QUALIPORT
Shares That Could Lose You Money

By Maynard Paton (TMFMayn)
June 7, 2004

The stock market's recovery has prompted many investors to revisit 'growth investing'. But for growth investors with short memories, danger lurks, especially if the common sense rules about industry competition, sector saturation and market cycles are forgotten.

The following shares have all got impressive financial records and shareholders that can rattle off a convincing investment story. They are most likely to lose you money, too.

Specialist retailers

Specialist retailers are the small investor's graveyard. Lured by the familiar high street names, inexperienced punters quickly forget about the dangers of racy earnings multiples and intense sector rivalry.

(The Qualiport has got this particular T-shirt with PizzaExpress.)

Nevertheless, an endless stream of new high street chains continues to attract the unwary. Four current favourites are listed below:

Share	Five-year compound EPS growth (%)	Share price (p)	Historic P/E
Domino's Pizza (LSE: DOM)	27	199	22
Majestic Wine (LSE: MJW)	21	823	22
Merchant Retail (LSE: MRT)	28	147	14
Topps Tiles (LSE: TPT)	36	168	20

Just like PizzaExpress and a whole host of other rollout formats, Domino's, Topps, Merchant and Majestic will eventually succumb to copycat rivals, and discover new stores are gradually having less and less impact on their overall growth rate. Worryingly for existing shareholders, when a fast-expanding retailer hits trouble, it has a nasty habit of seeing its price to earnings (P/E) ratios contract to around seven.

In the meantime, however, like-for-like (LFL) sales growth remains strong. At Topps, the latest figure was 19%, with 10% at Merchant, 7% at Majestic and 5% at Domino's. Of the four, perfume chain Merchant may well be the first to see its expansion rate crack. Recent results talked of a 'challenging year ahead', changes to manufacturer supply practices and 'operational challenges' involving new computer systems. Notably, no LFL figure was given for current trading within the group's outlook comment.

Housing market

Many investors mistake favourable industry conditions for a growth company's prowess. Though the bear market unmasked many pretenders (notably in the once-booming IT sector), one particular area continues to foster numerous growth share imposters: the housing market.

Following a twelve-year bull run, today's house price statistics suggest Britain's property cycle is about to turn. And when consumers end their love affair with bricks and mortar, those in the front line will not be able to buck the downturn.

The following table lists three builders, chosen because of their relatively low interest cover, followed by three mortgage companies, selected due to their heavy exposure to the more colourful parts of lending industry (e.g. self-certification, buy-to-let):

Share	Five-year compound EPS growth (%)	Share price (p)	Historic P/E
Countryside Properties (LSE: CYD)	19	219	7
Crest Nicholson (LSE: CRST)	22	341	8
Westbury (LSE: WBY)	18	436	7
Bradford & Bingley (LSE: BB.)	13*	279	10
Kensington (LSE: KGN)	112*	423	9
Paragon (LSE: PAG)	10	330	9

(*four-year average)

Don't be fooled by the low P/Es. Construction and money lending have never been areas noted for their sustainable competitive advantages, with cash flow, debt and accounting transparency prominent issues among the six highlighted shares.

Hedge funds

'Reversion to the mean' is something that will eventually catch up with Man (LSE: EMG). The hedge fund manager continues to trumpet superb profit progress, yet history shows no fund manager having outperformed the market forever. Unless Man goes on to own the world, sooner or later the funds will falter and performance-chasing investors will look elsewhere. So the remark 'the hedge fund asset class is rapidly maturing' in the latest annual report does not inspire that much confidence.

Though earnings at Man have improved 31% on average since 1999 and the current P/E at 1,588p a share is about 14, fund managers are usually valued as a proportion of the money under management. At the last count, funds under management totalled $38.5b (£21b), equivalent to 23% of Man's market value and well above the low, single-digit percentage applied to money managers in general.

Balancing the toppy valuation perhaps is the fact that Man continues to collect some juicy performance fees. Of the total earnings per share of 117p reported in the year to March 2004, 33p related to this particular type of income. However, returning $3.0b in the past financial year, when funds under management started at $26.1b (i.e. 11% ), doesn't seem too impressive given how most stock markets have performed since April 2003.

And don't forget, Warren Buffett (somebody who knows how to out-perform the market over long periods of time) said last month: "People that are now investing in hedge funds in aggregate are going to be disappointed". Who'd disagree with him?

Where next? Looking for shares to make you money? Enjoy a FREE 30-day trial of the Motley Fool's UK Value Investor newsletter. Click for more details.