QUALIPORT
The Wrong Bargains

By Maynard Paton (TMFMayn)
July 9, 2001

Carburton Street, London -- Over the long term, ordinary investors will never get rich pursuing a follow-the-crowd investment philosophy. Instead, investors should always consider companies or sectors that have fallen out of favour with the stock market. The words of two very rich investors underpin why successful investors should develop a contrarian stance.

After being asked where he looked for investment opportunities, Sir John Templeton responded:

"I would say where there are shares which are most depressed in price, where there is the point of maximum pessimism."

"If you want to buy shares when they are depressed, you look for a point when everybody is trying to sell... Where in the world are people extremely pessimistic? Then if there is a change, you can make a lot of money... I would spend some time asking myself which industry, which nation is almost everyone trying to get out of?"

Warren Buffett outlined his preference towards stock market environments within his 1990 Shareholder's Letter:

"The most common cause of low prices is pessimism -- sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer"

Techs in turmoil

Without doubt, the three most distressed sectors at the moment are Telecoms, Software and IT Hardware. So, is it now time for the Qualiport to investigate these areas? In a word, no.

Tech companies can largely be divided into three camps:

* Premier League: Those with a proven superior record, which should remain intact through the current turmoil;

* Second Class: Those with a reasonable past record, but have suffered in the difficult trading conditions, and;

* Harry Hopefuls: Those with no track record to speak of, but whose product potential ranges from zero to enormous.

Here's a selection for each group. For the loss-making hopefuls, I've used the price to sales ratio (PSR) as a valuation guide.

Premier League

Company          Share Price      Forward P/E

Vodafone            151p             29.7
Logica              690p             29.0
ARM Holdings        203p             62.2

Second Class

Company          Share Price      Forward P/E

Cable & Wireless    373p             41.9
CMG                 250p             29.4
Spirent             190p             18.8

Harry Hopefuls

Company          Share Price      Price to Sales

Trafficmaster       89.25p            8.3
Emblaze            183.5p            11.1
Parthus             45.5p             9.8
Izodia              37.25p            7.6
Lastminute          33.5p             8.8
NXT                 240p             12.2

Quality Counts

It's fair to say that many of these tech companies lie well outside the Qualiport's circle of competence. Unfortunately, the ones where the Qualiport's interest could be tweaked -- those Premier League players where some operational certainty can be assumed -- valuations still remain optimistic.

Of the rest, do the likes of Cable & Wireless (LSE: CW.), Parthus (LSE: PRH) or NXT (LSE: NTX) possess a sustainable competitive advantage? Difficult to tell, unless you have some specific industry insight. Some of the second- and third-liners may be relatively "cheap", but that's not enough on its own to invest. The Qualiport's "been there, done that" with MMT Computing (LSE: MMT).

(As an aside, should the company maintain its historic payout, MMT's shares, at 192.5p, now offer a prospective dividend yield of 10%. The shares are indeed cheap. However, everything rests on MMT's new management returning the company to historic levels of profitability before the company's large dividend-funding cash pile disappears. Not a Qualiport share buying situation.)

Side effect

Sadly, one side effect from the tech shakeout is the increasing attraction to more "traditional" companies. Rather than chance their arm with microchips, video streaming software and optical fibres, investors are now seeking much "safer" havens, such as food retailers and branded consumer goods companies.

The heightening emphasis on stability and predictability isn't going to do the Qualiport many favours in the short-term. With this portfolio favouring companies that exhibit such characteristics, finding ones that are attractively priced could become gradually more difficult. Indeed, the danger now is that investors could easily become involved in a follow-the crowd strategy with steady traditional companies! The Qualiport has "been there, done that" too, with Unilever (LSE: ULVR).

Undoubtedly, the current tough industry conditions will present many bargains within the tech sectors. Maybe one is MMT. However, they are the wrong type of bargains for the Qualiport. There are certainly plenty of other tech companies out there that could be deemed cheap at the moment but will eventually prove an expensive mistake for long-term investors. Because of the ever-changing nature of their industries, sorting the tech wheat from the tech chaff is a difficult game to win. And it's not a game the Qualiport will actively pursue. Only in a few years time will the Qualiport have any real insight into the technology bargains of these troubled times.

The author holds shares in MMT Computing

More: Time to Turn to Techs | MMT: Time to Cut Our Losses? | Fool Buys Unilever