Qualiport

[ September 18, 2000 ]

Drawing Your Circle

By Maynard Paton (TMFMayn)

Carburton Street, London -- Before I start on the main theme of this article, let's get something done straight away.

We're selling Misys (LSE: MSY).

Regular Qualiport readers will be aware of my concern over the company's acquisitive history and equity reinvestment returns.

I have, in the past, suggested that we sell Misys only when it became "grossly overvalued". This was a mistake. I should have sold immediately after my interpretation of the latest set of full results. Basically, being uncomfortable with a company's financial record, especially when it's accompanied with a high rating, should always combine to make a "sell" decision.

However, at the time of the full-time results, I foolishly (note the small "f") tried to hold out for a higher share price. The shares moved from 665p after the annual results announcement to just under 800p at the end of August. Back then, I thought that if the shares were to go over 800p, I'd sell.

Of course, Misys shares never breached my 800p "psychological barrier". They've since slumped to 631p.

So there are two options for the Qualiport. Either we hold on indefinitely, hoping for a better price that may never arrive. Or get rid of Misys, to instead concentrate on looking for better homes for our money and not to become mesmerised by short-term share price movements. I'm choosing the latter option.

So, in accordance with the Fool's Trading Rules, the Qualiport will sell all 542 of its Misys shares within the next 5 trading days.

Circle of Competence

Here are two paragraphs from Warren Buffett's 1996 Shareholders' Letter.

"Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.

Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital."

We've written about the "circle of competence" aspect of investing many times before. In essence, sticking to a few industries, gaining specialised knowledge and focusing on what you know should lead to improved investment returns.

In this Qualiport feature, I wrote:

"At the moment, the portfolio consists of a computer manufacturer, a magazine publisher, an insurer, a bank, a restaurateur and two totally different IT companies. In days gone by, we've also held a food manufacturer, a retailer and a rat catcher. A varied bunch.

The charge here is that we've been guilty of spreading ourselves too thinly across many different sectors, knowing a little about several, rather than a lot about a few. Has that thin spread led to our poor performance? Instead, when searching for new opportunities, maybe we should remain in industries that have superior prospects and economics."

To answer my two questions:

• Yes, our thin spread has led to our poor performance, and;
• Yes, we should consolidate our investment knowledge by concentrating on familiar industries, but not necessarily those areas that have obviously superior prospects and economics.

The success of an industry focus approach was highlighted when I reviewed Buffett's stock picks the other week. It was evident that his selections revolved around three distinct areas:

• Media -- newspapers, television and advertising;
• Finance -- banking, insurance and financial services, and;
• Branded consumer goods -- food, drink and toiletries.

Certainly, the media sector continues to exhibit superior prospects and economics. But as a rule, banks, insurers and consumer goods companies perhaps don't have quite the same investment characteristics. Nevertheless, Buffett has been handsomely rewarded over the years by sticking to his circle of competence.

My view is that you don't have to limit yourself to the greatest of growth sectors to make money, but to just restrict yourself to industries in which you have some "superior" knowledge. The industry in which you work is typically a good place to start (okay, so perhaps investing in profitless financial websites isn't true Qualiport style...)

Which industries?

Looking through the current Qualiport members and comparing them with my own "specialist" knowledge, two sectors immediately stand out.

• Software / Computer services. I was a computer programmer / analyst for nearly ten years, hence my leaning towards the sector (in particular, witness the purchase of MMT Computing (LSE: MMT)).

• Restaurants and Pubs. Last year, I wrote a chapter covering this sector for the Motley Fool's Industry Focus 2000. Having looked through the vast array of players in this particular sector, I've gradually learnt what the winning companies need to possess in order to succeed. Just as important, I've discovered how and why the underperforming players have failed. It makes sense to utilise this knowledge. Indeed, I've done this in the past with a PizzaExpress (LSE: PIZ) top-up.

And I'll also throw in a third area of my expertise, an area that has brings back bad memories for this portfolio...

• General Retailers. Again, this expertise largely stems from a chapter I wrote in the Motley Fool's Industry Focus 2000, alongside some experience gained from my own personal investments.

So for now, my hunt for a Misys replacement will concentrate mainly on these three areas. I've drawn a circle of competence. I'm sure there must be at least one company within the three sectors that has attractive investment characteristics for a 3-5 year holding period. Having said that, longer term buy and holds don't usually exist in the retail industry. But there may a small chance of finding "the next Matalan (LSE: MTN)".

(But to every rule, there's an exception! On Thursday, I'll put forward a company for the Qualiport that I have significant knowledge of, but operates outside of my defined circle.)

Indeed, I may have accidentally stumbled across a Qualiport candidate a few months ago. Do you remember this Pizza Battle feature? ASK Central (LSE: AKC) ran PizzaExpress very close in the financial performance stakes.

ASK alongside PizzaExpress within the Qualiport? Let me know your thoughts on the Qualiport discussion board, linked in the Resources box below.

Where Next?

The Qualiport analyses 23 years' worth of Buffett's stock picks
Qualiport Pizza Battle -- ASK Central vs. PizzaExpress
The Qualiport becomes uncomfortable with Misys