Qualiport

[ July 26, 2000 ]

Long-Term Principles

By Maynard Paton (TMFMayn)

Rochester, Kent -- Just after our sister portfolio, the Rule Shaker, has adapted its philosophy, the Qualiport has had a call to change its "rules" too.

Foolish regular Mark Lucas puts forward this excellent plea to your Qualiport managers. Mark asks:

"So can we please rewrite the QP rules? LTBH becomes an aspiration not a guiding principle...?"

Principles, not rules

Firstly, let's get rid of the term "rule". It sounds far too rigid. In my book, investment "rules" are for those who steadfastly follow mechanical stock market strategies. For those who prefer to use their own skill and judgement, I prefer to use the term "principle". Successful investing is all about being flexible, and having "general principles" allows just that!

Bruce neatly sums up the overriding Qualiport investing principle in this feature. He uses this succinct comment:

"Here at the Qualiport, we believe in buying good companies cheaply".

(As an aside, an old headmaster of mine also used to have just the one "golden principle". Instead of a long list of school "do's and don'ts", his abiding principle was "Use common sense at all times". Perhaps that phrase should be applied to many investors' rulebooks too.)

Where's the long-term?

We've laid down several pointers to help the Qualiport determine good, or better still, great, companies. Some of these "sub-principles" are undoubtedly more important than others. "A company that is attractively valued" and "a company that has identifiable growth prospects" are perhaps the two at the top of my list. There are admittedly various degrees of flexibility with the others.

So what about the famous long-term buy and hold (LTB&H)? Where does that fit in with the Qualiport? It's noticeably absent from Bruce's earlier declaration. Indeed, if you'd been away for a year or so, you would now discover that Rentokil Initial (LSE: RTO), Marks & Spencer (LSE: MKS) and Unilever (LSE: ULVR) had all disappeared from the portfolio. In this situation, you might think we'd never operated a LTB&H philosophy at all!

Folklore

The "birth" of LTB&H is mostly associated with Warren Buffett. His purchases of Washington Post (NYSE: WPO) and Coca-Cola (NYSE: KO.), which are still held a decade or two later, have long been part of investment folklore. Buffett's become very rich from holding on, and so the LTB&H is thought of as the way to go for the ordinary small investor.

But Mark correctly makes this observation in his post: "Finding fantastic businesses which are going to carry on being fantastic for 10 or 15 years is very, very difficult. Surely some selections are just as likely to be mediocre or poor as they are fantastic?"

He's right. The number of businesses that can be confidently purchased in the knowledge that all will be fine in ten years' time are few and far between. The fact that Buffett, the arch-proponent of LTB&H, has only ever had a handful of such companies speaks volumes.

The correct mindframe

But even so, the Qualiport remains a firm fan of the LTB&H investing approach. Just by using the notion that you are expecting to hold a company's shares for several years puts you into the correct "business perspective" mindframe. As Buffett never tires of saying: "Investing is most intelligent when it is most businesslike".

Thus the business questions you would ask of your prospective LTB&H company would cover aspects such the visibility of future sales growth, the prospects of industry competitors and the reinvestment potential of your slice of the company's profits.

If you were effectively going to be "locked in" for several years, you'd obviously be extremely choosy as to which businesses would get your money. Certainly you'd be particular in terms of the price paid too. You'd carefully study the history of the company, looking uppermost for a long record of reliability, predictability and superior profitability. The words "sustainable competitive advantage" would come to mind too. Although the past is no guide to the future, as we all know at the Qualiport, those companies exhibiting above average credentials must be the best place to start any investment hunt.

The frequently stated benefits of LTB&H usually revolve around not having to react instantly to daily share price movements and dealing costs being kept to a minimum. But a slightly understated, yet significantly important, benefit of the LTB&H philosophy is the aforementioned businesslike investment approach. Valuation aside, effectively forcing yourself to become immersed in superior businesses usually goes a long way towards a successful investing career.

In practice, though...

In practice, what actually occurs after we've made our share purchases doesn't always align with the initial LTB&H philosophy. Businesses and industries change. So although we have every intention of keeping the current Qualiport members for the long-term, we make the following proviso:

• If the business fundamentally deteriorates after the purchase, or
• If there are better opportunities elsewhere, or
• If the stock market is grossly overvaluing even the most optimistic of long-term prospects...

...we have the right to sell.

Thus to go back to Mark's original suggestion, the Qualiport will use the LTB&H both as a guiding principle and as an aspiration. We will aspire to go into every investment decision fully expecting to keep our shareholding for the long-term. And having the LTB&H as a guiding principle should not tempt us with less desirable companies, regardless of their valuation. We are liable to suffer if we do. "Cheap crap is still crap", as Bruce likes to say.

Summer Season

Although you'd hardly know it from the weather, the Qualiport's "summer" reporting season is now upon us. Five of the portfolio's constituents update their shareholders over the coming weeks. Here are all the dates for your diary.

Company                      Date                   Results

Misys                      Thur 27th July           Annual
Lloyds TSB                 Fri  28th July           Interim
Dell                       Thur 10th August*        Second Quarter
Independent Insurance      Tue  15th August*        Interim
PizzaExpress               Mon   4th September*     Annual

(* -- provisional)

The portfolio's summer of number crunching will kick off with either the Misys (LSE: MSY) or Lloyds TSB (LSE: LLOY) results this Friday. Until then, your thoughts on the relevance of the LTB&H within the Qualiport can be directed to the Qualiport discussion board, in the Resources box below.

Where Next?

• Bruce asks "When to Sell?"