Qualiport

[ November 16, 2000 ]

The Great Leveller

By Bruce Jackson (TMFGoogly)

Be humble. Respect the power of the market, for it is right more often than it is wrong.

These are some of the underlying themes running through the book The Super Analysts, by Andrew Leeming. It is made up of a series of interviews with some of the world's leading investment analysts. All of these people work for investment banks, either as fund managers (known as buy-side) or simply "analysts" (known as sell-side). The analysts are the people who write all those lovely reports about companies, complete with earnings estimates and "buy/hold/sell" recommendations.

Whilst the work sell-side analysts do is valuable to the investment community -- which includes us private investors -- it shouldn't be forgotten that these people are essentially sales and marketing people for their investment banks. Virtually the sole purpose of their reports is to encourage people to trade the shares they cover, and trade them with the bank they work for.

The bottom line is that by all means investors should use the reports to gain an insight into a company, but should largely ignore the investment recommendation. As ever, investors should make their own conclusions and investment decisions, because it's our money.

Value Investing

Another theme running though The Super Analysts is that of value investing. Of course all investing is value investing. Or at least it should be. Those buy-and-hold investors who buy companies regardless of their valuation do so at their absolute peril. Because they are almost invariably buying already richly valued companies, investors are relying on their skill in picking the very few truly exceptional companies. It should never be forgotten that the majority of quoted companies destroy shareholder value, so the universe of exceptional companies is extremely small, say less than 3%. Put another way, 97% of companies will not be suitable long-term buy and hold investments. A sobering statistic.

Tech Carnage

Take your pick of fallen technology companies. Virtually without exception, just about every one is significantly off its highs of March this year. Let me choose one company as an example of what can happen when valuation is ignored -- Freeserve (LSE: FRE).

In March this year, when Freeserve's share price was above 900p, it was valued at over £9 billion. Sales for the year ended April 2000 were £19.6 million. How could the £9 billion valuation have been anything other than utter market insanity? Even at today's share price of 135p, which capitalises Freeserve at over £1.3 billion, surely most of the future growth of the company is still priced into the shares.

If you choose to differ from my view, and you think Freeserve offers value at today's prices, you are inevitably betting that Freeserve is going to be one of the best performing companies ever, truly in the upper echelon of British companies. In that top 3%. You may be right, but the odds are stacked against you. And that's because you're paying a premium price for Freeserve.

Value ultimately matters, and to justify today's valuation, Freeserve has to continue growing at a very fast clip for many years to come. Is it worth £9 billion? Come and see me in 10 years at a minimum, although it's hard to see Freeserve being around as a separately quoted entity in 2010.

I must conclude this Freeserve bash with some positive thoughts. I use the service, and I find it very good. Despite the myriad of competing offers, I intend sticking with Freeserve. It is not Freeserve's fault that the market pushed its shares into the stratosphere. I use the company just as an example -- an example of how all investing should be value investing, and investors who shun valuation are playing a very risky game.

Where's The Value?

So, Qualiport managers, if you think Freeserve is such a poor investment, what's your bright idea? Well as it so happens, our bright idea at the moment is to make cash our biggest holding. It's sitting in a high interest bank account earning us a not-to-be-sniffed-at 6% per annum.

That's because at the moment, we haven't got any investment ideas. They don't come along very often, so it's not surprising we're sitting on that cash. Where possible, we like to add to our existing holdings, but at the moment none of them are in bargain basement territory. We're looking for value. PizzaExpress (LSE: PIZ) is arguably the closest to representing true value, but is not quite there yet. We'd top up again at prices below 600p.

Humility

Back to The Super Analysts. The market forces humility on investors because most of the time it is right. Cheap shares are cheap because the underlying company is struggling. Expensive shares are expensive because the underlying company is performing well. But every once in a while, the market goes through a period of irrationality. That's the time to buy.

But some words of warning for those investors who think the market is currently acting irrationally, particularly in respect of technology shares. The valuations of most of them have got a long way to fall yet! This article of a month ago titled "Panic -- The Market's Falling" lists some of the very highly valued companies I'm referring to. If an excellently managed and growing technology company become attractively priced, I'd be just as keen as anyone to buy shares in that company. For example, the Qualiport owns MMT Computing (LSE: MMT), a technology play, and our best performer. I write those comments not because I'm an arch bear on technology shares. I'm being realistic.

Don't under-estimate the power of this market, and don't forget about its ability to humiliate even the very best of investors.

Qualiport News

The market never ceases to amaze. Yesterday Independent Insurance (LSE: IIG) issued a weather related profit warning. And what happened to the shares? They rose almost 4%. Go figure. But, we're certainly not complaining, in the short term.

All comment and feedback encouraged to the Qualiport discussion board.

Where Next?

• Buy The Super Analysts at Amazon.co.uk