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We only have to look at the success of Stephen Bland (TMFPyad), with his value investing philosophy, to get slightly envious. After reading about some of the impressive short-term gains Pyad has realised, in his Value Investing column, I don't blame Bruce for throwing value-related "special situations" into the Qualiport pot.
Put simply, it is to stop judging the Qualiport portfolio by its stock market valuation every other day, but instead, to judge the portfolio by the operating results from the companies held within it. In a nutshell, we should think like the owners of the companies.
As a straightforward example, if we bought shares at 100p, with earnings per share of 10p, our owner earnings yield would equate to 10%. If earnings per share rose to 12p, the owner earnings yield would thus rise to 12%. And with a portfolio of shares, it's reasonably easy to arrive at an overall portfolio yield, after weighting the companies according to their original purchase cost.
Plugging in all the costs per share, and the latest full year earnings per share for each current Qualiport member, I arrive at a starting portfolio yield of 3.92%. This compares quite favourably to the current earnings yield of the FTSE All-Share, at 2.26%, but not so when looking at the return available from Government gilts, around 6%. The Qualiport appears to have bought in the middle ground. But notice how buying Dell Computer Corporation (Nasdaq: DELL) and Unilever, at the prices we did, weighs down the overall portfolio yield by virtue of their small contributions.
So, if everything goes to plan, and the companies report earnings in line with consensus forecasts, then the Qualiport's yield will rise to 4.84%. Thus our potential portfolio yield of one year down the line has increased by a whopping 23.8% over the current portfolio yield. Or in other words, weighted Qualiport earnings per share are expected to jump 23.8%! Most of this rise is due to the huge leap in earnings per share expected at Independent Insurance. These results are due soon, although the stock market appears to be rather ambivalent to Independent's anticipated growth at present.
And if everything goes as the Wise forecasters expect over the next two years, which you can be assured won't be the case, the Qualiport could be looking at an owner earnings yield of 5.52%, which means a jump in weighted Qualiport earnings per share of 13.8%. But even if I extrapolate things this far out, the Qualiport has still to reach the 6% risk-free rate of return.
Slightly Envious
And at the opposite end of the investing spectrum, everyone is probably aware of the substantial gains that could have been made in numerous technology-related companies. Riding a tech bandwagon has looked an easy road to riches of late. It's very unlikely, to say the least, that the Qualiport will ever follow any "momentum" type of investing.
But I have to admit, especially after reading Nigel Roberts' (TMFNigel) Growth Investing feature on his love for Baltimore Technologies (LSE: BLM), the stupendous tech-gains to be had do sow a seed of doubt in the minds of those who consider traditional valuation measurements as a key investment issue.
Nigel, I should make clear, recognised the strength of the underlying Baltimore products, and bought the shares, well before the "crowd". He now has on his hands, with his original purchase of Baltimore, a twenty-bagger. And he only bought the shares a year ago.
The Qualiport aims to generate an average annual compound return of 15%. At the 15% rate, it would take nearly 22 years for a typical Qualiport investment to reach the dizzy 20-fold investment returns that "early" Baltimore shareholders have recently enjoyed. But don't worry, the Qualiport isn't about to punt for the "next Baltimore".
So, with the long term buy and hold strategy firmly in place, back to Mark and the comments from his message. He gives us a technique to "counteract the temptation to panic and ditch the strategy."
Think Like An Owner
The concept is very simple, but putting it into practice can be complicated. Firstly, the concept. Here, the only aspects that need to be considered are the average prices we paid for each of our companies, and the earnings we have "received" from them. In time, the earnings from the companies should increase. And so the size of these earnings, in relation to our initial investment, should grow also. Mark takes his cue from Warren Buffett, and calls these growing company earnings "owner earnings".
This owner earnings return can be measured by using the basic earnings yield calculation:
Latest Earnings Per Share
Owner Earnings yield = --------------------------
Share Price at Purchase
Comparing the overall portfolio yield from one year to the next can lead us to determine the weighted growth in portfolio earnings. It also gives us a snapshot indication of how the portfolio yield compares as a whole to risk-free Government bonds, or "gilts".
As Mark suggests, our attention should now be placed on the growing owner earnings yield of the portfolio, and not at how the stock market values the portfolio in the short term. If this portfolio yield is growing strongly, eventually the stock market will catch up with the performance. Or so the theory goes.
But as I mentioned earlier, there are complications. For this first attempt, I've taken the latest full year earnings per share for each current Qualiport member. This adds a lot of subjectivity on my part. Firstly, I've ignored the two companies that have been cast aside by the Qualiport, Rentokil Initial (LSE: RTO) and Marks and Spencer (LSE: MKS). Although I'm guessing here, I'm sure the exclusion of these two won't have too dramatic an effect.
Then there is the question about the spread of the reporting year-ends. Unilever (LSE: ULVR) reported its full year results yesterday, whereas Independent Insurance (LSE: IIG) reported eleven months ago. Thus some earnings are more "current" than others.
All in all, I've assumed we have owned the current Qualiport companies throughout the whole of their last full financial year. Looking at the prices we've paid, and the share prices of each company at the start of their particular financial year, I don't think it should alter our overall calculations too drastically.
Company No. of Cost per Current Current Weighted
shares share earnings yield yield
(p) (p) (%) (%)
Dell 74 2712.72 41.2 1.52 0.17
Unilever 266 690.79 26.0 3.76 0.39
PizzaExpress 245 802.59 33.4 4.16 0.46
Lloyds TSB 356 764.94 46.2 6.04 0.93
Emap 301 1043.14 36.7 3.52 0.62
Misys 542 565.65 16.3 2.88 0.50
Ind. Ins. 1133 263.95 13.3 5.04 0.85
Total 3.92
Total cost of
current holdings (£)17730.70
An interesting exercise is to then alter the above calculations, and replace the historic earnings with the prospective earnings for each company's current financial year.
Company Prospective Weighted
Earnings Yield Yield
(p) (%) (%)
Dell 54.5 2.01 0.27
Unilever 28.3 4.10 0.42
PizzaExpress 38.8 4.83 0.54
Lloyds TSB 48.9 6.39 0.98
EMAP 51.9 4.98 0.88
Misys 16.5 2.92 0.50
Independent Ins. 20.1 7.62 1.28
Total 4.84
And feeling really brave, I've plugged in earnings expected two years in the future.
Company Prospective Weighted
Earnings Yield Yield
(p) (%) (%)
Dell 72.7 2.68 0.30
Unilever 31.0 4.49 0.47
PizzaExpress 46.6 5.81 0.64
Lloyds TSB 53.7 7.02 1.08
EMAP 53.0 5.08 0.90
Misys 20.8 3.68 0.64
Independent Ins. 23.4 8.87 1.50
Total 5.52
Mark rounds off his message with this very sound remark: "I suppose... it makes you think long and hard before buying shares on very high P/E ratios, knowing how long it will take before 'your' earnings divided by purchase cost reaches a decent level."
Looking at the portfolio yields, it appears the historic purchases made at high price-to-earnings ratios have had a material effect. Only if we hold the current holdings for at least another two years and all the forecasts are met, will the Qualiport owner earnings yield exceed the risk-free return from gilts. Having laid the foundation, it should be an interesting exercise to see how the Qualiport actually does perform in the future using this performance evaluation technique.
But, as you've no doubt realised, these have been rough and ready calculations. Should I have included the former Qualiport companies? How should I cater for future buying and selling within the calculations? And does anybody fancy having a crack at deriving the Qualiport yields from years gone by? Let me know your thoughts over on the Qualiport discussion board.
Related Links
• Nigel Roberts -- What Should A Baltimore Lover Do?
Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.