Qualiport

[ April 5, 2000 ]

Greed, Fear and a Buy

By Maynard Paton (TMFMayn)

Carburton Street, London -- I can't help but start this article by commenting on the large share price plunges of the so-called "new economy" companies over the last few days. Being quite cynical for some time over most valuations witnessed in the media, telecoms, IT and Internet sectors of late, I have been genuinely pleased to see some of the froth being blown off the share prices of these fast growing industries.

There is, of course, the hope that the shake-out, with our Foolish educational perspective in mind, may have calmed some shareholders' expectations. Hopefully, the ambitious investors who have been simply following the latest tech-stock fashion, may think twice about pouring money into companies solely on the basis of positive momentum. As I'm sure all Qualiport regulars know, buying shares because others have bought them beforehand just ain't a recipe for long-term success.

Being a fully paid up member (or more accurately, a lurker) of the Communion of Bears discussion board, witnessing a few tech stock speculators (making the clear distinction between these people and long-term tech stock INVESTORS) having a hard time does give me a little pleasure. I'm sure fellow Bears can relate to this. Call it "schadenfreude" if you like.

Okay, okay, I admit it! My smug grin throughout the recent Nasdaq falls probably arises through sheer jealousy more than anything else. I suspect that, if you are anything like me and pay due attention to traditional valuation measures, you probably have put to one side the companies involved in the emerging "technologies of tomorrow". And if you missed out on the subsequent huge re-rating of these companies, then you can't help but chuckle at the stock market's sudden change in sentiment.

All this delight pales into insignificance should an irrational stock market sell-off present great companies at fair, or even, dare I hope, bargain prices. When the optimism and greed of shareholders evaporates into pessimism and fear, then there could be opportunities aplenty for the rational long-term investor.

After going into detail about Warren Buffett's purchase of GEICO on Monday, and how he bought in the face of pervasive pessimism over that company's outlook, there is further sound Buffett advice for investors after he described his purchase of Wells Fargo a decade ago.

Back in 1990, Wells Fargo (NYSE: WFC) dropped 50% on fears that falling Californian real estate values would lead to heavy losses to the banks that lent to homebuyers. Because of Wells Fargo's leading position in mortgages, it was particularly vulnerable. Again, Buffett bought despite a "chaotic bank market", as foolish (small "f") loan decisions were wheeled out put on public display. Again, Buffett bought into a company when financial discipline and management talent was under scrutiny.

In this case, it's Buffett's subsequent comments about an investor's approach to the ups and downs of the stock market, after considering Wells Fargo, that catch the investor's eye.

"We welcomed the (Wells Fargo) decline, because it allowed us to pick up many more shares at the new, panic prices."

"Investors who expect to be ongoing buyers of investments throughout their lifetimes should adopt a similar (Wells Fargo) attitude toward market fluctuations; instead, many illogically become euphoric when stock prices rise and unhappy when they fall. They show no such confusion in their reaction to food prices. Knowing they are forever going to be buyers of food, they welcome falling prices and deplore price increases."

"The most common cause of low prices is pessimism -- sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer".

Although, the recent falls in some technology companies have been alarming, the optimism still remains. Companies with proven growth records, or considerable "tech-monopolies", still stand on breathtaking multiples. At the close of last night, six highly regarded tech stocks with rosy growth prospects were, unfortunately, still highly regarded by investors.

Company                    Price       Prospective P/E
                            (p)

ARM Holdings (LSE: ARM)    3002            347
CMG (LSE: CMG)             4132             76
Logica (LSE: LOG)          1713            104
Sage (LSE: SGE)             588            100
Trafficmaster (LSE: TFC)    687            107
Vodafone (LSE: VOD)         321.5           73

Although I'm using snapshot price to earnings (P/E) ratios, none of these multiples look very appealing. Don't get me wrong, all the companies have great revenue prospects and I'd seriously consider any of them for the Qualiport. But at these current valuation levels? Oh no. No signs of too much pessimism in those six I'm afraid. If the valuations dropped by two-thirds, then I could be interested in buying.

MMT Computing

Bearing in mind Buffett's comments above, I was very pleased to see MMT Computing's share price take a hammering lately. A fortnight ago, I put forward MMT as a potential Qualiport company, and the shares stood then at 692.5p. Now they stand at 547.5p after falling 22% in two weeks. Using current brokers' forecasts, MMT is now on prospective price to earning (P/E) multiples of 11.5, falling to 9.4 for the year ended August 2001. Nothing has fundamentally changed within the MMT business. Well, not officially, anyway.

But one thing a falling share price does do is act as a catalyst for shareholders to concentrate on the possible downsides of an investment. It's bizarre, but when a stock price is rising, confidence in the prospects of your company increases. And the possible problems ahead become dismissed.

In contrast when stock prices decline, so the doubts and fears creep in. And it's been no different with myself and MMT. Does the stock market know something? Will their interim results, out next month, be appalling? Who knows? Indeed, there are one or two concerns from the latest MMT annual report that suddenly jump out when the MMT share price drops. Alongside the Y2K-influenced decline in continuing turnover, there has been a deterioration in the performance of some recently acquired businesses. Have the management, who haven't put a foot wrong in the past, bought a dud? But are all the worries, and more, reflected in the current price anyway?

There's one Buffett phrase that is ringing in my ears at the moment: "Be greedy when others are fearful, and fearful when others are greedy".

With that in mind, I'm announcing a Foolish Qualiport purchase. Sometime in the next 5 trading days, in accordance with the Fool's trading rules, the Qualiport will buy £2,000-worth of MMT Computing.

In a nutshell, I'm going on MMT's proven growth and management record, and its exposure to one of the fastest growing industries there is -- IT consulting and software. These positives, coupled with the current miserly valuation, outweigh the negatives. On Monday, I'll go into more detail about this decision.

Related Links

• MMT -- Qualiport Material?
• MMT website

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.