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As I mentioned earlier, I'm quite comfortable holding Unilever for the Qualiport at the moment. It's solid, if unspectacular. I've already declared on these pages why I want to sell the Qualiport's holding of Unilever, as and when the share price ever arrives at a fair value. But in the meantime, I'm a happy holder.
So just where is the predictability within an industry in which competitors can overnight give away an identical service to yours, for free, and so quickly steal all your customers?
Yesterday, Independent Insurance Group (LSE: IIG) announced full-year results. The company reported operating profits rising by 25% to £69.8m and earnings per share increasing 24% to 21.9p. But just as I was getting to grips with the mysterious ways of insurance accounting, Bruce doing his best to explain the bean counting practice in his Friday feature, Independent go and change their accounting polices. I won't bore you with the nitty-gritty, but the change added £13.4m onto the above profits.
My first reaction was to think of the Qualiport stalwart and fellow global consumer goods company, Unilever (LSE: ULVR). A quick check on the share price was in order. I can't remember exactly, but Unilever shares had plunged something like 35p to 345p when I looked. It was a big hit. I then remembered writing about Unilever two months ago, when the company's share price was flying high at the "fair" value price 478p. Doesn't January seem such a long time ago?
But I'm pretty relaxed about holding Unilever shares. The company itself is quite predictable. Producing food, washing powder and deodorants isn't subject to any rapid industry change. People will still go out and buy Unilever products -- Persil washing powder, Timotei shampoo, PG Tips tea and the like -- regardless of what happens to the P&G stock price. Okay, so maybe P&G are undergoing an operational blip at the moment, and their trading difficulties in Latin America could affect Unilever as well, but I'm sure that the underlying demand for P&G products hasn't just suddenly dried up overnight either.
If you take a look at this article by Brian Graney (TMFPanic) of the US Fool, you'll quickly realise that the overall full-year earnings for P&G will now come in only 5% lower than had been originally expected. Yet P&G stock dived 30% yesterday, losing $27 to end the session at $61, and Brian comments on the knee-jerk irrationality of Mr Market. But the P&G episode does give a warning about investing on "high" price to earnings (P/E) ratios. Before the profit alert, P&G traded on a forward P/E ratio of 29. Any bad news was surely going to hit the stock.
It's interesting to compare P&G with Unilever. The American giant, after its profits warning, now languishes on a forward P/E of 20. Unloved Unilever, at 338p, perches on a forward P/E of just 12. Brian does mention that the P&G goal for annual earnings per share growth is 13% to 15% over the next four years. When I reviewed the results on 28th February, the implied earnings growth target from Unilever over the next five years was in the same range.
Although Unilever are increasing their top line revenues at a slower rate than P&G (4% versus 6-8%), I'm surprised at the disparity between the companies' P/E ratings. Comparing the profit multiples of any two different companies is always a dangerous game, but the comparison does give further backing to my assumption that Unilever shares are currently anything but overvalued.
Freeserve
There is a slight "inevitability" about Unilever. You just know that the company will be around in five to ten years' time, slowly but surely plodding on, selling its wares to all and sundry. It may not be a significantly bigger company in five years' time than it is now, but you know it will still be around. You see, not much changes in the world of washing powder.
Compare that to the world of the Internet, where the word "inevitable" is rarely used. Take Freeserve (LSE: FRE). After being king of the hill for just eighteen months, as the UK's first subscription-free ISP portal, the game has suddenly changed. Search engine AltaVista threw down the gauntlet earlier in the week, offering an even free-er ISP. Just a membership fee is charged, with the telephone bill waived. At the same time, British Telecommunications (LSE: BT.A) announced a similar deal.
But those offers were all subsequently topped by the proposal from cable operator NTL (Nasdaq: NTLI). NTL are now to supply completely and utterly free Internet access. No call charges. No subscription. Totally free. "Woo-Hoo!" I hear you say. That is, unless you hold shares in Freeserve, in which case you could be muttering "D'oh!".
Predictability
I've said before that I firmly believe Unilever will be around in five years' time, and at a higher valuation. It may not be significantly greater, but it will be greater. Can the same be said of Freeserve with the same confidence? Can Freeserve actually survive over the next five years?
I can do no better than quote Warren Buffett on the subject of technological revolutions and importance of predictability derived from the absence of any change.
"We think [new technology] is very beneficial from a societal standpoint. Our own emphasis is on trying to find businesses that are predictable in a general way as to where they'll be in 10 or 15 or 20 years. That means we look for businesses that in general aren't going to be susceptible to very much change. We view change as more of a threat investment-wise than an opportunity. That's quite contrary to the way most people are looking at equities right now. With a few exceptions, we do not get enthused about change as a way to make a lot of money. We're looking for the absence of change to protect ways that are already making a lot of money and allow them to make even more in the future."
To me, washing powder isn't susceptible to very much change, makes a lot of money, and will make more money in the future. The same just can't be said about the Internet. "Be certain of a good result, rather than be hopeful of a great one" is another applicable Buffett quote in these circumstances.
One thing that does count when contemplating a long-term investment is this "industry change" factor. Are your products likely to be superseded any time soon by a superior or cheaper alternative? For a long-term investment, the absolute "certainty" for the future demand of your particular company's services or products is paramount.
Independent Insurance
But what really spooked the stock market was an additional £20.3m charge, for "late and non-reported claims", after IIG's withdrawal from the London general liability subscription market. Coupled with Chairman Michael Bright's admission of making a wrong call over new business growth for 1999, IIG shares have slumped in the last few days. After reaching 244p just before the results, they now stand at 191.5p.
Yesterday, Bruce (TMFGoogly) and Stuart ventured to the post-results press briefing hosted by IIG. I'm sure Bruce will fill in all the details in Friday's Qualiport, and give his views as to the current state of play at the company.
Related Links
• Any Reprieve for Unilever?
• Selling Unilever On The Cheap?
• The Tide Turns for P&G
• AltaVista -- It's All Free!
• Why Won't Buffett Invest In Tech Stocks?
• Bruce previews results from Independent Insurance
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.