 3.0% 27/01/99 74 Dell (US) 44.63 45.40 1.7% 27/10/98 755 Indep Ins 2.58 2.60 0.8% 22/04/99 348 Misys 5.76 5.12 (11.1%) 19/12/97 783 Rentokil 2.55 2.10 (17.6%) 17/07/98 266 Unilever 7.53 5.44 (27.7%) 17/04/98 169 EMAP 11.34 8.30 (26.8%) Last Rec'd Total # Company In At Value Change 04/11/98 245 Pizza Exp 1966.34 2013.90 47.57 29/09/99 356 Lloyds TSB 2723.20 2769.68 46.48 27/01/99 74 Dell (US) 2007.42 2036.12 28.70 27/10/98 755 Indep Ins 1972.64 1963.00 (9.64) 22/04/99 348 Misys 2028.71 1781.76 (246.95) 19/12/97 783 Rentokil 2046.53 1644.30 (402.23) 17/07/98 266 Unilever 2052.00 1447.04 (604.96) 17/04/98 169 EMAP 2341.32 1676.60 (664.72) Cash: £2,710.26 Current Total : £18,042.66 Total Invested: £20,184.62 Profit/(Loss) : (£ 2,141.96) Value Per Share Day Month Year Qualiport -0.23% -1.19% -14.57% FTSE 100 -0.99% 1.39% 3.92% FTSE All Share -0.97% 1.07% 6.82%