Qualiport

[ December 10, 1999 ]

Investing or Speculating

By Rob Davies (TMFEssex)

We live in interesting times, as the Chinese curse goes. Today the share price of Unilever (ULVR) fell to 404p, the lowest it has been for over two and a half years. This is a fantastically sound company. It has no debt and products that are sold worldwide and are recognisable by virtually everybody in the developed world as well as an awful lot of people in the developing world. The company is well managed, with return on capital employed of 24.8% and an operating margin of 10.6%.

There are really only three problems with it. The share price in the last 12 months has been diabolical, revenue growth is modest and it has some formidable competitors. Despite these drawbacks it is still a great company and one that, over time, should provide the investor with a safe return. It will take time for revenues to rise with the current low rates of inflation, but they will over time because a major area for growth in the company is the developing world. Rising incomes in emerging markets will undoubtedly be partly translated into higher consumer expenditure on household goods and products.

Nevertheless, in a world of low inflation it is clear that revenue growth will be modest. For that reason value considerations must play a big part in the investment decision-making process. At 404p I would argue that Unilever qualifies as an investment. At these levels the share is trading on a price to earnings ratio (P/E) of 15. However, when it was trading at levels above 650p a year ago I would have been reluctant to apply that label to the shares.

This is why the definition of investing is so hard. Is it investment at 404p and speculation at 650p? The dictionary defines investing as committing money or capital to gain a financial advantage. Obviously, the return you might make from an investment in Unilever at 404p ought to be better than one made at 650p, but the logic is the same.

These thoughts are prompted by two events. The precipitous decline in Unilever shares and the comments in today's papers, attributed to an official of the FSA, that buying shares in the fast-moving high technology companies was "a form of gambling". Gambling is defined by the Cambridge dictionary as "to do something risky that might result in loss of money or failure, in the hope of making money or achieving success." Its near relation is speculation. And that is defined as "to buy and sell in the hope that the value of what you buy will increase and that it can then be sold at a higher price in order to make a profit."

The key word in both these definitions is hope. I have no doubt that many people buying shares in these high-tech companies are doing it because they are "hoping " to make money. But I am also sure that a number of them are people working in the industry and can see the huge new opportunities offered by the breakthrough in communications offered by the Internet, mobile telephony and digital TV. How do we differentiate between them and which ones will make us money? The answer is of course that you can't, but the rather sweeping statement made by the FSA merely reinforces a view held by many in the UK that shares are risky.

That is unfortunate because, while it might be true on an individual basis, in a well-balanced portfolio of shares it is patently and demonstrably not true. I was unable to contact the FSA for clarification on these comments but it might be interesting to assess where the risk lies in the tech shares compared to -- say -- Unilever.

The quote said that "consumers need to think carefully about the risks involved". For a start it is rather surprising that she used the word consumer and not investor. That rather suggests that she thinks these people are buying fancy consumer durables instead of investing in growth companies. But what exactly are the risks?

Is the risk the volatility? I would not have thought so. It is easy to find a stack of FTSE 100 companies that have had moves approaching 50% in the last year. That list would include Rentokil (LSE: RTO), Marks & Spencer (LSE: MKS) and GEC /Marconi (LSE: MNI).

So it cannot be because they are merely volatile. Perhaps then it is because they are highly valued. One of today's Internet-related stocks on the move is Exchange Holdings (LSE: EXC). It announced a deal with Yahoo! and for that, and everything else, the market values Exchange at 52.6 times last year's sales. Compared to Yahoo! (NASDAQ: YHOO), on a price to sales of 200, it is quite possible to argue that Exchange is a reasonable price. Yahoo is a proven example of a stock that has delivered shareholder value with its 7,500% a year rise in the last three years. And it has always been expensive.

Indeed, if a managed fund exposed to the US did not hold Yahoo! the trustees would accuse the managers of taking risks by not holding it.

So if it is not the valuation that is risky maybe it is the business model. No one is entirely sure how companies like Freeserve (LSE: FRE), for instance, will look in a few years time. That certainly is a risk. But shareholders in the retail sector have seen the value of their investments decline over the year as it has become clear that online retailing is going to be a major threat. Just holding old style retail shares, without any of the companies involved in the new online businesses, could be equally judged by trustees as taking unnecessary risks with a portfolio.

While it is unclear what these new high-tech shares will be doing in five years time, we can be pretty sure that Unilever will still be selling soap and ice cream in five years. So it is clearly lower risk, and that normally means lower returns.

To my mind, then, it is clear that buying shares in Unilever can be classed as an investment. But there is no way that I would define buying shares in high-tech shares as gambling. Much closer to the mark is speculating. It still relies on hope, but the activity is not as fundamentally risky as relying on the throw on the dice or the luck of the cards. But a portfolio of high-tech shares that collectively provide exposure to the new economy would surely classify as an investment.

Tell us what you think the difference between investing and speculating is on the Qualiport message board.
Listed below are links to some other articles that might help you make up your mind.

Qualiport message board
TMF Googly on growth shares
TMF Nigel on Freeserve and one-dimensional valuations

Qualiport Numbers
10/12/1999 Close

Company  Change    Bid
DELL(US)-0.80    42.60
EMA     +0.65    13.58
IIG     +0.02     2.75
MSY     +0.20     8.65
PIZ     -0.08     7.30
RTO     -0.06     2.32
ULVR    -0.07     4.00
LLOY    +0.25     7.63


Qualiport Stocks

Last Rec'd  Total # Company    Buy  Current Change

 22/04/99   542     Misys      5.57  8.65    55.2%
 17/04/98   301     Emap      10.20 13.58    33.1%
 27/10/98  1133     Indep Ins  2.60  2.75     5.8%
 29/09/99   356     Lloyds TSB 7.56  7.63     1.0%
 27/01/99    74     Dell (US) 44.63 42.60    (4.5%)
 04/11/98   245     Pizza Exp  7.93  7.30    (7.9%)
 19/12/97   783     Rentokil   2.55  2.32    (9.0%)
 17/07/98   266     Unilever   7.53  4.00   (46.9%)

Last Rec'd  Total # Company     In At  Value   Change

 22/04/99   542     Misys      3065.85 4688.30 1622.46
 17/04/98   301     Emap       3139.85 4087.58  947.74
 27/10/98  1133     Indep Ins  2990.63 3115.75  125.20
 29/09/99   356     Lloyds TSB 2723.20 2716.28   (6.92)
 27/01/99    74     Dell (US)  2007.42 1910.55  (96.87)
 04/11/98   245     Pizza Exp  1966.34 1788.50 (177.84)
 19/12/97   783     Rentokil   2046.53 1816.56 (229.97)
 17/07/98   266     Unilever   2052.00 1064.00 (988.00)

Cash:                                          £ 28.46
Current Total :                             £21,215.98

Total Invested:                             £20,184.62
Profit/(Loss) :                              £1,031.36 

Value Per Share

                    Day      Month      Year      
Qualiport          1.54%     6.67%      0.59%
FTSE 100           0.88%     2.16%     14.57%
FTSE All Share     0.86%     2.16%     17.94%