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Weekly Update: Integrated Research Now A Strong Buy

Dear Motley Fool Share Advisor Subscriber,

What better way to get back into the swing of the sharemarket than a pleasing trading update (pdf) from Integrated Research (ASX: IRI), our very first (pdf) Share Advisor recommendation?

We have an update a little further down, but Dean was so impressed he is now calling Integrated Research a strong buy.

We’ve received a handful of requests for our opinion on specific companies. Whilst our financial services licence does not permit personal advice, we hope that over the coming months and years we’ll equip subscribers with the tools to make better investing decisions.

We will also provide opinions on some of the better companies in our newsletter and later this year on our planned discussion boards.

Business focused investing
The first tool we want to equip all subscribers with is an appropriate focus.

Here at The Motley Fool, we are business focused investors. We invest in companies, not share prices. We focus on the long-term, not trying to predict, or worry about, all the short-term distractions that move markets on a daily or weekly basis.

The first question we ask about a company is whether it is a business we’d like to invest in for the long-term.

The Good, the Bad and the Ugly
Businesses can be broadly categorised into the good, the bad and the ugly. We aim to invest in good companies at great prices, though we recognise that we may have to pony up for great companies. So, let’s expand that aim to buying good companies at great prices or great companies at good prices.

Good to great businesses should form the vast majority of any portfolio. (We’ll cover portfolio management in more detail in this month’s newsletter, coming out January 26th.)

An example of a good business at a good price was our recommendation of Telstra (ASX: TLS) as our top ASX 20 pick for the long-term in August 2011. Needless to say our Share Advisor recommendations also epitomise good businesses at attractive prices.

Warning! Warning! Danger, Will Robinson!
We want to completely avoid bad businesses. These companies often appear cheap, but as some subscribers found out in 2011, these companies can get cheaper and cheaper. Alumina (ASX: AWC) and BlueScope Steel (ASX: BSL) are two examples from recent subscriber emails.

OneSteel (ASX: OST) is the poster child for bad business. It appeared cheap in September when we recommended running away fast. OneSteel is down 40% since then, proving once again that cheap shares can get even cheaper. It’s worth reiterating our tip from back then, “if a company’s return on capital is less than its cost of capital then run away…fast.”

Finally there are ugly businesses.
These are companies with blemishes, but if bought at the right price and time, they can provide attractive returns. Oakton (ASX: OKN) and other Australian IT providers such as Data#3 (ASX: DTL) and SMS Management & Technology (ASX: SMX) currently fall into this category.

So before you buy any company and when you’re evaluating your portfolio, ask yourself this simple question. Is this a good business that I want to invest in for the long-term? If the answer is no, then walk away as there are plenty of good companies that from time-to-time can be bought for good prices.

Share Recommendation Updates

Integrated Research (ASX: IRI) expects profit for the six months ending 31 December 2011 to be in the range of $3.1 million to $3.6 million, compared to $2.4 million for the equivalent prior period. An increase in IP Telephony licence sales was the main driver.

For those counting at home, that translates into profit growth of between 29 per cent and 50 per cent. Eat your heart out Myer (ASX: MYR).

Pleasingly, the profit was above Dean’s forecast. Yay! It’s also encouraging to see the continued growth in IP Telephony.

As a reminder, the growth in IP Telephony is a large part of our investment thesis. When a company’s fastest growing revenue stream becomes its largest, earnings growth can exceed expectations for many periods as analysts slowly reassess the company. As the following chart highlights, IP telephony is now IR’s largest revenue stream.

IR earnt $5.1 million in the second half of 2011, so trailing twelve month earnings are now in the range of $8.2 to $8.7 million or 4.9 to 5.2 cents, or a P/E of around 10.

IR also announced last week the issue of 1.55 million performance rights with an exercise price of zero — employees can convert these rights into shares at any time before late 2014 for no cost.

It’s always important to keep an eye on the outstanding share count. In IR’s case, shares outstanding have remained constant at around 166 million since 2006. These performance rights represent less than 1% of shares outstanding. So dilution is not a concern.

With the founder and Chairman, Stephen Killelea, owning 57% of shares I am confident the board will continue to act in the best interest of shareholders.

Somewhat surprisingly, IR shares hardly moved today. This fast growing company continues to fly under the radar. At a trailing 12 month P/E of just 10 and dividend yield of 8.4 per cent, IR is a strong buy.

Thorn Group (ASX: TGA) also remains a buy. Thorn’s full year end on March 31 and earnings aren’t out until late May.

Coming next: Expect the unexpected

Our next email update will be Monday 16th January.

As a reminder, the third issue of Motley Fool Share Advisor will be emailed to you on Australia Day, Thursday 26th January.

Dean’s short-list of ASX picks look as compelling as ever, including one company whose shares have fallen over 40 per cent in recent months. When it comes to Dean’s recommendations, expect the unexpected.

As ever, if you have any questions or comments, we encourage you to email us at membersupportau@fool.com.au.

Yours Foolishly,

Bruce Jackson and Dean Morel
Motley Fool Share Advisor

Disclosure: Dean owns shares in Integrated Research. Click here to view The Motley Fool’s disclosure policy.

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