The latest news from The Motley Fool: It pays to think laterally
Sunday 19 September 1999
Foolish Investors are always encouraged to buy shares in industries and companies they know. That doesn't mean that we shouldn't look beyond familiarity, of course. Quite the opposite in fact. We should only use familiarity as a starting point, and carry out our careful Foolish analysis of the companies we are interested in before deciding what to buy.
An extension of the "buy what you know" philosophy is to think laterally. If you are interested in a specific sector or industry, and think it is heading for future success, have a look round and think about what other peripheral businesses will benefit too.
A good recent example is the building industry, which has been going through a healthy period of late. That has been at least partly driven by the rising demand for houses and the rapidly booming prices that have resulted. A number of housebuilders, after a year or so in the doldrums, have seen their share prices rise as a direct result.
Take a look at Barratt Developments, for example. Barratt's share price has risen from about 170p a year ago to the 260p level today (and, in fact, peaked at nearly pounds 4 just a few months ago). George Wimpey is another good example. Wimpey's share price stood at a lowly 99p just a year ago, and rose to a 199 peak of nearly twice that in May this year.
However, Wimpey's share price has suffered a sharp fall over the last week, after accounting irregularities were uncovered at one of the company's subsidiaries.
But just looking at housebuilders isn't lateral thinking. When house prices start soaring on the back of increased demand, it isn't only the companies that build houses which will profit.
As anyone who has moved house recently will certainly understand, the mortgage repayments are just the start of the expenses, and there are plenty of others to come. So why not consider investing in all those companies in other industries that are irrevocably tied to house buying?
To start with, what do housebuilders make their houses out of? Bricks, wood, copper pipes, electrical wiring. All kinds of stuff, in fact, and someone has to supply it all.
And what do they use to put all that stuff together, to turn it into something that someone might want to live in?
They use diggers and power tools, and someone supplies those, too. Take Travis Perkins as an example. That company's share price stood at under pounds 4 at the beginning of the year, and its shares are now trading at around pounds 6.50, a rise of more than 60 per cent. That's a significantly better return than internet companies have achieved this year, despite all their glamour. So what does Travis Perkins do? Its business is the distribution and sales of timber and plumbing materials to the building trade, as well as the hiring of tools.
When you buy a new house, what is the chance that you will share the previous owner's taste in bathrooms, kitchens, lighting, and all those things that turn a brick building into a personalised home? Probably pretty slim, we'd bet. So who are you going to buy a new bathroom from?
One company heavily involved in the home improvement market, with most of its business coming from the sale of plumbing and electrical supplies, and whose share price has done quite well over the year, is Caradon, up 50 per cent from pounds 1 in January.
Furniture suppliers might be expected to do well too, but that is a competitive high-street business. Even so, DFS Furniture has recovered nicely since last year's share price fall. That fall started when DFS announced a profit warning, but since the beginning of this year DFS shares have gained 60 per cent from 190p to more than 300p.
So you have got your new house, you've installed your seductive lighting system, and you've replaced that ancient loo with a luxurious modern bathroom. What's next? How about the garden?
Shares in Wyevale Garden Centres have been gaining steadily for several years now. With the exception of a short sharp drop late last year when the market briefly hesitated, the company has shown a steady improvement from around pounds 1.40 in 1995 to more than pounds 4.70 today. Shares in AIM-listed Dobbies Garden Centres have done well too, and they have grown as fast as those spring bulbs you might have bought there.
Interesting though they may be, please don't take any of these discussions as recommendations, and rush out and buy shares we have mentioned. We certainly don't intend these as share tips. It is all just meant as an example of lateral thinking, and we have relied heavily on hindsight to find a few interesting companies that astute investors might have profitably analysed earlier in the year.
So think about your favourite companies carefully, and think laterally, Fools.
ASK THE FOOL
I sometimes see "normalised" earnings per share quoted for companies, alongside the standard figure. What does "normalised" mean?
The Fool responds: The normalised earnings per share (eps) figure for a company is calculated by omitting any exceptional earnings or costs, and so it can be more useful for analysing long-term trends in earnings performance.
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MY DUMBEST INVESTMENT
After Warren Buffett took a stake in Allied Domecq, I followed him and bought some shares myself. To my horror, Allies Domecq's share price has since collapsed by 40 per cent.
The Fool responds: Don't panic, the fall in share price is just a technical correction. Allied Domecq will distribute some of the cash from the recent sale of the company's pubs and off-licences to Punch Taverns in the form of a special dividend. The fall in the share price simply reflects this payout, and the dividend cheque you receive should compensate you.
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