THE CASH-KING PORTFOLIO
by Tom Gardner (TomG@fool.com)
Alexandria, VA (Nov. 23, 1998) -- Do you remember September 1st, Fool? Stocks were tumbling on a downward pitch. The market pundits were out in full force, crying Asian crisis, a slowdown in corporate earnings, the madness of the individual investor. On CBS This Morning, the program's two nationwide financial advisors publicly attacked The Motley Fool's position of buying and holding great companies, instead instructing all CBS viewers to get out of stocks, put the money in T-bills, and wait out the coming bear market.
On September 1st (not that I pride myself on short-term market calls), I inked a column entitled: Raised to Really Strong Buy: Cash-King Rating Upped. Our portfolio had fallen back to a rise of just 2.11% for the year, and I felt certain that the long-term buyer of businesses was being presented with a great opportunity to pick up shares on the cheap. (Here, I need to emphasize "long-term buyer" as someone looking to own a great business for more than five years, ideally ten.) Dave and I sat quietly on the set of CBS This Morning while their financial advisor hammered us on live television, reminding viewers that he spent many years on Wall Street (apparently, something to be proud of), and all the while, a wide collection of first-rate companies were trading 30-40% off their 1998 highs.
Fast forward to today, and the Cash-King Portfolio is up more than 20% for the year. Intel, which was at $76 and being labeled a $60-stock by Merrill Lynch semiconductor analyst Tom Kurlak, is now selling for $112 a share. American Express, the dog of our portfolio, had bounced back to $82 after falling much lower -- but today is trading at $104 1/2. In fact, today all but two of the companies we own are trading for more than we purchased them, and our two losers, General Motors and Chevron, are Foolish Four stocks that are down just 0.56% and 2.96%, respectively.
One wonders if CBS This Morning will introduce some accountability to its financial advisors in full view of the nation. Not likely.
Let's take a look at the Cash-King Performance for the week that was:
Cash-King Last This Change Cisco $64.69 $74.63 + 15.4% T. Rowe $30.94 $35.25 + 13.9% AmEx $94.56 $104.56 + 10.6% Intel $103.75 $112.06 + 8.0% Pfizer $105.50 $112.00 + 6.2% Coca-Cola $69.75 $72.81 + 4.4% Microsoft $110.00 $113.63 + 3.3% S Plough $101.88 $104.19 + 2.3% Gap Inc. $68.88 $68.00 - 1.3% Fool Four Last This Change GM $70.13 $72.00 + 2.7% Chevron $83.00 $80.88 - 2.6% Kodak $77.50 $76.69 - 1.0% Exxon $72.88 $72.00 - 1.2% S&P 500 1126 1164 + 3.4% Total C-K $25,116 $26,355 + 4.9%
The Cash-King Portfolio rose nearly 5% for the week, outmatching the S&P 500 by 1.5%, but a good 15% shy of The Fool Portfolio's performance this past week. If you haven't been reading and following The Fool Portfolio, I highly recommend it. In mid-December, when that portfolio will be renamed The Rule Breaker's Portfolio, our portfolio will be renamed The Rule Maker's Portfolio -- both to account for the oncoming Fool book appropriately entitled:
Rule Breakers, Rule Makers
I am working through the final galleys on the book this week, and I assure you that this is the best of the books David and I have written to date. For Fool aficionados, you can pre-order that book through Amazon by clicking here. The book goes on sale, I believe, in mid-January.
Briefly, today, I want to focus on Gap Inc. (NYSE: GPS), which was up another $2 1/2 at the time of this writing, to $70 1/2. The holding is now up 38% for us since our May, 1998 purchase -- in the wake of a few excellent quarters of business. Gap has been storming the streets of America (and, increasingly, Europe) with all three of its primary brands -- Old Navy, Gap, and Banana Republic. Not to take anything away from the lead brand, but Old Navy has been the real surprise grand-slam for the company in 1998.
I'd like to take a look at Gap's recent 3rd quarter earnings report and hold it up to our Cash-King criteria. Here's a link to the company press release with the numbers for you to view alongside this column. For the three months ending on November 1st, Gap's sales rose 36% and earnings were up 44%. Earnings outgrowing sales only means one thing -- profit margins are improving. Let's look in:
3Q 1998 3Q 1997 Gross Margins 42.7% 40.8% Net Margins 9.9% 9.3%So, Gap improved both gross and net margins over the same period last year. The retailer still sits below our ideal standard of 50% gross margins, but directionally, it's on target. In net margins, Gap is now 2.9 percentage points above our standard. An excellent showing.
Let's see how Gap is doing managing its ownership pie. Here's the listing of total number of shares outstanding, fully diluted:
3Q 1998 3Q 1997 Total Shares Diluted 398 mil. 409 mil.
In the third quarter, Gap actually reduced the total number of shares outstanding by 11 million. The company has decided that it can doubly improve the value of its company by spending 1) to expand operations and 2) to limit the supply of shares in the marketplace. We like that.
With strong sales and earnings growth, with excellent and improving margins, and with the total number of purchasable shares being reduced, Gap's income statement shined brighter than a star this quarter.
Let's look to the balance sheet.
The Flow Ratio -- (current assets - cash) / current liabilities -- measures a manufacturer's ability to hold down inventory and accounts receivable, while maintaining or driving the lever of unpaid bills higher. It tells us a little bit about how powerful a company is in its industry of suppliers, distributors, and competitors. We like to see the Flow Ratio below 1.00, and ideally, it is falling. Here's Gap's for the 3rd quarter, 1998:
1. (current assets - cash) / current liabilities a. ($1.84 billion - $272 million) / $1.69 billion b. $1.57 billion / $1.69 billion c. 0.93
Gap's Flow Ratio for the quarter was 0.93. This beats our 1.00 standard. And of great importance, the Flow fell from the same period last year, indicating that Gap is tightening down on the management of product and cash flow through its business. In the third quarter of 1997, Gap's Flow Ratio was 1.13. Over the past year, Gap's Flow Ratio has fallen 17.6%. Outstanding!
3Q 1998 3Q 1997 Flow Ratio 0.93 1.13
The final item is the company's Cash & Equivalents relative to its Long-Term Debt. In the third quarter, Gap had $272 million in cash and $496 million in long-term debt. Whereas we look for companies with 1.5x more cash than debt, Gap had just 0.55x as much cash as debt. Furthermore, the relationship between cash and debt has worsened over the same period last year. In its 3rd quarter 1997, Gap's cash-to-debt ratio was 1.27x.
3Q 1998 3Q 1997 Cash-to-Debt 0.55x 1.27x
The cause of this wobbling was Gap's decision to repurchase a whole mess of shares this quarter. While we never like to see debt o'ertaking cash, given that Gap was able to repurchase shares at what now represent bargain-basement prices, we're certainly willing to overlook this shortcoming. Putting it into context, Gap's $238 million in earnings for the quarter represents nearly one half of its $496 million in long-term debt. To my eyes, paying down the debt won't be very difficult over the next ten years.
All in all, I rate Gap's quarter a solid A, verging on an A+. The investing community has agreed, pushing Gap shares up $4 since the announcement. On September 2nd, Gap was trading at just $48 per share. CBS was telling America to go to T-bills (I promise to lay off this point after today!). And the Fool who held straight through, or added to her position, has seen a 47% rise in less than two months. Yes, buy and hold great companies.
Tomorrow, I'll be back with the Foolish story of a woman trying to interest her friends in saving and investing. You won't want to miss it.
Tom Gardner, Fool
Order your copy of David and Tom Gardner's new book, Rule Breakers, Rule Makers, in advance. This Simon & Schuster beauty doesn't arrive until January, but you can reserve your copy today! The first half of the epic book, on Rule Breakers, elucidates the Fool Port's investment style; the second half, on Rule Makers, further explains Cash-King investing.
Day Month Year History C-K +3.47% 12.24% 24.76% 24.76% S&P: +2.12% 8.15% 18.11% 18.11% NASDAQ: +2.55% 11.63% 18.67% 18.67% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 119.19 52.28% 5/1/98 37 Gap Inc. 51.09 73.50 43.86% 2/3/98 22 Pfizer 82.30 116.88 42.01% 2/13/98 22 Intel 84.67 113.56 34.12% 6/23/98 34 Cisco Syst 58.41 76.19 30.44% 2/6/98 56 T. Rowe Pr 33.67 38.13 13.22% 8/21/98 22 Schering-P 95.99 107.69 12.19% 2/27/98 27 Coca-Cola 69.11 75.44 9.16% 5/26/98 18 AmExpress 104.07 108.94 4.68% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 75.63 19.76%