Qualiport

[ October 5, 2000 ]

Right On The Fence

By Bruce Jackson (TMFGoogly)

This investing lark can be tough at times. The Qualiport is down almost 16% this year. It is down almost 13% since the beginning of 1999. Oops.

In life, you never stop learning. That is particularly the case when it comes to investing. Reading great investing books is an excellent way to learn. Reading and posting on our discussion boards is another great way to learn about investing in general and specifically about individual companies.

Whilst all that reading gives you a good foundation, nothing beats experience. I've written many times before about how you learn the most from your mistakes. Mistakes which have a negative financial impact are the ones that should stick in your mind the longest.

Enter Rentokil Initial (LSE: RTO), Unilever (LSE: ULVR) and Marks & Spencer (LSE: MKS). The loss on the first was minimal, the latter two a bit more painful. In the case of M&S, it could have been a lot worse. The Qualiport sold out at 392p and the shares now hover around the 200p mark. Personally I've learnt much from the experience of buying, holding and ultimately selling those three companies, and I hope you have too.

If I was to briefly summarise the lessons learned:

- buy good companies cheaply
- sell them if and when they become overvalued

Onto another painful mistake...

We Were Right

Monday's Qualiport article was titled "Dell -- The Qualiport's Bad Apple?". Maynard wrote:

"I think it will be very tough, but not impossible, for (Dell) to achieve its stated 30% sales growth target. There could be an upset on the horizon..."

Low and behold, last night Dell Computer Corporation (Nasdaq: DELL) warned that third quarter revenue growth will be 3% less than expected and that it expects full year revenue growth to be around 27%. Maynard is a genius, a fortune teller, a company insider, or all three!

In after-hours trading last night, Dell shares dropped 10% to a new two year low. Basically demand in Europe has been weak, and small business customers have not been buying personal computers. For the full scoop, check out this story over at big brother fool.com.

We got this one right. Thankfully for the Qualiport, Dell is our smallest holding making up only 9% (and falling!) of the total portfolio. What should we do with this fallen hero? As usual, there are three choices.

Buy Hold Sell

1. Buy some more -- IF this is a temporary glitch in Dell's otherwise superb past growth record, this could be an opportunity to buy some more shares. The market almost always overreacts to bad news, and the shares could get battered down to relatively cheap levels.

2. Hang on -- the easy option. Fence sitting. The only reasons to fence sit are:

a) because you still believe in the company but they are not cheap enough to buy more, nor expensive enough to consider selling.

b) you don't believe in the company's really long term prospects, but believe the shares are temporarily undervalued. Buying more is not an option, nor is selling. As an investor, this is by far the weakest situation in which to find yourself. How many times have you said to yourself "I'll just sell these when they get back to xxxp" only to find they never get there. In fact, the only place they usually get is cheaper still.

c) because they are one of your 'inevitables' -- a company you'll never consider selling. These are extremely rare. Warren Buffett has about three inevitables, one of which is Coca-Cola (NYSE: KO). I suspect even Buffett is having second thoughts about holding Coca-Cola indefinitely, given that in the last two years the stock has fallen 35%, it still trades at a lofty forecast price to earnings ratio (P/E) of 40, and has single digit sales growth. I'd argue that the chances of finding an 'inevitable' are not much far above zero.

3. Sell -- you don't believe in the company's long-term future prospects, and the shares are fairly valued.

The Fence

Much as I hate it, at the moment I'm afraid I fall into category 2 b). Part of me still believes that Dell is a quality company going through temporarily difficult times. After all, 27% year on year revenue growth is impressive. With the shares trading on a forward P/E of about 30, they don't appear super expensive.

Another part of me believes that future revenue growth is going to keep rapidly falling (as a percentage), and that selling now is the best option. Sales for 2000 are forecast to be US$32 billion -- the rule of large numbers (is that a rule?) comes into play, whereby at a certain stage it becomes impossible to grow at large percentage rates.

This is a little off-topic, but related. At one stage during the Japanese equity boom, telecoms giant NTT was capitalised at a value great than the whole of the West German stock market, and not far behind the whole of the UK stock market.

The point is that eventually and inexorably, markets and prices of individual companies revert to the norm. A company growing sales at 10% per annum deserves an average market rating. With interest rates now around 6%, that implies a fair P/E of 16.7 (1 / 6% = 16.7). How long till Dell's sales growth hits 10%? That is the conundrum.

Maynard will make the ultimate decision about Dell's future in the Qualiport. He's back on Monday.

All feedback encourages to the Qualiport discussion board. Before last night's warning, there was already an interesting thread about Dell.