Stock answers

By Fiona Rotherham

Sunday 1st May 2005

He's an accountant so he understands the numbers, but Bruce Sheppard reckons his rules for investing in listed and private companies can be followed by just about any investor.

Rule one: Stick to simple businesses with a compelling business proposition. For example, Air New Zealand getting more bums on seats. It's also good if the company has a compelling commercial advantage - take Auckland International Airport, which has a monopoly on landing international flights in Auckland (so far).

Look for understandable companies with a clear competitive advantage and a simple business, Sheppard says. "Do I sound like Warren Buffet?" he asks. "Yeah, I probably do." Conversely, avoid unfocused investment companies, conglomerates and companies with financial engineering on the balance sheet (such as Tranz Rail capitalising track de-stressing).

Rule two: Make sure there's a strong correlation between cash flow and reported earnings. If the reported earnings are $1 and the cash flow 80c and that persists for a decade, it's a pretty clear indication the earnings are not really $1. Over the long haul there should be a correlation between the two.

Rule three: A good business run by an idiot will still be a dog of an investment. You have to get to know the people running the business - in particular the chairman and the CEO. Sometimes a strong chairman is more important than the CEO, and sometimes a capable, exciting CEO is more important than the chairman - but weakness in either will lead to governance problems eventually. The only way to get to know them is to ring them up and talk to them. Attend the company's annual general meeting to observe how they behave in public and whether they duck questions from shareholders. You'll never know any of that from just reading the annual report, Sheppard says.

Rule four: Investigate how the company's executives handle things when they screw up. Look first at how quickly they fix the problem. Second, see if they confess to their shortcomings. "I don't care if they make mistakes, because you don't get anywhere in business without taking risks. If they try to cover things up, run like they have the plague."

Rule five: Sheppard buys shares in New Zealand companies only. "I have no chance of ringing the CEO of British Telecom and having him take my calls, but there's a chance of Rod Deane taking my calls (remote as that is)."

Rule six: Unlisted companies also feature in Sheppard's investment basket. He looks for energy, enthusiasm and excitement - extreme risk for extremely high returns. As you get older, your risk profile changes, he says. At 20 you should be pressing for the highest possible return, while at 70 you should leave all your money in the bank.

Rule seven: Don't put too many eggs in your basket. You should have only a handful of New Zealand companies on your preferred investment list. If you have $1 million, Sheppard advises putting half into your favourite company, and the rest divided between the next best two on your list. "If something is worth backing, then it is worth
backing well."

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