Qualiport

[ October 12, 2000 ]

Panic - The Market's Falling

By Bruce Jackson (TMFGoogly)

How's your share portfolio been performing over the past few weeks? Not great I suspect. The Qualiport has been struggling too. What should you do?

Panic Selling?

I've recently been doing a bit of selling -- not only selling Misys (LSE: MSY) from the Qualiport, but also from my personal portfolio. You may be thinking that surely now's not the time to sell, with the market falling, and you'd be partly correct. But there are still many companies trading at very high levels. There's nothing wrong with selling them now, even though the overall market is falling.

What you shouldn't do is panic sell. That happens when you sell a company just because its share price is falling. Don't do that! Don't go there! That's NOT investing.

Buying Opportunities

Market panics create buying opportunities. But we're far from the panic stage. The current market wobbles are nothing more than a reality check. It's very difficult for pure Internet B2C companies to make money, so the share prices of those companies are rightfully tanking. It was pure fantasy that just after they floated lastminute.com (LSE: LMC) was capitalised at £730m on forecast 2001 sales of just £10m. No wonder their share price is in the doldrums, and has probably got further to fall yet.

Reality

Reality has started. But it's got a long way to go yet. Take these FTSE 100 companies for example.

Company           Share   Market  Forecast
                  Price    Cap      P/E

Arm Holdings       670p    £6.6b    235
Celltech Group    1261p    £3.4b    104
Capita Group       575p    £3.7b     85
Logica            1980p    £8.8b     74
CMG               1295p    £8.2b     70

Reality is still a long way off for some of those valuations. Some simple maths tells you that Arm Holdings (LSE: ARM) is massively over-valued. Many people compare Arm to Intel (Nasdaq: INTC), and look at Intel's US$237 billion market capitalisation as a benchmark. But what they conveniently ignore is the relative price to earnings (P/E) ratios. After a recent profit warning, Intel trades on a forward P/E of 21.

If you assume that Arm's long-term P/E will be 21, to justify today's valuation they need to make net profits of £341m or earnings per share (EPS) of 34.7p. EPS are currently forecast to be 2.85p for 2001, meaning Arm will have to grow profits by more than 28% per annum for the next 10 years just to justify today's valuation. If they achieve that very demanding goal, and the P/E shrinks back to 21, the share price in 2011 will be 670p, exactly where is stands today. That's 10 years for 0% growth! Reality will hit, but it's not there yet.

The Glitch

Increasingly so, I am firmly of the opinion that the time to buy companies is on the glitch. Throughout a company's long corporate life, they will undoutedly go through bad patches. The Qualiport's very own Dell Computer Corporation (Nasdaq: DELL) is having a minor glitch, and the share price is rightly being punished.

The challenge for the private investor is to determine whether this is a temporary or permanent glitch -- no mean task. An example of a temporary glitch is Psion (LSE: PON). Back in 1998, revenues from their traditional hand-held organisers were slowing, and competition was increasing. In short, they looked dead, and a share price of 41p told the sorry tale. But the clever and visionary investor may have recognised that this was merely a glitch in the impressive long-term record of a successful technology company.

An example of a permanent glitch is Marks & Spencer (LSE: MKS). They lurch from bad to worse, as today's admission that all was not well in food sales saw the share price hit an eleven year low of 172p. The Qualiport sold out in May last year at 392p. We couldn't see any signs of recovery then, and nor can I see any now.

As you can see, 'glitch investing' requires much skill and not a small amount of faith. Picking that Psion was going to recover and refocus its business model to such a dramatic extent needed a lot more faith than skill. But heck, it's that type of thinking and behaviour that sorts the investing chaff from the wheat.

No Glitches

We're yet to see widescale glitches here in the UK. In the US, Intel, Dell, Lucent (Nasdaq: LU), Motorola (NYSE: MOT) and Apple (Nasdaq: AAPL) have all had profit warnings in recent weeks. Most of the companies cited soft European markets as one of the reasons for their shortfalls. So why aren't we hearing the same story from UK quoted companies? Is it because few UK companies are required to report 3rd quarter earnings? What if many UK quoted companies know they're having a soft sales period, but are hoping to trade their way out of it in the final quarter of the year? Hope is usually not enough.

Christmas Profit Warnings?

I wouldn't be surprised to see quite a few technology company profit warnings in the lead up to Christmas. Don't get me wrong -- I've not suddenly turned into an arch bear, although reading this you're probably justified in thinking otherwise.

I'm constantly learning, and constantly looking for buying opportunities. Selling is the easy part. Learning tells me to buy 'temporary glitch' companies because that's when the buying opportunities come. The Qualiport is sitting on over £5k in cash, and is ready willing and able to pounce. But, as ever, patience is the key.

Where Next?

All suggestions and comments encouraged to the Qualiport discussion board.