QUALIPORT
Shares That Lost You Money

By Maynard Paton (TMFMayn)
January 6, 2003

An important part of the stock market learning curve is to sense businesses that are set for shareholder heartache. In January 2001, I presented an anti-Qualiport; the companies involved having at least one attribute that this portfolio tries to avoid.

The investment characteristics and shares were:

* Overvaluation: Telecity (LSE: TCY) and Fibernet (LSE: FIB);
* Excess competition: Ted Baker (LSE: TBK) and Coats (LSE: CO.);
* Unpredictability: Cambridge Mineral Resource (LSE: CMR) and KS Biomedix (LSE: KSB), and;
* Dubious management: Photo-Me International (LSE: PHTM) and Wiggins (LSE: WGG).

Here's how the eight shares have performed over the intervening two years:

Company        Share Price        Share Price        Change
                22/01/2001         06/01/2003         (%)
                    (p)               (p)

Telecity            603               3.25          -99.5
Fibernet            880              22.75          -97.4
Ted Baker           320             206             -36.6
Coats                47              49.5            +5.3
Cambridge Mineral    27              12             -55.6
KS Biomedix         601              13             -97.8
Photo-Me             77              19.5           -74.7
Wiggins              30               2.9           -90.4

Excluding dividends, the shares are down some 68% on average. Over the same time, the FTSE 100 has fallen 35.8%. Apart from textile firm Coats, whose 'value' characteristics (notably a 6% dividend yield and a price to book ratio of 0.65) have kept its shares afloat, the lessons should be obvious.

Sustainable competitive advantage

This time last year, I highlighted three small, highly rated and fast growing companies, whose competitive barriers were very questionable. To reiterate, if you're a long-term investor, the one characteristic every company in your portfolio must have is a 'sustainable competitive advantage'. Far too many businesses exhibit high rates of growth for a few years (with investors gladly buying in on rich multiples), only to succumb to the competition some point down the line.

The next table shows how the three selected shares performed in 2002:

Company         Share Price         Share Price       Change
                 22/01/2001          06/01/2003         (%)
                    (p)                (p)

Merchant Retail     129                123             -4.7
Unite               347                153.5          -55.8
Liontrust Asset     438                326.5          -25.5

Excluding dividends again, the three shares recorded an aggregate fall of 10.7% in 2002, a half-decent performance given the market's 25% dive.

Unite (LSE: UTG) fared the worst. Like many firms involved in PFI work, the supplier of accommodation to students and NHS workers had to restate its accounts during 2002. At a stroke, a £3m pre-tax profit turned into a £3m pre-tax loss. Certain contract difficulties dogged the firm, too.

Merchant Retail (LSE: MRT), owner of The Perfume Store chain, kept to its growth path during 2002. The retailer's latest results showed pre-tax profits up 51%, buoyed by like-for-like perfume sales running 18% ahead. Nevertheless, Merchant sill faces competition issues. There are few hurdles to stop deep-pocketed Boots (LSE: BOOT) and supermarkets from damaging Merchant's expansion programme. Still one to avoid.

Being a fund manager, it's not surprising the shares of Liontrust Asset Management (LSE: LIO) fell pretty much in line with the market. In terms of valuing money managers like Liontrust, it's worth referring to famed short seller 'Evil Knievel': "Most fund managers are valued at (a maximum of) 5% of funds under management (FUM), even in takeover situations."

In January last year, Liontrust's then £144m market value was equivalent to 7.6% of its £1.9b FUM (including funds in transition). These days, the figure has fallen to a more reasonable 3.8% (£110m of £2.9b). All in all, it's fair to say that for Liontrust shares to beat the market in future, its funds must do likewise. While the company's stock picking has been good so far, the chances are the ever-growing FUM and the generally poor reputation of professional managers will eventually bring a reversion to the mean.

And what of 2003?

So which shares will lose you money in 2003? Difficult to say, really.

Given the numerous blow-ups witnessed over the past few years, the stock market is currently in a cynical mood. And although plenty of shares will certainly disappoint investors over the next twelve months, it's tricky to find such firms whose valuation isn't factoring in some sort of future mishap already.

For instance, Big Food (LSE: BFP) and Ashtead (LSE: AHT), two companies with operational problems and too much debt, trade on price to earnings (P/E) ratios of just 7 and 3 respectively.  Elsewhere, the acquisitive-but-heading-for-a-fall Torex (LSE: TOX) languishes on a P/E of 7. Merchant Retail, described above, is valued on a P/E of 11. Suffice to say, the market currently offers few obviously overvalued shares.

Without doubt, by far the best opportunities to identify shares that could lose you money have been and gone. Instead, the task for investors this year (and every year, in fact) is to find companies that could make you money. From the Qualiport's own watch list, good places to start would be Lloyds TSB (LSE: LLOY), Halma (LSE: HLMA), Renishaw (LSE: RSW), Carpetright (LSE: CPR), DFS Furniture (LSE: DFS) and the London Stock Exchange (LSE: LSE).

The author owns shares in Carpetright, DFS Furniture, Halma and the London Stock Exchange