Post of the Day
September 15, 1999

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Whoa.....wait a minute here!

Author: BruceBrown

I just finished doing my morning cheerleading warm-up exercises. That consisted of blowing my nose, making the coffee, dressing the kids for school, doing two loads of laundry and hefting a nice pastry from plate to mouth. Then I read some Dell posts and feel I have to respond.

First observation. Nasdaq's most active list yesterday was:


Gee, is it any wonder why? Four gorillas and Dell - one of the best business models of the decade. So, NancyT's decision to sell her Dell and chase Cisco is a very common one. We can't fault NancyT for what she did. It was her decision and she had her reasons. The market loves to trade sideways and money is flowing to and fro. That's part of the 'big picture' and we have to accept that it happens on a daily basis. Always has and always will. Fund managers, professional investors and amateurs alike. However, it's not how one creates wealth.

PeterEdison posted this:


....selling, you regain most of your original investment and, perhaps, learned an important lesson about building wealth. Not sure whether your invest according to a set of rules that you wrote, but I have a set of buy rules and sell rules. For new purchase, my sell rule is that the stock is history at a 10% loss, period. If, however, the purchase is a winner, I let it run because the profits from winners will make the losses pale into insignificance.

I don't want to challenge your set of rules. I just want to state a few facts that might not work so well with your rules.

The investor that bought Intel earlier this year when it ran up to 142 before sinking below 100 would have been kicked out with those rules. Those are pre-split prices by the way. Now Intel is trading between 170 - 178 (using the pre-split price).

The Investor that bought Cisco around 110 - 115 saw it fall to the low 90's (pre-split prices again). Now it trades at 142.

The Investor that bought Microsoft at the first high of the year 94, saw it drop to the 70's. Since then it has traded as high as 101, but is now at 95.

The Investor that bought Qualcomm three times this year near it's high, saw it drop between 15 and 20 percent each time only to recover to 'new, higher ground'.

The Investor that bought Dell at 55 saw it drop (as we all know all to well) and recover to the 47-49 range twice (April and end of August).

These are just the 5 stocks that were Nasdaq's most active yesterday. Rewind back to last October. Using your rules - an investor would have been kicked out of all 5 stocks. Using your rules, an investor would have been kicked out of all the 5 above scenarios as well.

Using my rules. Which is, regardless of a new purchase or not - hanging on for the longer term in great companies that I researched well and chose to invest my money - I can sleep at night whether the stock dips down 10 percent, 20 percent, 30 percent or more. Had I used your rules on the above stocks over the past years - I would not be sleeping so well today. Granted, we all have to do what we have to do in order to sleep. My rules allow me to, if I so choose, pick up more shares on such wide dips rather than sell the ones that are 'new' such as Qualcomm is in my portfolio. Compare what an investor's worth would be today had the never sold over the past 10 years to one who owned the same stocks and was in and out based on ups and downs. History is always a good lesson.

Granted, gorillas are awarded a higher multiple than other stocks. That is why Dell will never trade at a valuation for extended periods of time to the likes of INTC, CSCO, MSFT or QCOM. However, Dell is an important part of the INTC/MSFT value chain and has been awarded a higher multiple than any other member of that value chain because of it's stellar business model, growth, management and peformance. (GAP and CAP - see below.) The bears that come on this board or on CNBC or in periodicals never seem to grasp that concept - 'that the market knows what it is doing in terms of valuations'. They have been roaring since 1986 against Microsoft. Since 1990 for Cisco. Even longer for Intel. The roaring started in earnest last year for Dell and of course, now that Qualcomm has gone from 19 to 170 the roaring is getting louder for that stock as well. I want to pound them all over the head with some easy concepts to grasp in terms of what it is all about. Dell's multiple has to be higher than its competitors because of its 'world-class competitive behavior'. Let me present you with something from the second revision of "The Gorilla Game" in hopes all will run out and buy the book. It comes from a chapter that discusses CAPs (Competitive Advantage Period) and GAPs (Competitve Advantage Gap) and how they are used to value a company's share price. I credit Geoff Moore/Paul Johnson/Tom Kippola with the following:

"Companies competing in the PC sector are playing a 'royalty game' to see who is going to end up king, prince, and serf. Royalty games are frequently determined by simple execution, and that accounts for the variation in this chart (BB- I'm not going to post the chart) among Compaq, Gateway, and Tandy. Apple is in a sector of one with its Macintosh operating system, but the technology is now throroughly on Main Street, and so it too has become an execution play. All four of these companies are being granted modest GAPs and CAPs.

The really amazing result here is Dell. You cannot earn a 7.6 price/sales ratio simply based on out-executing your competitors, although that is apparently precisely what Dell has done. Twenty-one months ago, when we first did this comparison (1997), Dell had a P/S ratio of 2.4. That is what you would associate with strong execution - superior GAP with no change in CAP relative to your competition. What has happened since?

Dell announced at that time that it had a strategic competitive advantage in its execution systems. The market at that time, however, granted it a change in GAP but was reluctant to accord it a change in CAP. That is because all three of Dell's major competitors - Compaq, IBM, and HP - announced initiatives to match or better Dell's systems. In the intervening twenty-one months, however, all three companies have failed spectacularly to deliver on that promise. So now the market says, OK, maybe Dell does have a sustainable competitive advantage here that we undervalued, and so it has not only acknowledged a new GAP but also a new CAP as well. That is where the 7.6 price/sales ratio comes from."

Damn. That was worth the $18.20 price of the book alone. That is why Michael Dell is smiling. That is why CPQ's share price is where it is and that's why we long term Dell investors have increased our wealth.

By the way, Cisco has a 19.1 P/S ratio. Hence, the valuation of Cisco. Those of you bears and TA investors need to realize just why the market is giving these valuations to the likes of Dell and Cisco. It's not rocket science here. It's not luck. It's not 50 DMAs. It's not 200 DMAs. It's all based on competitive advantage period and competitive advantage gap. Two very powerful tools that one uses to value stocks in the technology arena. I read a lot of posts that make me bang my head on the hardest surface nearby on stock message boards. I hate to see the 'little guy/gal' get forced out of investments and hence - my long posts here and in other places to try and keep we 'little guys and gals' in the 'know'. It really is a big picture out there and luck is not part of it. True, interest rates can change the CAPs/GAPs. However, long term, an investor still makes out like a sweet smelling rose. I want all of us to 'enjoy the flowers' so to speak.

My rules include using this CAP/GAP valuation method, rather than worrying about setting sell stops when a new purchase falls 10 percent or more - keep my chuggin' right along. We all have to set our own rules. Be Foolish and develop a good set of rules. Be careful about trading money sideways in and out of investments that might 'look better' or might provide a 'better return'. Pick the good ones based on excellent research. Buy the shares and avoid the noise. Work and save money to buy more shares of the good quality investments you want that have excellent CAPs and GAPs.

Back to a question I stated above. Gee, is it any wonder why DELL, INTC, MSFT, QCOM and CSCO were the most actively traded stocks yesterday on the Nasdaq? CAPs and GAPs my friends.

Time to warm-down after all that cheerleading. I have to memorize an opera with not the most pleasant subject matter which I make my debut in on October 14. It's about the cleansing process which led to WWII. The Consul. I play the husband who gets 'cleansed'. My baby dies in the first part of the story and my wife gasses herself at the end of the opera after I am taken away. Quite an important production playing here in Vienna, you can imagine. It makes all those light-hearted, swash buckling guys I usually play seem pointless.