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Weekly Update: Integrated Research A Buy, Seek Goes Shopping

Monday January 14, 2013

Dear Motley Fool Share Advisor Member,

The legendary US college basketball coach John Wooden was so universally liked, respected and well known that he was most often referred to simply as Coach Wooden.

Among his many speeches and a few books, he left us with many great quotes.

A personal favourite, which I was reminded of over the weekend, is ‘The true test of a man’s character is what he does when no one is watching’.

His point – beautifully made – was that it’s one thing to act the part in public, but quite another to do what you know is right even when you could get away with acting differently.

There’s no hiding here at Motley Fool Share Advisor. And that’s just how we like it. The Motley Fool has long been ‘investors writing for investors’ and we’re happy to operate in the full glare of our members.

We’ll have our share of successes and hopefully less than our share of failures, but we’ll always be fully accountable to you, our valued members.

In this week’s update:

  • Our review of Integrated Research‘s (ASX: IRI) profit downgrade.
  • Seek (ASX: SEK) tops up in Asia.
  • Another reason to love Amazon.com (Nasdaq: AMZN); and
  • Why Aesop might have been the world’s first great investor.

Digging Deep Into Integrated Research

We know a great many of you buy all or most of our recommendations. As importantly, we know from your feedback that a large number of our members are embracing Foolishness as an approach to investing more broadly.

That makes situations like last week’s first half earnings downgrade from Motley Fool Share Advisorrecommendation Integrated Research (ASX: IRI) an important event — it’s both portfolio-impacting in a very real way, as well as a test — and a reminder — of our investment approach.

Speaking of reminders, you’ll recall we emailed you last Thursday with the details of the downgrade. Specifically:

– First half revenue was down 3%.

– First half results were impacted by the delay of a few license sales.

– The company has a strong sales pipeline.

– The company anticipates it will make up for the license sales in the second half to enable growth for the full financial year.

– The company continues to invest for growth, increasing headcount by 16%, primarily in R&D and sales.

– No further announcement is expected until 21 February 2012.

At the time, we also reminded you that:

“As Motley Fool Share Advisor members will know, we follow the business, not the share price.”

This is a great opportunity to put our investment philosophy to the test.

We spend a lot of time selecting companies for the Motley Fool Share Advisor scorecard. We hate to have to sell them, but we won’t hesitate to do so when the need arises.

You’ll recall we recommend three broad reasons for selling a company’s shares — if the company’s prospects dim (or we were wrong about them in the first place), if the shares become significantly overvalued or if we find a better place for our money. The latter is more a portfolio management question, but the former two are company-specific and apply at any time, but even more so when we have situations like last week’s profit announcement.

So to those questions at hand.

I — Scott here — spoke to Integrated Research CEO Mark Brayan last week. He assured me that the downgrade was more a question of timing — some key contracts the company had expected to sign in the first half would now not be signed until the second half of the 2013 financial year.

Those pieces of business are wrapped up in larger contracts that are being negotiated, and Integrated has little influence on the timing. Mr. Brayan remains comfortable that they’ll be signed soon.

We respect and like the company’s management, and are prepared to take Mr. Brayan at his word. If the contracts are signed, as he expects, then the ‘timing’ issue will be just that. The full year numbers won’t be impacted, simply the mix between the financial halves.

It’s worth remembering that situations like this will crop up from time to time with ‘contract’ based companies. Metcash (ASX: MTS) might have an incredibly predictable flow of customers into its IGA stores every week, but many companies like Integrated rely on contract flows and the timing of new business.

That takes us nicely to our first question — and to keeping perspective. At Motley Fool Share Advisor, we don’t really care that much about one six-month period in isolation. We’re far more interested in the long term business. (If that sounds strange, it’s because we’re in a financial world that thinks ‘long term’ ends in a week or two!).

If you’re still not convinced, let me pose this question. Would you prefer to own shares in a company that reliably earned $10 each year for 5 years, or a company that had ‘lumpy’ earnings, but delivered $100 in total earnings over a 5-year period? I hope you agree the answer is obviously the latter.

We care far more about the long-term prospects of Integrated Research’s business. Our investment thesis was never about this half, or even this year. It was predicated on the long-term growth of the company’s markets — growth potential we continue to believe in.

Of course, no future can be confidently and accurately predicted 100% of the time. Investing is inherently risky, because it deals with (unknowable) future earnings. We try to limit the risk by getting a good sense of the possible futures, the company’s strength and management ability — among other things.

One thing we are going to keep an eye on (and which I told Mr. Brayan) was the risk that Integrated Research becomes a ‘gunna’ company… one that’s ‘gunna do this’ and ‘gunna do that’. We don’t think that’s the case, but we’re keeping a close eye out, just in case. While one half year period doesn’t impact our investment thesis, a few halves back to back might shake our faith in the business.

Answering our questions then, do we think the company’s quality has deteriorated or been misjudged? At this stage, no, notwithstanding the ‘gunna’ risk. And are the shares overvalued? Compared only to this year’s earnings, the shares aren’t cheap, but we didn’t recommend it just for this year’s earnings — but on the bright future some years hence.

If you’re one of the many Motley Fool Share Advisor members that own shares in Integrated Research, you might be feeling a little shell-shocked after last week’s price falls. Fair enough, too.

But Foolish investors keep their eyes on the horizon. One key advantage we have over the so-called ‘smart money’ is what the analysts call ‘time arbitrage’. For our purposes, we’ll call it ‘common sense’.

To wit, is the entire value of Integrated Research today worth 20% less than it was a week ago just because of a couple of contracts that didn’t get signed by an arbitrary date on a calendar? Of course not. Yet that’s what the market is suggesting, based on the share price fall.

If the quality of a business deteriorates significantly and permanently, it is undoubtedly worth less. While we’ll keep a close eye on further developments, we don’t think that’s the case here. If we’re wrong, we’ll change our recommendation.

Until that time comes (if ever), we remain positive on the future of the business, and continue to recommend Integrated Research (ASX: IRI) to our members as a Buy.

Recent comment on Integrated Research:

December Best Buys Now

Seek Ups The Ante In Asia

Hot on the heels of increasing its stake in JobsDB to 100% before Christmas, Seek (ASX: SEK) obviously had a busy holiday period, announcing that it is also increasing its stake in Zhaopin — one of the leading employment sites in China — from 55.5% to 72.3%, and that it would seek to purchase additional shares in Zhaopin to take its holding to 79%.

The increased shareholding will be funded from Zhaopin’s own cash, as well as cash and debt from Seek.

The additional ownership stake is expected to add value to Seek’s business from the 2013 financial year. When we recommended the company, we were excited about its international operations, and their growth potential. Seek’s increasing ownership stake in these businesses is one way to accelerate its participation in and reward from that growth.

Our only caution is that Seek does not extend itself too far with increasing debt obligations, but so far, we’re satisfied by what we see.

Accordingly, Seek (ASX: SEK) remains a Buy.

One More Reason We Love Amazon.com

Motley Fool Share Advisor recommendation Amazon.com (Nasdaq: AMZN) is a truly remarkable business.

It has revolutionised book selling, then became a one-stop shop for everything from groceries to computers, clothes and jewellery. Amazon then actively cannibalised its own business by promoting its Kindle electronic reader and now sells more eBooks than physical books.

Aside from the way Amazon changed, rechanged and continues to change the retail landscape, one of the reasons we love Amazon.com is its CEO Jeff Bezos.

I listened to a great podcast on the weekend (Harvard Business Review’s HBR IdeaCast – which you can subscribe to on iTunes, and which I highly recommend) containing a short interview with Mr. Bezos, which you can find here. (You don’t have to have iTunes — that link takes you to a transcript of the interview and you can play the audio straight from the webpage).

Here’s a single snippet:

[INTERVIEWER]: So how much do you care about your share price?

JEFF BEZOS: I care very much about our share owners, and so I care very much about our long term share price. I do not follow the stock on a daily basis, and I don’t think there’s any the information in it. Benjamin Graham said, “In the short term, the stock market is a voting machine. In the long term, it’s a weighing machine.” And we try to build a company that wants to be weighed and not voted upon.

I don’t know about you, but that’s a company, and CEO, that I want to invest with.

The interview gives a very succinct view on the company and its approach to shareholders, innovation and success.

Incidentally, you can find Bezos’ wonderful 1997 shareholder letter — highly recommended reading — mentioned in the interview, here.

Slow And Steady Wins The Race

It wasn’t intentional, but there’s a strong them running through today’s update — perhaps not surprising, given that we’re long-term, business-focussed investors here at The Motley Fool!

We all like a little excitement now and then. That’s fair enough. From some, that’s rock climbing, for others driving fast cars (safely, and below the speed limit, we hope!), while others get their adrenalin rush from playing their favourite sports.

There are unfortunately a not-small-enough proportion of the population who instead get their buzz from gambling on the sharemarket.

Investing in shares needn’t be gambling, as I hope you know, but the sharemarket is just one in a long line of inventions that were created to enable progress, but are then used by some in ways that weren’t intended by their inventors.

You’ll be able to spot the gamblers. They’re the ones who are day-trading… watching the market’s moves minute-by-minute, imagining they can beat the supercomputers in the back rooms of the investment banks. Or those who jump into a stock because they liked the look of the chart, or had a ‘good feeling’. They’re the ones who end up spending more on brokerage and short-term capital gains taxes than they should — meaning even if they do manage to make a profit on the trade, much of their success is frittered away by costs.

Fools, if you want excitement, please take up skydiving or bungy jumping. Your financial future deserves better.

That doesn’t mean investing can’t be interesting, absorbing and engrossing, mind you — but it’s the search for the next great company that should excite you, not how quickly you can jump in and out of your investments on a whim.

Or, in many fewer words and a simple picture (from BehaviorGap.com via The Motley Fool’s Facebook page):

The Motley Fool Share Advisor Scorecard

If you haven’t had a chance to pick up some of our recommendations, we still think there’s great value to be had in all of our Buy recommendations.

For those who’ve come in late, reading the scorecard is simple. Company names highlighted green are Buy recommendations, while companies highlighted in yellow are HoldsCompany names highlighted in red are Sells.

The ‘Return’ column shows the return of each recommendation since we recommended it, and is coloured green when the return of that company is beating the market and red when it lags the market return.

Please also note that the ‘Then’ price is automatically adjusted by our data provider to show the cost base of each company, including dividends. The ‘Now’ price is the current market price, or the price on the date we decided to sell a recommendation. In that instance, the All Ords Total Return is also frozen as of that date.

The All Ords Total Return is similarly dividend-adjusted, making for a fair and more accurate comparison than share prices alone.

Company Rec Date Then Now Return All Ords Total Return
Retail Food Group (ASX: RFG)buy 20-Dec-12
2.95
3.29
11.5%
2.1%
3D Systems (NYSE: DDD)buy 20-Dec-12
49.10
57.24
16.6%
2.1%
Domino’s Pizza (ASX: DMP)buy 22-Nov-12
9.39
10.95
16.7%
7.0%
Westinghouse Air Brake Tech(NYSE: WAB)buy 22-Nov-12
77.45
84.28
8.8%
7.0%
Codan (ASX: CDA)buy 25-Oct-12
2.07
2.31
11.6%
5.3%
Priceline.com (Nasdaq: PCLN)buy 25-Oct-12
544.59
621.77
14.2%
5.3%
Seek (ASX: SEK)buy 27-Sep-12
6.73
7.54
12.0%
8.5%
Google (Nasdaq: GOOG)buy 27-Sep-12
723.66
701.92
-3.0%
8.5%
Corporate Travel Management(ASX: CTD)buy 23-Aug-12
2.30
3.82
66.4%
9.2%
Starbucks (Nasdaq: SBUX)buy 23-Aug-12
45.73
52.18
14.1%
9.2%
Metcash (ASX: MTS)buy 26-Jul-12
3.12
3.43
10.0%
16.2%
Netflix (Nasdaq: NFLX)buy 26-Jul-12
58.02
96.08
65.6%
16.2%
OrotonGroup (ASX: ORL)hold 28-Jun-12
6.94
7.03
1.3%
18.7%
Westport Innovations (Nasdaq: WPRT)buy 28-Jun-12
35.37
26.57
-24.9%
18.7%
Amcom Telecomm.(ASX: AMM)buy 24-May-12
1.02
1.48
44.9%
18.6%
Teradata (NYSE: TDC)buy 24-May-12
72.07
61.98
-14.0%
18.6%
Sirtex Medical (ASX: SRX)hold 26-Apr-12
6.24
13.17
111.2%
10.0%
Titanium Metals (NYSE: TIE) 26-Apr-12
13.59
15.79
16.2%
10.2%
Industrea (ASX:IDL) 22-Mar-12
0.98
1.21
23.5%
2.2%
WisdomTree (Nasdaq: WETF)buy 22-Mar-12
7.83
7.39
-5.7%
12.1%
Vocus Communications(ASX:VOC)buy 23-Feb-12
1.70
1.81
6.2%
12.9%
Amazon.com (Nasdaq: AMZN)buy 23-Feb-12
168.85
254.15
50.5%
12.9%
QBE Insurance Group (ASX: QBE)buy 26-Jan-12
11.20
11.74
4.8%
14.5%
Dolby Laboratories (NYSE: DLB)buy 26-Jan-12
30.45
29.12
-4.4%
14.5%
Thorn Group (ASX: TGA)buy 22-Dec-11
1.48
2.08
40.4%
19.7%
Apple (Nasdaq: AAPL)buy 22-Dec-11
387.98
493.53
27.2%
19.7%
Integrated Research (ASX: IRI)buy 5-Dec-11
0.40
1.32
227.0%
13.4%
Coach (NYSE: COH)buy 5-Dec-11
59.34
55.86
-5.9%
13.4%

All figures are accurate as of 4:00pm on Monday January 14, 2013.

As a reminder, the prices of the U.S. recommendations are in Australian dollars and all start prices are adjusted for dividends. As we explained from the outset we wish to be totally transparent with our scorecard and to ensure all returns account for dividends, capital gains and currency movements.

Coming Soon – Best Buys Now and our January Recommendation

The next week and a half are going to be busy for us here at Motley Fool Share Advisor!

This coming Thursday, January 17th, we’ll be emailing you our January Best Buys Now, where we share our best three ASX ideas from our scorecard.

Then one week later, on Thursday January 24th, the latest issue of Motley Fool Share Advisorwill arrive in your inbox (after the close of the day’s trade).

If you’re keen for some Foolishness while you wait, we’d recommend you take a look at some of ourpast issues.

Yours Foolishly,

Bruce Jackson and Scott Phillips

Motley Fool Share Advisor

Disclosure: Of the companies mentioned in this email, Bruce Jackson owns shares in Corporate Travel Management, Thorn Group, Vocus, Woolworths, 3D Systems, Apple, Google, Starbucks, BHP Billiton, Telstra and Titanium Metals. Scott Phillips owns shares in Corporate Travel Management, Domino’s Pizza, QBE Insurance, OrotonGroup, Woolworths, Telstra and Amazon.com. Click here to view The Motley Fool’s disclosure policy.

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