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Merchant Kings
Kmart vs. Wal-Mart
by Al Levit
(alanl@ix.netcom.com)

Glendale, CA (Oct. 15, 1998) -- A few weeks ago, Rob Landley wrote a couple of columns (A New Cash-King) introducing a new type of company that we Cash-King investors might want to add to our portfolios. After some initial debate, Rob finally settled on the name Merchant-Kings to describe these businesses. Rob asked for your thoughts in general on these companies, and he asked for my thoughts in particular. And so today, I'm going to launch into a few of my thoughts about Merchant-King investing.

Over the past few months, Rob and I have had some minor differences of opinion. For example, I believe that Microsoft (Nasdaq: MSFT) is one of the greatest companies that has ever existed. I'm not sure that Rob totally agrees with me on this point. We've also had differences of opinion on Dell Computer Corp. (Nasdaq: DELL). I've always maintained that Dell was a great company, but I've never believed that Dell was a Cash-King. Rob has been firm in his belief that not only was Dell a great company, but in fact Dell is a Cash-King.

Given this state of affairs, I'm sure that many of you believe that I will be coming to a completely different conclusion on the Merchant-Kings than what Rob proposed. After all, Rob felt that there were low-margin businesses out there that could be just as financially rewarding as the Cash-Kings that we love so much. He even identified three of them, namely Dell, Home Depot (NYSE: HD) and Wal-Mart (NYSE: WMT).

Well, I must admit that when I first read Rob's columns, I felt something was lacking. After all, we're looking for more than just financial rewards in the Cash-King portfolio. We want to be able to sleep comfortably at night without having to worry about selling our stock for a decade or more, except in very unusual circumstances. One of the things that gives us this comfort with most of the high-margin darlings in our portfolio is the patents that protect the consumer products that our companies have designed -- the Coca-Cola logo, Viagra, Intel Inside, Windows, the American Express Card, these brands have protection and staying power.

The Merchant-Kings, on the other hand, operate on a completely different business model. They keep their competition at bay by being able to deliver products to customers more cheaply than anyone else. The brand strategy isn't quite the same, though they are competing on convenience and price. But competitors can't duplicate their methods because of the time and investment needed to duplicate their size and well-established business relationships. However, as a shareholder I must admit that a company with this sort of protection has never made me nearly a comfortable as the protection provided by the patents owned by Cash-Kings Microsoft, Intel, Cisco, Schering-Plough, and Pfizer.

On the other hand, when all is said and done it is long-term performance that really matters, and when I started looking into this I realized that Rob was on to something. Yes, he was. Rob's three Merchant-King examples have shown outstanding performance over the last ten years, far greater than the market averages. I wondered whether this kind of performance was characteristic of Merchant-Kings, or whether there was something special about these three in particular. In order to find out, I needed to come up with some more Merchant-Kings.

Accordingly to the proposed rules, a Merchant-King specializes in distribution. Sometimes the Merchant-King distributes a narrow range of products (Dell), other times the product list is quite varied. The things that Merchant-Kings seem to always have in common are:

  • Relatively low margins, and
  • An emphasis on execution.

With these constants, I'd propose the following as additional candidates to be Merchant-Kings:

  • Circuit City (NYSE: CC) -- The Home Electronics/ Appliance chain
  • CompUSA (NYSE: CPU) -- Leading computer retailer
  • Kmart (NYSE: KM) -- A Wal-Mart competitor
  • Lowe's Cos. (NYSE: LOW) -- A self-service warehouse-style hardware store
  • Toys R Us (NYSE: TOY) -- The leading toy retailer

I've listed these companies alphabetically, but it is more interesting if they're grouped by historical performance. Done that way, three groups emerge:

  • The not-so-good group, which includes Circuit City, CompUSA, Kmart, and Toys R Us.
  • The outstanding group, which includes Lowes, Home Depot, and Wal-Mart.
  • And its own group, called Dell.

Dell, of course, has had performance so good that it not only is in a group by itself, but it makes the outstanding historical performance of Lowes, Home Depot, and Wal-Mart merely "good" by comparison.

Of course, the real question is what makes the four high performing Merchant-Kings so much better than the rest. I can't begin to claim any expertise in this. If I had to start guessing I would say that there is something about the hardware industry that lends itself to warehouse-style selling, since two of the four successful Merchant-Kings come from that industry. As for Dell, the reasons for its tremendous growth have been extensively documented. They include:

  • Dell uses a direct-to-order method, where computers aren't built until they are actually ordered.
  • A large portion of Dell's orders come directly from the Internet.
  • Dell does more than deliver a product; it also produces a high-quality product that has consistently received top reviews for service and reliability.
  • Dell has avoided the lower margin end of the business (e.g., sub-$1,000 PCs) and has expanded its production of higher margin servers and notebooks.

As far as Wal-Mart is concerned, I admit that I really don't know why it has done as well as it has. I know it has been on a roll for decades now, and I have some sense of how it got there, but there's much more exploring to do. I'm hoping to see a conversation start-up on this topic in our Cash-King Strategies message folder. If we can include the Wal-Marts and Home Depots and Dells -- if they belong in the same category -- while excluding the Kmarts and Toys R Us's, I have a feeling we'll have turned over another stone on market-beating performance here.

Tomorrow, I'm going to follow-up with whether the stock of a Merchant-King belongs in a Cash-King portfolio. Until then,

Fool on,

Al

Cash-King Strategy Folder
Cash-King Companies Folder


10/15/98 Close
Stock  Change    Bid 
 AXP   +7 5/8   88.50 
 CHV   +1 5/8   85.75 
 CSCO  +4 13/16 56.94 
 KO    +3 1/8   67.50 
 GPS   +3 7/8   60.50 
 EK    +1 13/16 74.56 
 XON   +1 5/8   75.63 
 GM    +3 3/4   56.06 
 INTC  +2       84.56 
 MSFT  +5 1/4  105.44 
 PFE   +1 1/4   97.50 
 SGP   +4 1/8   99.38 
 TROW  +5 7/16  30.69 
 

 
                  Day     Month   Year    History 
         C-K      +5.80%   1.45%   7.16%   7.16% 
         S&P:     +4.17%   3.00%   4.13%   4.13% 
         NASDAQ:  +4.55%  -4.89%  -3.32%  -3.32% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    105.44    34.71% 
     2/3/98   22 Pfizer        82.30     97.50    18.47% 
     5/1/98   37 Gap Inc.      51.09     60.50    18.42% 
    8/21/98   22 Schering-P    95.99     99.38     3.53% 
    2/13/98   22 Intel         84.67     84.56    -0.13% 
    6/23/98 34.5 Cisco Syst    57.56     56.94    -1.09% 
    2/27/98   27 Coca-Cola     69.11     67.50    -2.33% 
     2/6/98   56 T. Rowe Pr    33.67     30.69    -8.87% 
    5/26/98   18 AmExpress    104.07     88.50   -14.96% 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     74.56    18.08% 
    3/12/98   20 Exxon         64.34     75.63    17.55% 
    3/12/98   15 Chevron       83.34     85.75     2.89% 
    3/12/98   17 General Mo    72.41     56.06   -22.57% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2530.50   $652.05 
     5/1/98   37 Gap Inc.    1890.33   2238.50   $348.17 
     2/3/98   22 Pfizer      1810.58   2145.00   $334.42 
    8/21/98   22 Schering-P   2111.7   2186.25    $74.55 
    2/13/98   22 Intel       1862.83   1860.38    -$2.45 
    6/23/98 34.5 Cisco Syst  1985.95   1964.34   -$21.61 
    2/27/98   27 Coca-Cola   1865.89   1822.50   -$43.39 
     2/6/98   56 T. Rowe Pr  1885.70   1718.50  -$167.20 
    5/26/98   18 AmExpress   1873.20   1593.00  -$280.20 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1491.25   $228.30 
    3/12/98   20 Exxon       1286.70   1512.50   $225.80 
    3/12/98   15 Chevron     1250.14   1286.25    $36.11 
    3/12/98   17 General Mo  1230.89    953.06  -$277.83 
  
                               CASH     $48.07 
                              TOTAL  $23350.10 
   
 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.

*The year for the S&P and Nasdaq is as of 02/03/98

</THE CASH-KING PORTFOLIO>

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