Verisign

I am not known as a spontaneous person but on Friday I threw caution to the wind and sold Microsoft to buy into Verisign.

Verisign was not even on my wish list but when I saw how much the share price had been clobbered after issuing disappointing guidance for Q3 and that the forward P/E was now under 20 I decided that this was an opportunity I didn't want to miss.

It turns out I was right to get in quickly - on Monday the share price rose over 4%!

I don't normally favour companies that have their hands in too many pies but Verisign are involved in all the right businesses. Their main business (which the company name was chosen for I guess) is to issue digital security certificates to e-commerce web sites. This is a repeat business as the certificates expire after so many years. Verisign have over 90% of the market share. Revenue growth is slow but this business will generate cash until the end of time.

The product that all the analysts are excited about is Jamba! (or Jamster in the US.) This software facilitates the delivery of content to mobile phones. The main growth driver has been ringtones but other types of content can be delivered like TV and music.

Writing this article has confirmed how little I really know about Verisign. What was my justification for jumping in?

1) Products are in growth areas.
2) VRSN is cash rich and cash generative
3) Growth is 20% and forward P/E is under 20 (or was on Friday!)
4) Full year guidance was actually increased last week, implying that the street has over-reacted.
5) In the last 6 months the share price has twice plummeted to $25 and then recovered quickly to $30.
6) Analyst opinions are still very positive.

Only time will tell if I am right but I am not losing any sleep over this one!

eBay bounces at last

Ah that's better... Finally eBay gets re-rated and I don't have to stare at a big loss in my portfolio any more. By most metrics eBay have returned to 40% growth and that is what has excited investors again. What I like about eBay is that they get 54% of their revenues from the US, meaning that they still have enormous scope for growth around the world.

My eBay shares still show a 2% loss but I will be holding them of course. Google gave me a great H1. Maybe eBay will give me a great H2?

Google slightly missed their EPS estimate last night, vindicating my decision to sell a few weeks ago. I will not consider buying back in unless they fall a long way.

Microsoft had strong earnings figures last night but it looks like the market expected the results to be strong and the share price will probably fall slightly today. I have always looked on my Microsoft investment as a "near cash" holding, available to be sold if a more exciting prospect comes up. As I have found a new prospect and the MSFT shares are showing a small profit I may sell Microsoft today.

The new prospect? Finally I have found a UK company that I love! Arm Holdings PLC design processors used in mobile phones, PDAs, iPods and many more devices. The processor is of course the legendary ARM processor, which ships something like 5 times as many units a year as Intel. ARM do not actually manufacture the chips but license their Intellectual Property to their partners such as Texas Instruments. ARM get royalties for every chip sold, and the figures are approaching 1 billion a year. A nice business model!

ARM are on a forward P/E of 25 - not bad for a company with a 20% growth rate.

With eBay bouncing so well yesterday over 80% of my portfolio is not in US companies so now may be a good time to bring some money over the pond into the UK.

My portfolio is now up 30% for the year to date. Not bad for an amateur!

Qualcomm or Motorola

Yesterday a sizable chunk of money was paid into our current account from the cashing in of our endowment policy. Yes! No more unnecessary monthly charges. No more paying for life insurance that I don't need. No more letters saying that the policy is underperforming and needs more money. The cash is firmly under my control now and it is going to stay that way. Let me see if I can do better than the 6% annual rise that the endowment company predicted.

One quarter of the amount will be invested in a US company. I could quite happily invest all of it in US companies but that would leave me very exposed to movements of the Dollar. Why are they so many global US brands and so few UK ones? Our one cell phone manufacturer has now gone bankrupt (Sendo.) Maybe it is our work ethic or maybe a corporate lack of ambition. All I know is that when I try to think of US companies I would like a slice of I can instantly think of at least ten. eBay, Google, WalMart, Microsoft, Qualcomm, Motorola, Disney, Continental Airlines, Comcast, Intel, Texas Instruments. That was 11 without even trying. When it comes to UK companies I struggle to think of more than 3. Vodafone (world leader in wireless communications), British Airways (well managed), Glaxo SmithKline (lots of drugs coming through), Big Yellow (well managed, growing, nice margins.) There are others but very few have the sort of competitive advantage that the US ones have.

Anyway I have narrowed down the choice of US company to Motorola or Qualcomm. Lets look at Motorola:

P/E: 29 - just inside the limit of 30 which I have set for this account
Yield: 0.82% - hmmm under the 1% minimum. The limit could be stretched I guess...
Market Cap: $47 - well over the £2 billion minimum.
Projected Growth: 12%

A bit dodgy on the yield but MOT just about squeezes in. My time is up but I love Motorola's broad product portfolio. It seems well placed to benefit from the boom in wireless communications.

Current favourites for mortgage portfolio:

US: Motorola
UK: BAA, Tesco, Vodafone.

Other options: Qualcomm, WalMart, Lloyds TSB, RBS, O2, Scottish Power.

Bye bye.

Microsoft

Well I managed to keep my cash out of the market for over a week. That is pretty good for me. I just find it too boring having a bunch of cash doing nothing when it could be invested, generating excitement for me!

The money all went into Microsoft. I did consider Sun Microsystems for a while as I like buying battered blue chips but their line of server products is suffering from a great amount of competition and I still don't really see how they are going to make money from Java. The whole Java thing has been a massive distraction for Sun and has not benefited shareholders at all.

So why Microsoft?

1) Their share price has gone nowhere for three years but in the meantime they have settled their court cases and grown their MSN initiative. I think the share price is ready for a rise.

2) They are getting into paid search in a big way. This is a huge growth market and Microsoft, Google and Yahoo will all enjoy tapping it.

3) Microsoft's MSN Messenger (instant messaging) product is taking off in a big way and will be a huge source of advertising revenue in the future.

4) Microsoft are trying to get into the mobile phone industry. Their Smartphone operating system has had limited market penetration but Microsoft enjoy being the underdogs.

5) When the Google bubble bursts, money that might have gone into Google will have to go somewhere else, like into Microsoft.

Of course, Microsoft are a huge company, and their share price is not about to double in the next few years. However I think $33 by the end of 2006 is possible, which would be 30% growth from the current price.

The bad bits?

Microsoft have suffered from distractions. They went a bit crazy over the .NET initiative, spending billions on an application run-time environment which still isn't available in Windows by default (I guess it will be in Longhorn, their next Windows operating system due out next year.)

Linux, the free operating system is a worry I guess. But how many consumers / work-places are actually using it? I don't use it at home, mainly because I don't want to spend endless hours trying to get all the hardware to work with it. And a Linux distribution can cost almost as much as an upgrade version of Windows. (Linux can be downloaded free-of-charge but most people pay for a packaged distribution which includes manuals and a user-friendly installation program.)

Linux has had great success as a server operating system, running web servers and email servers etc. However the market share it has won has been at the expense of the Unix companies like Sun and Silicon Graphics. In fact both Microsoft and Linux are merrily gaining market share at the expense of these companies.

So Linux is a worry but Microsoft love competing and they will compete with all their might.

So in summary I am looking for a 30% rise in the MSFT share price over the next 18 months or so as the company is re-rated based on the growth of MSN, the release of the next version of Windows and growth in the Smartphone, cable TV and server products segments.

Alternatively the MSFT share price could do a Vodafone on me and just go nowhere for the next few years!

The rules of engagement

When choosing companies to invest in it is important to first know what the purpose of the account is. Can I afford to lose most of the money in the account? Or am I relying on it to pay off the mortgage one day?

I will shortly have three investment accounts: my aggressive growth fund, my son's college fund and my mortgage fund.

The growth fund is rainy day money. I do not know yet what I am going to do with it. Maybe start a business or failing any inspiration I could use it to pay off some of the mortgage, reducing the monthly interest payments. If I lost every penny in this account my day-to-day life would not be affected one bit. Therefore I am willing to take risks with this account. By taking risks I don't mean gambling or investing in companies that may go bankrupt, rather investing in companies on high multiples like eBay or Google, or cyclical companies like Frontline. By taking a measured amount of risk this account will probably do much better than my other accounts. It will probably have bad years though, but that is OK.

My son's college fund is obviously money I cannot afford to lose. My son would not be too happy if at the age of eighteen I told him that he cannot go to University yet as the market is not performing well! This money has to go into safe, British, blue chip, dividend-paying companies that can keep increasing their earnings and dividends for at least 10 years. When the end date is getting close some of the money should be transferred to a savings account to protect it from a stock market crash just before the money is needed.

The requirements of the mortgage fund are similar. I do not want to find out, at the age of fifty, that due to one of my holdings going bankrupt it will be another ten years before I can pay off the mortgage. Profitable, dividend paying blue chips are the answer again.

I thought it would be good to have some specific filters rather than vague ones. So here are the rules / limits that companies for the mortgage account must pass:

1. P/E must be less than 30
2. Yield must be at least 1%
3. Market Cap. must be greater than £2 billion.
4. Earnings must be projected to increase over the next five years.
5. No more than 25% of the account can be in foreign companies.

1. Companies on a high P/E are very sensitive to bad news or reduced guidance. eBay was re-rated lower to the tune of 40% when its Q4 2005 results and guidance did not impress the investors. Being on a P/E of over 100 gives the share price a long way to fall. Of course some companies are worth high multiples, but they are for the growth account.

2. I like dividends! Income for no work has to be a good thing! In years where the share price goes nowhere the income from the dividends can keep the account value going upwards. When re-invested the power of compounding can work its magic on your account.

3. It is actually a myth that small cap. companies are dangerous investments. If they are well managed and have a good balance sheet they are not especially risky. However they are not likely to have a diversified product offering, meaning they are more at risk from competition or changes in the market. If I want to buy a small cap it will have to go in the growth account.

4. Cyclical stocks are excluded by this rule. I want steady, increasing earnings and dividends, not profits that jump up and down like the waves of the sea.

5. When buying overseas stocks you are exposed to currency risk. Any foreign companies I buy will almost certainly be American and who knows where the dollar may go over the next 20 years. However there are too many fantastic companies in the States to avoid this market entirely. The great think about having a maximum percentage is that when the American companies do well the profits are automatically captured in order to reduce the exposure to 25%. If I had been holding a company like Cisco in the late Nineties this rule would have ensured that I cashed in some of the profits before the share price crash in 2000.

So there are the rules. In a few days I should be receiving a large amount of cash from my cancelled endowment. The next job is to select four or five companies that fit the criteria.

Favourites at the moment are Royal Bank of Scotland, Glaxo SmithKline, BAA, O2 and Qualcomm.

More soon.

Phil.