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Last year saw my involvement with JJB Sports (LSE: JJB). It's simpler all round if you don't ask why they were bought, but I no longer hold them.
Further evidence of the attractions of the simple approach was Bruce's recent Qualiport purchase of Emap (LSE: EMA). Bruce commented at the time. "At around 800p, Emap's earnings yield is over 6.5%, and growing at hopefully 12% per annum in the years ahead."
It's all very well for me to comment on buying companies with temporary operating problems or buying based on rough estimates of future growth. You can't do that with every company. For these resolutions to work, I need to identify the correct companies in the first place. I won't go into great detail about that here, because it's a feature in itself, but I'll leave it to Warren Buffett to summarise:
Does it all sound too easy?
HonkyTonkFool, in this post, relays to us his investment principles for 2000. And a good set of resolutions they are too.
In fact I'm going to take one of his resolutions on board immediately: "Study one new company every month". So, a goal for me during 2000 is to report on least one fresh company a month for possible Qualiport inclusion.
But my favourite quote from the post is "Remember the quality/value relationship. Buy boldly on a high probability event". That was the essence of the "Less is More" PizzaExpress (LSE: PIZ) article I wrote last month. When confronted with tremendous quality offered at a knockdown price -- that's the time to buy. And buy big time.
Here are the three investment lessons I learnt last year with a "conclusion for 2000".
Recognising short term company problems can lead to a buying opportunity.
I hold shares in Games Workshop (LSE: GAW). They appear to have developed a niche business with room for steady, if unspectacular, expansion. Management have always remained positive with their outlook statements for long term growth. But a multitude of problems caused a steep share price decline during 1998-99. Investors, including me, were focusing on a slowdown in sales, the rise in sterling, and primarily, overstocking.
This is a post I wrote in my pre "TMF" days about Games Workshop, written about a month prior to their 1999 full year results announcement. This is the key paragraph to the post:
"So here's the current dilemma. We're all long term on this one; so should we all be dithering about overstocking problems, which probably are short term? If the company has a unique product, few real competitors and a very large future market still to go for, then is putting off an investment at a very fair 377p sensible? Is concentrating on probable short term stocking problems really that important over the long term? It's a tough one. Have a string of new competitors started biting into GAW's market? Have GAW customers started to desert them in droves, for other 'hobby substitutes'...? Unlikely, so if the management can sort out the stock, which I guess it can as it's purely in their hands to a certain extent, has the last few months seen a good long term buying opportunity?"
Using hindsight, Games Workshop was undergoing some growing pains. Although the group have subsequently taken significant steps to remedy the historic problems, they aren't totally out of the woods just yet. But what hadn't changed during the severe downturn in share price was the overall business model. I wasn't aware of any new industry competitors, any slip in their competitive advantage, nor any change in the durability of demand for their products. The products were still as attractive to their customers with the shares at 858p in 1998 as they were at 377p in 1999.
Looking back, the "uncertainty" over the operating problems was a buying opportunity. If you believe the "certainty" of the company's products and growth prospects outweigh the "uncertainties" over any operational problems, then a buying opportunity could be at hand. Especially when the stock market considers the "uncertainties" far more important than your "certainties".
My resolution -- to realise that quality companies undergoing temporary problems can make attractive investment propositions.
Forecasts and valuations
So here's another post made in my pre "TMF" days. It's the first part of the post that I'm revisiting.
I was trying to forecast JJB's earnings per share for this current year. I could only produce a figure of 26p, without making any (at the time) unrealistic assumptions. But look at all the complicated calculations and assumptions needed to generate my earnings per share forecast. It all seems very impressive.
However within three months, the interim results were out and my 26p figure looked rather limp. An unexpected uplift in sales caused full year forecasts to be upgraded to around 34p. As a private investor with limited resources and information, I had no idea whether JJB sales were going to improve or not. Nor did the market -- the shares rose 30%, I think, on the interim results announcement. Although I was surprised on the upside, the probability of a downside error in my calculations was, I think, just the same.
Disappointed by this and many other vain attempts to second guess profits exactly, reading The Intelligent Investor, by Benjamin Graham, put things into perspective:
"The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future."
In future, I'm going on Ben's margin of safety principle. Essentially for me, this is to buy something for 50p today that is calculated to be worth 100p at some point in the future, using simple assumptions and conservative projections for growth.
I won't take up space with these alternative calculations and methods. There's a short example with Marks & Spencer (LSE: MKS) in a prior Qualiport margin of safety feature, and another with PizzaExpress.
My resolution -- give up on forecasting exact profits using complicated methodology. Instead, I'll use rough and conservative projections and then build in a suitable margin of safety in any stock purchase.
More simple valuation in action
There were no complicated calculations here. Bruce merely made a conservative projection of 12% earnings growth, based on past Emap's performance. The only question was whether the growth prospects would come to fruition. Certainly an earnings yield of 6.5% (or inversely, a p/e of 15) was in no way demanding for a long term media growth stock, when risk-free government gilts had a similar yield at the time.
In the buy report, Bruce declared: "I believe Emap's class will eventually come through". In effect he was using the quality of the company, and the continuation of the historic operating record, to bring home the 12% annual earnings growth. No further complicated calculations were then needed, with an earnings yield of 6.5%, to determine whether Emap shares were undervalued or not.
All that was required was a belief in the company, the company's products and the durability of the competitive advantage with these products. Bruce also had to put to one side a gloomy share price that implied bad news, but also made the company look good value. All in all, a quick look at those few figures and gut feel told Bruce that Emap was cheap. It was.
My resolution -- carry on the straightforward valuation approach. I'll now compare the current earnings yield to the risk-free yield. These days, if both yields are equal and the earnings can be expected to grow at a double-digit rate, then I don't need much calculation to tell me the stock looks cheap.
In conclusion
"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors."
So my steps for investment success in 2000 and beyond are:
Your long term investment resolutions and other comments can be directed to the Qualiport board.
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Company Change Bid DELL(US)-4.20 46.50 EMA +0.08 13.18 IIG +0.02 2.67 MSY -0.55 8.13 PIZ +0.15 7.45 RTO -0.12 2.24 ULVR +0.04 4.58 LLOY -0.02 7.23 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 22/04/99 542 Misys 5.57 8.13 45.8% 17/04/98 301 Emap 10.20 13.18 29.2% 27/01/99 74 Dell (US) 44.63 51.50 15.4% 27/10/98 1133 Indep Ins 2.60 2.67 2.7% 29/09/99 356 Lloyds TSB 7.56 7.23 (4.3%) 04/11/98 245 Pizza Exp 7.93 7.45 (6.0%) 19/12/97 783 Rentokil 2.55 2.24 (12.2%) 17/07/98 266 Unilever 7.53 4.58 (39.1%) Last Rec'd Total # Company In At Value Change 22/04/99 542 Misys 3065.85 4406.46 1340.62 17/04/98 301 Emap 3139.85 3967.18 827.34 27/01/99 74 Dell (US) 2007.42 2085.45 78.04 27/10/98 1133 Indep Ins 2990.63 3025.11 34.56 04/11/98 245 Pizza Exp 1966.34 1825.25 (141.09) 29/09/99 356 Lloyds TSB 2723.20 2573.88 (149.32) 19/12/97 783 Rentokil 2046.53 1753.92 (292.61) 17/07/98 266 Unilever 2052.00 1218.28 (833.72) Cash: £ 38.91 Current Total : £20,894.45 Total Invested: £20,184.62 Profit/(Loss) : £ 709.83 Value Per Share Day Month Year History Qualiport -2.31% -4.30% -4.30% -1.07% FTSE 100 -1.95% -5.69% -5.69% 11.11% FTSE All Share -1.81% -4.86% -4.86% 15.35%