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QUALIPORT
Quality Shares For A Long-Term Portfolio

By Maynard Paton (TMFMayn)
March 3, 2003

The four steps to successful long-term investing are:

1. Identify superior companies;
2. Determine an attractive valuation for those companies;
3. Wait for the stock market to offer you the attractive valuations, and;
4. Buy the shares.

Every three months, I update and publish the Qualiport's watch list -- a list of companies that I'd be happy for this Foolish long-term portfolio to own.

The list also includes 'buy prices', which I consider to represent attractive valuations for each share. Generally speaking, these entry prices are based on each company's historic free cash flow being capitalised at around 7-8%. However, certain valuations are based on other methods. Details of each company's valuation can be found by clicking on the company's name within the table below. (In addition, any queries on the valuations can be directed to the Qualiport message board, where I'll be happy to go into more detail.)

Of course, as time passes by, things change and the buy prices will inevitably alter. For instance, results later this month from Gallaher (LSE: GLH), Johnston Press (LSE: JPR), Metal Bulletin (LSE: MTLB) and Ulster Television (LSE: UTV) will probably lead to a change in their 'fair value' levels. However, the current buy prices do give a rough guide as to how far some of the shares have to fall before a purchase will be considered.

Education

But please note. The watch list should not be seen simply as a collection of tips. The Qualiport is run for Education, not Recommendation. Remember also that this Foolish portfolio is NOT a real money portfolio and big mistakes have been made in the past. The ultimate message is simple: Do your own research and make you own decisions.

So, in order of market value, here's the watch list:

Company                  Market     Recent    Buy     Price Fall
                         Value      Price    Price     Required
                          (m)       (p)      (p)        (%)

Imperial Tobacco          7,224      991      915         -8
Gallaher                  4,044      623      500        -20
Emap                      1,801      703      661         -6
Associated British Ports  1,310      402      384         -4


Johnston Press 996 354 330 -7
London Stock Exchange 949 320 317 -1 Carpetright 476 630 597 -5 Halma 392 108 115 DFS Furniture 347 328 391 Renishaw 257 353 337 -5 Scottish Radio 203 610 393 -36 Ulster Television 137 261 235 -10 Games Workshop 130 434 377 -13 Metal Bulletin 63 117 119

Changes

One change has been made since December's update: disposing of Lloyds TSB (LSE: LLOY). With 2,138.53 now in the Qualiport kitty, some thoughts on the three undervalued shares:

1. Halma

Halma confirmed in October that its results for the year ending March 2003 would be within the range of current market expectations (i.e. profit growth would be broadly flat). However, that performance will be bolstered by an acquisition. Strip out an estimated 2.4m BEA contribution and 'underlying' operating profits this year look set to fall 5% (in line with the last interim performance).

Also worth noting is the forthcoming departure of David Barber, non-executive chairman and the driving force behind Halma between the 1970s and the mid-1990s. However, chief executive Stephen O'Shea has been at the helm a good few years and has continued the company's consistent and robust progress.

Can't-do-without products, industry growth driven by ever-greater legislation, high margins, low fixed assets and shareholder-orientated management -- Halma possesses many long-term investment attractions. At 108p, the shares stand on a forward P/E of 12.3 and offer a dividend yield of 5.1% and free cash flow yield of 8.0%.

2. Metal Bulletin

Like Halma, annual profits at Metal Bulletin are also expected to be flat. This too comes after some sizeable acquisitions, made in early 2001.

These days, when quality shares are often seen on cheap ratings, investors can be quite choosy. Thus if I were to add a small company media firm to the Qualiport, I'd probably go for Ulster Television rather than Metal Bulletin. While Metal Bulletin has many fine financial qualities, Ulster's are generally better. What's more, Ulster's industry and competitive position (it being an ITV franchisee) are far more visible than Metal Bulletin's reporting on commodity markets.

For the time being, I'll keep Metal Bulletin in the watch list. However, as regular readers of this portfolio will know, when it comes to media, I'm also a big fan of commercial radio. Possibly replacing Metal Bulletin with Capital Radio (LSE: CAP) has crossed my mind lately.

3. DFS Furniture

DFS Furniture (LSE: DFS) looks incredibly cheap. Even on a historical basis, the shares (at 328p) stand on a P/E ratio of 9.8 and offer a dividend yield of 6.9% and free cash flow yield of 8.8%.

But while DFS is a good company, selling furniture is hardly the stuff of business franchises. There's plenty of innovative retail competition about and lots of management running must be done just to stay still. Of the fourteen shares on the watch list, DFS is the cheapest but also the weakest in terms of the overall 'moat'.

Trading update

After some deliberation, the Qualiport will spend 2,138.53 on Halma shares within the next five trading days.

If I wanted to add more shares to the portfolio, I'd probably have to trim the Johnston Press (LSE: JPR) holding. For the record, the shares I'd most like to see join the Qualiport with Halma are Associated British Ports (LSE: ABP), either one of the tobacco firms and Ulster Television.

The author owns shares in Carpetright, DFS Furniture, Games Workshop, Halma, Johnston Press and London Stock Exchange.