Qualiport

[ July 19, 2000 ]

The Qualiport League

By Maynard Paton (TMFMayn)

Rochester, Kent -- Over the past few weeks, I've revisited the four Qualiport members -- Misys (LSE: MSY), Lloyds TSB (LSE: LLOY), Independent Insurance Group (LSE: IIG) and Dell Computer Corporation (Nasdaq: DELL) -- that had previously been given little portfolio coverage. Having reviewed the three other constituents -- Emap (LSE: EMA), PizzaExpress (LSE: PIZ) and MMT Computing (LSE: MMT) -- in the past few months too, I now feel that I'm largely on top of the pros and cons of each Qualiport company.

If the Qualiport is to outperform over the long term, then this regular company monitoring is a must. And when I write "monitoring", I mean the monitoring of the corporate "story" and company's valuation, not the daily share price movements. If a company's fortunes are changing, for better or for worse, or Mr Market is offering ridiculous prices, high or low, then we ought to act.

Regrets, we've had a few...

Looking back, we've missed some opportunities. We've dwelled many times upon Rentokil Initial (LSE: RTO). Oh how we could have sold on the first signs of the sales slowdown while the shares remained on a rich valuation! But in my opinion, a far bigger mistake was not taking advantage of the general market enthusiasm for technology companies that was witnessed earlier this year.

In February, Misys climbed to over 1200p. At the time they stood on a prospective price to earnings (P/E) ratio of over 70. Consider at the time that Misys had just announced interim results informing of a Y2K-related profit slump and brokers were only expecting a 14% earnings jump in 2001, and do the words "grossly overvalued" come to mind? Although Bruce suggested "sell Misys?" at the time, I wasn't so keen.

My thoughts revolved not around valuation, but upon visions of massive growth opportunities. Misys were going to be huge within the online US healthcare marketplace, or so I thought. Unsurprisingly, my belated research into Misys told a different story. In this feature, I guessed that revenues of £55m could be achievable from the group's exciting Internet healthcare venture. This figure was hardly the earth-shattering number I had originally dreamt of, given that Misys recorded turnover of £549m in the year to May 1999. Had I been monitoring the Misys story earlier on in the year, and realised that the stock market was grossly exaggerating the company's prospects, it's unlikely we'd be still hanging onto the shares today. With Misys now around 570p and a paper gain of £3,000 evaporating into nothing, it's an expensive lesson learnt.

Tight ship

In terms of numbers, I'm keen to run the Qualiport as a tight ship. I'm comfortable with the current quota of companies and will be more than happy to reduce the company headcount should the appropriate circumstances arise. Any more than seven or eight companies in the Qualiport and I feel that our "monitoring" efforts will become diluted and marginal investment decisions will be made. I'm anxious not to repeat the Misys experience.

Basically, if we are to consider any new companies, then they have to measure up to the least attractive holding within the Qualiport. If the investment potential of the newcomer far exceeds that of the Qualiport company with the lowest prospects, then I feel a "switch" may be in order. "Sell to buy", in other words.

Qualiport league tables

So, having recently looked at all the Qualiport incumbents, I thought I'd lay down my current overall portfolio thoughts. Which of the current seven are the most and least attractive?

My subjective judgement will be based on three factors -- the financial record, growth prospects and valuation. Here are my sub-tables to help determine an overall portfolio league.

   Record              Prospects           Valuation 

1. Dell                Dell                Lloyds TSB
2. Lloyds TSB          Misys               MMT Computing
3. PizzaExpress        MMT Computing       PizzaExpress
4. Emap                PizzaExpress        Independent Ins
5. MMT Computing       Emap                Emap
6. Independent Ins     Independent Ins     Misys
7. Misys               Lloyds TSB          Dell

In terms of the historic record, Dell is a clear winner with its magnificent and acquisition-free 30%-plus annual growth rate. I gave Lloyds TSB second place because of its outstanding long-term equity reinvestment performance when considering its size and the cut-throat and mature industry it operates in. Independent Insurance lost out through its dire cash flow performance during the last three years, while I remain distinctly unimpressed by the paper-based acquisition spree that created Misys.

Considering the visibility of the each company's long-term prospects, I've placed those involved in the IT industry firmly in front. I also think the potential to double the number of UK restaurants should keep the money at PizzaExpress rolling in for a few years yet, while online platforms should help publisher Emap in the quest for additional revenues. I'm not entirely sure of the growth potential for the Qualiport's two financial companies, although I'm confident that Independent, with its small niche operation, will have more opportunity than Lloyds TSB.

Valuation was simply a case of looking at the current P/E ratios. Because of Independent Insurance's poor cash flow performance, I've replaced the earnings part of that calculation with a more conservative average cash flow figure. As described in this feature, this change considerably increases Independent's relative valuation.

Points

So, if I simply award each company between one and seven points for each of the three categories, seven points for the highest, one for the lowest, a set of straightforward totals should give a reasonable picture of my overall view.

   Overall                   Points

1. Dell                       15
2. Lloyds TSB                 14
=  PizzaExpress               14
=  MMT Computing              14
5. Emap                       10
6. Misys                       9
7. Independent Insurance       8

Interestingly, there's a distinct split between the group. Firstly, my thoughts on the top half of the table and the £1,600 in the Qualiport kitty. After our recent purchase of PizzaExpress, I suspect any top-up would be between Lloyds TSB and MMT Computing. I'm loath to add more to our Dell holding when the company stands on a prospective P/E ratio of 57.

In terms of the bottom half, I feel that Misys and Independent Insurance are perhaps the two current weakest holdings in the portfolio. But I want to make it clear that I'm definitely not declaring any "sell" decisions.

As I mentioned when I reviewed Misys...

"Overall, I'm happy to keep Misys in the Qualiport. I'm not keen on its chunky acquisitive growth, but I'm hoping Misys can move towards a rather more organic approach in the future. The scope is there."

... and when I reviewed Independent…

"Certainly at this stage, I'm prepared to put my doubts and misgivings to one side, and place my faith with the proven and established management team and their historically superior operation. There is the distinct possibility of misinterpreting an underperforming business with one going through a natural industry cycle. Indeed, for the time being at least, it would be silly for the Qualiport not to benefit from the apparent sector revival."

... both companies do have growth opportunities. It's just that through a combination of their history, prospects and valuation, I currently consider Misys and Independent are the two least attractive companies within the Qualiport.

Your say

Do you agree? Perhaps you consider the highly-rated Dell to be on the top of any potential "sell" list? Maybe the competitive future of banking makes you nervous for the future of Lloyds TSB? Or will international expansion be the making of PizzaExpress?

Let us know your top-up and disposal thoughts, and whether the "tight ship" strategy is sound, over on the Qualiport discussion board, in the Resources section below.

Where Next?

Read these other Qualiport "thoughts for the future"