Qualiport

[ February 14, 2000 ]

Putting Off The Numbers

By Maynard Paton (TMFMayn)

Carburton Street, London -- Bruce wrote a very enlightening Qualiport article on Friday. In the feature, Bruce admitted that his disorganisation had prevented him from covering the results of Dell Computer Corporation (NASDAQ: DELL) and Lloyds TSB (LSE: LLOY).

This remark intrigued me: "If we've done our homework in the first place, and picked the right companies for the Qualiport, it shouldn't matter whether we pore over their numbers today, next week or next month."

As someone who hasn't looked at the figures from Dell or Lloyds in any depth either, I tend to agree with the comment. But then I would say that, wouldn't I?

As Bruce implies, the "maintenance" aspect of owning shares in a company, reviewing the financial figures, does not have to be an urgent task. In fact, the time taken can be quite minimal. Increasingly, I'm finding that the majority of the investment homework is performed prior to any share purchase. And to a certain extent, a lot of that investigation is done away from any serious accounting number-crunching.

The groundwork can be laid by asking the usual questions of your prospective company, to ascertain its long term buy and hold worthiness. Alongside the essential historical record showing material profitable growth, superior returns on equity and cash flow, there are many just as important "business" queries that need to be asked.

The two enquiries I always like to make are, firstly, to determine whether the potential investment has significant avenues for future sales and profit growth, and secondly, what is likelihood of any competition stealing those anticipated revenues? The second point is very important, and does tend to become forgotten by investors who become blinded by visions of growth.

You only have to take a look at the valuations placed on various Internet stocks for examples of this myopia. Most "investors" in these types of companies are factoring in substantial profits several years down the line. But given the low barriers to entry in becoming an Internet business, and the ever-changing landscape of the industry itself, future profits are far from certain. But I digress.

In a nutshell, the prospects of organic sales growth with a durable competitive advantage are key. So when reviewing the Qualiport constituents after their yearly results, I focus primarily on the continuation of these company characteristics.

PizzaExpress

Take PizzaExpress (LSE: PIZ), and its interim results last week. The numbers weren't overly spectacular. Operating margins had declined slightly, the conversion of accounting profits to cash had deteriorated and like-for-like sales growth was disappointing. Were any of these reasons to sell? Not really.

The PizzaExpress business story is still intact. With eating out considered a growth market, and PizzaExpress expecting a near-doubling of its restaurants in the UK and making tentative steps overseas, increasing revenues should be rolling in for a few years yet.

Competition, though, is a far more subjective issue. PizzaExpress has outperformed considerably over the last few years in a pretty crowded marketplace, with numerous dining alternatives always springing up. Probably the best indicator of PizzaExpress' relative peformance in the casual dining market will be from fellow pizza restaurateur ASK Central (LSE: AKC), whose results are due next month. I have recently compared PizzaExpress to ASK on a number of financial ratios, with PizzaExpress coming out ahead in almost all. When the ASK results are released, I will evaluate the two pizza parlours for a Qualiport feature.

Dell Computer

Glancing at some of the post-results comments from Dell, I'm very impressed, although it's my first ever look at the US computer giant.

Some of the remarks from chairman Michael Dell give a lot of confidence for the future financial well-being of his shareholders. Dell suggests that the online retailing of their computer equipment at present represents only a fraction of what the Internet will mean to his company in the future. Currently, online revenues make up nearly 50% of group sales, and average US$40m a day, up from US$14m a year ago. A quick peek at the top line growth figures saw group revenues jump 38% to US$25bn in the year to this January.

Dell also comments: "Customers are increasingly demanding the type of direct relationship we pioneered in this industry. They're insisting on the efficiency and value of our direct Internet business model, and we believe we're widening our fundamental competitive advantage in the process." Dell also reported that the company's revenues grew at double the industry rate. There are quite a few other similarly bullish "outstripping the industry" comments within the Dell divisional results. I don't think they're suffering too much from the competition here.

Add in the fact that profits rose 28% and cash and cash equivalent balances doubled in the last financial year, and you don't need to perform many more in-depth accounting ratio calculations to tell you why the Qualiport is more than happy to hold shares in Dell.

Lloyds TSB

And so on to Lloyds. The bank released, on the face of it, some half-decent results. Total income rose 11%, and with a reduction in costs, overall earnings per share rose 18% in 1999.

But other factors have been put to the fore. The recent rises in interest rates, with pundits commenting that more hikes are to follow, will put an obvious damper on the bank's future performance. Various downbeat comments on the Lloyds Internet strategy and the achievability of the cost-cutting targets have all helped to put the Lloyds share price into a tailspin of late.

But looking back at Bruce's buy report, nothing too dramatic has happened to Lloyds itself in the meantime. In terms of the growth outlook, notably in the new Scottish Widows subsidiary, there is still the trend away from a government-funded to an individually self-funded retirement. As I'm sure you're all aware, there is an increased requirement for personal financial products, which should be to the benefit of Lloyds in the years ahead.

But am I forgetting the ever-present and increasing competition here? For example, Lloyds commented last week that its mortgage business was suffering from aggressive competition from new and existing lenders. Everyone, it seems, is keen to lend you money for your next house purchase.

The bank, and shareholders, have to suffer the ups and downs of the interest cycle. That's part and parcel of any investment in this sector. In terms of fending off the competition, utilising the Internet and capitalising on future personal finance trends, responsibility lies with the management. And an investment in Lloyds is really a bet on the management to reproduce the excellent financial performances of yesteryear well into the future.

Rather than go into Lloyds' numbers in isolation, I think it would be a good idea to compare the Qualiport bank to some of the other players in the industry. Funnily enough, this week is "bank reporting week", with five other major banks announcing their results over the next few days. My intention is to compare Lloyds to some of the other reporters, and determine whether Lloyds has maintained its financial operating superiority and whether aggressive competition is hurting anyone else in the marketplace.

So, is it important for Qualiport writers to immediately assess any financial information in depth? Or can a casual glance and report of the profits and sales figures a week or two later suffice? Let us know your thoughts on the Qualiport board.

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