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Fool On The Hill

Thursday, December 24, 1998

An Investment Opinion
by Dale Wettlaufer

Holiday Rants

You'll be getting hit with a bunch of retrospectives in the coming days, so why don't I jump in on the action before it starts in earnest. I think I have to offset all my holiday season good cheer with a good old-fashioned old man curmudgeon rant on the topics that push my buttons. So here it goes.

1. Tulip-O-Mania

You know what I'm sick of hearing? This phrase. So sick of it. If the people who so readily use the term really read Extraordinary Popular Delusions and the Madness of Crowds, they would probably draw the parallel with the South Sea shares bubble.

2. Internet Stocks: The Mania

You get to hear how these things are a mania from all sorts of sages who have been oh so right over the years, such as Alan Abelson. The problem with these nabobs of negativity is that not all Internet companies are crap. Not all biotech companies were crap. Not all disk drive companies and not all PC companies were crap. Sure, you have huge booms when new industries are born and things get out of hand with equities prices, but these people offer the excuse of "looking out for the little guy" for their inability to analyze things properly and take risks with their own capital.

Take, for instance, Abelson's call on America Online (NYSE: AOL) earlier this year. What was that? So wrong. I'm wondering if Mr. Abelson still thinks the company is worth $2 split-adjusted or whatever it was. Do these people every say, "I was wrong?" No, they'll continue to argue that you're screwed up in the head and they're the voice of reason. When the stock falls 70%, they'll claim a victory. But the funny thing is, the price to which it makes the 70% fall could be 500% above the price at which they started crying their intellectually childish cries of Tulip-O-Mania.

3. Bill Fleckenstein

Dude, you're wrong. OK? PC companies -- Dell Computer (Nasdaq: DELL), Gateway (NYSE: GTW), Micron Electronics (Nasdaq: MUEI), and Compaq (NYSE: CPQ) are all still here and have had a great year. And even if you're ever right, you're way too early.

4. Fred Hickey

The poor man's Bill Fleckenstein. You're wrong too. You win points in a match, but very few games and certainly no matches.

5. Jonathan Cohen, Merrill Lynch

Psst. Just because you can't figure out (Nasdaq: AMZN) doesn't mean everyone else is incorrect. $50 price target? Right. That's about as good a call as your calls on America Online (NYSE: AOL) when you were with Smith Barney.

6. Value Freaks

Look, cash sells at 30.8 times earnings (that's a yield of 5% after 35% taxes. That's 1/(0.05*0.65). Quit with the "historical P/E on the S&P 500" yick-yack. Look, when a company like Cisco Systems (Nasdaq: CSCO) makes equipment and software that facilitates the doubling in Internet traffic every 100 days, equating its fair P/E with its EPS growth rate over the next year is pretty much braindead. Cisco should sell for the same multiple as a money market fund when traffic over the Internet increases by a factor of more than 12 every year? I DON'T THINK SO.

Value freaks, stick to steel companies but don't talk to me about where Cisco should be valued, thanks. And by the way, I'm a value investor. That means I buy things beneath their intrinsic value, but it doesn't mean I have to scour around for just the worst dogs that never have a chance of making money but which happen to be selling at 60% of net working capital. Hardly anyone ever liquidates and distributes the net assets to shareholders these days anyway.

7. Y2K Zealots

This is a ridiculously complex question for people who work with the issue professionally. For those that don't, how can you have a strong opinion either way? You don't know the possible lollapaloozas that can come out of the smallest failure. On the flipside, it's pretty hard to say the world is going to turn upside down. Look, we're humans. There probably will be failures and we'll probably be able to deal with them. Doesn't mean my whole portfolio will be going into Zitel (Nasdaq: ZITL) and Data Dimensions (Nasdaq: DDIM). I'm agnostic on this.

8. Coca-Cola (NYSE: KO) Valuation Haters

Look, when a company generates a 50% cash-on-cash return on capital invested in its business and has a reasonable chance of increasing that invested capital at a good rate and achieving those economics on new invested capital, it most certainly is worth 40 times earnings. So if Coke grows EPS 10% this year, it's only worth 10 times earnings? Sorry. It's worth a whole lot more than that when you can stop growing the business today and spit out $0.50 for every dollar invested in the business. When you add in the growth that is almost assured with this company in new markets, its real value -- the value that the private market would pay for it -- is quite large. Forty times earnings is not out of line.

9. Coca-Cola's Investor Relations

Hey, you're providing access to your management to a select group of people (analysts) and to people that might not even own the stock and might even be short the stock. At the same time, you're denying access to your owners and providing very scanty information. You're world-class company. Set a world-class standard in investor relations. Try treating your owners like real owners of a company. They're not at dumb as you think.

10. Will Small Cap Stocks Come Back?

What has Modern Portfolio Theory done to us? This is irrelevant. Make investments in companies based on their economics, management, products, and other observable traits, not the capitalization decile its stock falls into. Just because it's a small cap stock doesn't mean it will do such and such. If its economics stink, its status as a small cap stock won't save it.

11. Valuation of Big Cap Stocks

In the last six years, return on invested capital for the big S&P 500 companies has increased, and that's adding back the GAAP-mandated write-offs to capital, too. No big baths allowed. Smaller companies haven't followed this trend. Thus, the valuation disparities between the cream of the crop and smaller companies. When a company shows good returns or reasonable prospects to achieve those returns, then it will deserve a big company-like valuation. Not before.

12. Margins

If there's one perception I can change, it's that margins on their own don't matter nearly as much as everyone thinks. It's how you manage capital as well as your margins that determine the economics of a business. A company that turns its assets once a year and manages a net margin of 40% is not worth as much as a company with a 20% net margin that can turn its assets 4 times a year, all else being equal.

13. Concentration of Assets

If you know what you're doing, you shouldn't have a big problem with owning just a few companies. If you don't know what you're doing, you could probably use the diversity of an S&P 500 index fund. This doesn't mean you should go out and throw 100% of your assets into a good-looking little software company if you don't know a good deal about it, but this whole idea of diversification in your portfolio, where you take 3% positions across the portfolio, is ridiculous. Your good ideas won't effect your results all that much. Besides, where else in your life are you diversified? You have one or two houses and one spouse or significant other. Your salary comes from one or two places, and a big portion of your net worth could be tied up in your stock options or the private business you own outright. When your wealth turns into publicly traded securities, there should be no urgency to split that among 35 companies in your portfolio.

With that, I bid you happy holidays. I feel much better now.

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