Rule Breaker Portfolio

Fool Portfolio Report
Thursday, December 11, 1997
by Tom Gardner (TomG@fool.com)


ALEXANDRIA, VA (Dec. 11, 1997) -- America Online and Amazon.com bucked the downward market trend, and The Fool Portfolio outperformed by losing 1.03% versus declines of 1.53% by the S&P and 2.38% from the Nasdaq. Boy, the Naz is starting to look like an NFL quarterback without an offensive line. On October 1st, the Nasdaq market was up 31% for the year. Today, it stands up 20.72% for 1997. An outstanding year, but a tough autumn for the smaller-cap marketplace.

Here in this motley-framed Fool Portfolio window (click here to see it), which we peer into everyday, we've focused a good deal of attention on some of our more volatile, smaller companies in weeks and months passed. They're up, they're down, they're all around. Volatility, thy name is small- or mid-cap growth stock!

3Com is a darling today; no, it's not tomorrow; well, it may be again soon. The Donald blasts ahead 50%, then gets hammered by rising interest payments. America Online was at $75, then it fell to $25 -- and today it closed at $86 1/8. And Iomega -- with the financial media's "Kick Me" sign stamped on its back -- has risen ten times in value in two-and-a-half years. But it's still 50% off its highs off April, 1996. You want volatility? Take a look at Iomega's three-year graph.

Never mind that the national financial media has been mostly wrong about the immediate viability of many of these smaller businesses -- while the industry trade coverage has mostly been superb. No, the focus of tonight's report is not more banter about the lack of financial training among the journalism-school-trained financial media. Although it was fun to write that sentence. Nope, tonight's focus is away from our smaller holdings and over to a larger, yet less known, company in The Fool Portfolio:

Lucent Technologies.

In October, 1996, AT&T made final the spin-off of Lucent -- which, by the way, makes the things that make communications work. On that day, 42 shares of LU trading at $47 5/8 dropped into our autumn basket. And, over the past fourteen months, Lucent has risen to $76 per share, a 59.61% rise. This has come to pass while the S&P 500 has climbed 38.6%.

Lucent Technologies -- a market beater.

But who is this company? Where are they located? What do they do? And what are their prospects? We've been asking ourselves these question recently because, to be honest, we've been flirting with the idea of holding onto this through our Foolish Four rotation. If we abide the method of the mechanical approach to Dow-Dividend investing, then we're bound to cashing out our Lucent shares around the middle of February.

But we're Fools... not machines. Lyndon LaRouche hasn't yet planted semiconductor chips in our brains. We still have the power to reason. So we're considering holding Lucent and violating the mechanized Foolish-Four model. Considering it... and here's where we are.

Lucent is a mammoth telecommunications company, with more than $26 billion in annual sales. Profit margins for the trailing twelve months are 5.7%. The company has $1.5 billion in cash, and $1.6 billion in long-term debt. Further, Lucent's Flow Ratio -- defined as (current assets - cash) / current liabilities -- is an enviable, but not out-of-this-world, 1.17.

"What's the Flow Ratio and why should I care?" you demand.

The Flow Ratio measures how well a company manages incoming payments (receivables) & existing inventories against outgoing payments (payables). If you think about it, you want your companies to get paid upfront for their stuff and to carry as little inventory as needed. The result? Low receivables and low inventories. Additionally, you wouldn't mind having a company which, though it had the cash on hand to pay, could resist by contract the making of timely payments to suppliers. Didja catch that?

Good.

The outcome would be high current liabilities (payments it had to make eventually) and low current assets (outstanding bills and product purchases yet to come) -- a company that holds a tight control over the money that flows through its business. (There's a reasonable chance that that flew over your head. If so, drop by the Lucent folder and let's talk about it.)

Suffice to say that with strong growth in sales, healthy profit margins, and a sturdy balance sheet, Lucent has a great lie out in the middle of the fairway. But there are more strokes to be struck, more holes to be played.

The core of Lucent's business and, thankfully, its fastest-growing segment, is providing telecommunications equipment to network operators. In this category of their business, Lucent

1) sells switching systems to telephone
companies, which link telephones, fax
machines, computers, and satellites
together, allowing customers to get
information no matter what communications
tool they're using;

2) sells access solutions -- enabling the
transfer of voice, data, and video -- over
private networks;

3) sells Internet solutions to internet-service
providers looking to alleviate traffic congestion
on their service;

Investors in Lucent are putting their money on both the companies ability to exploit the substantial demand for networked communications and to aggressively manage the flow of cash through the business. The company announces earnings for the first quarter of 1998 on or around January 21, 1998. Analysts are expecting $1.52 per share.

Beyond watching if the company hits those numbers, I'd suggest that -- as my Foolish profile on our Web site reads -- you "watch the balance sheet." When the next quarterly financial report flows through, check and see if Lucent has gained or lost ground on paying down long-term debt? And has the company tightened controls on receivables and inventories, inching its Flow Ratio down from its present perch at 1.17? And have sales to network operators, essentially half of Lucent's business today, increased markedly relative to the first quarter of 1997?

Lucent shareholders and might-be shareholders... here are a few more links for your information foraging. Oh, and, on the newsfront, Lehman Brothers' analyst Tim Luke reiterated his outperform rating this week, with a 12-month target price for Lucent of $95.

Talk on the Lucent Message Folder

A Snapshot of Lucent Technologies' business

Lucent Technologies' Web Site

Tony Danza's Film Credits

Fool on!

Tom Gardner

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TODAY'S NUMBERS
Stock Change Bid ---------------- AMZN -1 1/2 54.13 AOL -1 1/2 85.00 T - 3/16 57.81 CHV - 1/4 78.25 DJT - 7/16 7.13 GM +1 1/16 64.38 INVX - 7/16 23.31 IOM -1 1/16 27.94 KLAC - 3/8 39.25 LU -1 15/16 78.19 MMM - 5/8 93.88 COMS -1 15/16 35.75

Day Month Year History FOOL -1.22% 1.41% 25.82% 235.80% S&P: -0.61% 1.51% 30.92% 111.56% NASDAQ: -1.48% -0.25% 23.67% 121.70% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 85.00 1068.73% 5/17/95 980 Iomega Cor 2.52 27.94 1008.63% 10/1/96 42 LucentTech 47.62 78.19 64.20% 8/11/95 125 Chevron 50.28 78.25 55.61% 8/12/96 130 AT&T 39.58 57.81 46.07% 8/12/96 110 Minn M&M 65.68 93.88 42.93% 9/9/97 290 Amazon.com 38.22 54.13 41.61% 8/12/96 280 Gen'l Moto 51.97 64.38 23.86% 4/30/97 -1170 *Trump* 8.47 7.13 15.87% 8/24/95 130 KLA-Tencor 44.71 39.25 -12.21% 6/26/97 325 Innovex 27.71 23.31 -15.87% 8/13/96 250 3Com Corp. 46.86 35.75 -23.71% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 30175.00 $27593.13 5/17/95 980 Iomega Cor 2509.60 27378.75 $24869.15 9/9/97 290 Amazon.com 11084.24 15696.25 $4612.01 8/11/95 125 Chevron 6285.61 9781.25 $3495.64 8/12/96 280 Gen'l Moto 14552.49 18025.00 $3472.51 8/12/96 110 Minn M&M 7224.44 10326.25 $3101.81 8/12/96 130 AT&T 5145.11 7515.63 $2370.52 4/30/97 -1170*Trump* -9908.50 -8336.25 $1572.25 10/1/96 42 LucentTech 1999.88 3283.88 $1284.00 8/24/95 130 KLA-Tencor 5812.49 5102.50 -$709.99 6/26/97 325 Innovex 9005.62 7576.56 -$1429.06 8/13/96 250 3Com Corp. 11714.99 8937.50 -$2777.49 CASH $32438.81 TOTAL $167901.12








Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.