Qualiport

[ September 14, 2000 ]

Visionary Investing

By Bruce Jackson (TMFGoogly)

A visionary I am not. I can usually see as far as the end of my nose, and that's only with my glasses on. But to be a successful long-term investor, you have to have some vision of how the future will pan out.

My possible pure value play suggestion of Monday, Homestyle Group (LSE: HME), is a classic example. The company looks cheap, based on its forecast earnings growth of 44% then 24% over the next two years, bringing its price to earnings ratio (P/E) down to just 6.7.

That seems cheap. A P/E of 6.7 is the equivalent of an earnings yield of 14.9% (1 / 6.7 = 0.149), which is miles above the base interest rate of just 6%. Add in the prospective dividend yield of 6.6%, and you'd be easily be forgiven for thinking that someone was giving money away.

But you'd be wrong. The stockmarket is not a place where money grows on trees. If a company is cheap, it is almost certainly cheap for a reason. It is only on the very odd occassions that the market gets things completely wrong. Those are the times when you should act, looking to buy good companies at irrationally low prices.

Be A Cyclical Visionary

Back to Homestyle Group. It is cheap for a reason. It operates in a commodity business -- furniture retailing. It operates in a very competitive industry. It operates in a cyclical industry, one in which it is dependent on the health or otherwise of the housing market. That's why it is cheap.

Back to vision. If you are going to beat the market, you have to be able to predict the future. The buyer will be optimistic, the seller pessimistic. In the case of Homestyle, you will be betting that the housing market remains reasonably buoyant for at least the next 18 months. After that, you are betting on inflation remaining under control and the lack of a recession. You are looking into the future, being a visionary.

The market always looks forward. One of the mistakes the Qualiport has made is to concentrate too much on the past. Sure, the past can help you identify a good company, but it doesn't guarantee a good investment -- Rentokil Initial (LSE: RTO) being a good example.

Be A Pure Visionary

The person buying ARM Holdings (LSE: ARM) today is looking to the future. Their version of the future is very bright, one where literally hundreds of millions of ARM chips are sold each year. As buyers, they are betting on the future being brighter than sellers think it is. They have a vision, and time will tell whose vision of the future is correct. Buyers of Glaxo Wellcome (LSE: GLXO) in 1965 had a vision -- perhaps it was a vision of a pharmaceutical giant worth £71 billion. That would have been a very optimistic vision back in 1965, but obviously it was achievable.

Be A Patient Visionary

There are other ways to beat the market. They involve huge amounts of patience, and potential periods of underperformance, especially in these relatively go-get-'em days of high stock market valuations. They involve buying great companies cheaply. They become cheap when they get into trouble and when the whole market becomes irrational. When a company is in trouble, your challenge is to make sure the trouble is only temporary (difficult). When the whole market becomes irrational, opportunities will abound (easy -- but tough psychologically to achieve).

Be a Value Visionary

Big companies can't grow quickly. It's a numbers game. If a big company keeps growing at 15% per annum for 20 years, it will soon be worth a disproportionately high percentage of the the country's Gross Domestic Product (GDP). That's impossible. Have a look at some of these numbers, in this excellent post by LarryDuff about Glaxo Wellcome (LSE: GLXO).

It was also highlighted in this morning's Breakfast News. Here's an extract:

"McDonald's (NYSE: MCD) disclosed sales for the month of August rose 5% to $3.6b and for the first eight months of the year total sales were $26.9b, an improvement of 5% on a year ago."

It's quite difficult for companies that big to grow fast -- 5% growth is nothing to write home about, and perhaps that's why Warren Buffett sold his shares in McDonald's. The shares now trade on a P/E of 18, and are now trading at the same price they were 2 1/2 years ago. That's not a good return on your investment.

In Summary...

Quality matters. Size matters. Valuation matters. But most of all, vision matters.

Where Next?

Comments, feedback and general investing thoughts encouraged to the Qualiport discussion board.
Homestyle Group -- a value play?