Mistakes We've Made [Drip] February 25, 2000

Mistakes We've Made
As Johnson & Johnson sinks & sinks

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By Jeff Fischer (TMF Jeff)
February 25, 2000

When you dollar-cost-average into your investments, you expect to need several years before achieving significant returns on your dollars, because every time that you make a new monthly purchase, you impact your cost basis.

So, it isn't surprising that we're relatively flat on our Mellon Financial (NYSE: MEL) investment, which is our latest addition to the Drip Port. We believe that we're buying the stock at favorable valuations and we're benefiting from its dividend yield (we recently received a $6 quarterly dividend payment from Mellon, which is nice for such a young, small portfolio -- imagine 17 years from now).

What is surprising to us is that we've gained 150% on Intel (Nasdaq: INTC) already -- although we did take extra risks to earn this return. We were buying Intel throughout 1997 and 1998 when most people saw the business quality declining due to falling chip prices and the new cheap PC market segment. As a result, we bought the stock at attractive prices while many people were selling. Now Intel has a "back-in-favor" valuation.

So, no mistakes yet on Intel or Mellon Financial.

Then there is Campbell Soup (NYSE: CPB). We began to buy the stock at relatively high valuations on the premise that Campbell was reinventing its business to become a higher-growth, higher-margin business. And it has, at least in the margin department. We stopped buying the stock when large fees were instituted in its direct purchase plan (the stock was around $48 per share at the time). At that time, I said that I wouldn't pay such large fees -- 5% on a $100 purchase -- and soon after, that the business wasn't living up to expectations. The stock began to slide.

In the high $30s, a large discussion took place on the Drip board and many Fools said, "You guys should buy the stock now, it's down." At that point, I didn't want to buy Campbell because the business had no earnings visibility, not having met initial expectations, and, still, because of the fees. Some argued that because we were not likely to buy the stock anymore, we should sell it. Others argued that we should stay "long term" on it regardless. The correct answer now, in my opinion, would have been to sell it, and I didn't, and I take full responsibility for that. Yes, we're long-term investors. Yes, we had just began to buy Campbell Soup in 1998. But no, we're not blind investors. We don't like to hold something that isn't positioned to perform as we hoped.

Not only were the fees in the plan bad, but the business wasn't improving as hoped, which meant that the stock's valuation was still especially high, and now we've seen just how high. The stock has lost about 50%. Before the "Big Fall," we were saying for many months that we'll likely sell Campbell when we find something new to buy with the money. We haven't yet. No, you shouldn't rush a new investment, so sometimes -- in the meantime -- money is better on the sidelines than in a falling stock.

All in all, I should have been more decisive on Campbell Soup when the plan fees were instituted, and Drip Port should have gotten out of what immediately became an unattractive situation for us due to the fees. Even later, there were chances to sell at much higher prices in the $40s, even when we knew that the business wasn't growing like we'd hoped. But even then the issue of being long-term investors was still tugging at us -- "Are you long-termers or not, huh? How can you sell so soon after buying?" Well, if you think that you've made a bad buy decision, being long-term won't save you, so you should sell. Only sell when you're as certain as possible, however, that you won't regret it later. (So many wishy-washy, knee-jerk, unconfident investors have a hellish existence, I'm sure. We're not that way, thankfully, by any means, and hope you're not either.)

Finally there is Johnson & Johnson (NYSE: JNJ), which, after two strong years, keeps going down & down. The stock has fallen from $105 to hit new 52-week lows around $71, finally joining all its pharmaceutical brethren down in the dumpster. What's the problem? Really, the main issue is that the stocks were bid to such high valuations to begin with -- they were at 40x and 50x earnings while typically growing under 20% annually. Sure, these high-quality firms deserve a premium value multiple, but still, they were "up there." And we talked about that. Randy Befumo and I discussed all the valuations in the industry as being up there. J&J's was among the most reasonable (and that has played out as true so far, measuring performances since then), but it was still high.

So now, more than two years into our J&J investment, we're down about $10 on our average cost-basis in the stock. Not horrible, but it could have been avoided, couldn't it? If we felt that the price was high, why not wait to start buying? Because you can never be sure? Yes, that's partially why. And because we had capital we wanted to invest in the industry? Yes, that too. And because the best time to start is usually now? That's true, too, within the right context. Still, Brian Graney argued that J&J's valuation was high in the low $80s, too, and we kept buying. Didn't we make some kind of mistake? Didn't we? It's now down in the low $70s and we could have gotten more for our money had we waited.

Yes, hindsight is too easy. And hindsight and regrets never get you anywhere anyway. Luckily we don't have any regrets -- we are investing how we're compelled, and educated, to invest at the given moment. However, we do have lessons to learn from our past.

One key lesson involves valuation. Intel has carried this portfolio so far. It's a good thing that Intel was our first investment. Coca-Cola (NYSE: KO) was our other runner-up, but we didn't buy it in the end due to its valuation. We still aren't interested. The stock has fallen 40% from its high and 30% from prices where we would have started buying. If Coca-Cola were our first purchase for the Drip Port, where would we be now? We'd be deep in the red -- losing money. Instead, we are handily crushing the S&P 500's dollar-cost-average return since we launched (see the numbers below), and, quite frankly, we have done considerably better than I thought we would in our first 2 1/2 years, even with our mistakes.

Yes, we're long term. Yes, these are shorter-term issues, but still, we want to be the best investors we can possibly be, and arguably we knew better regarding Campbell Soup and Johnson & Johnson at their previous, much higher valuations. When the whole herd is buying stock in all the giant companies and trying to justify 40 P/Es with earnings growth rates in the low teens, maybe it's time to sit back and wait for better buying opportunities, or else put your money elsewhere -- like in Intel when everyone is thinking the business is going downhill, and you have strong reasons to believe otherwise.

Touchstone Friday. The holiday-shortened week was festive here in Drip Port. All of the columns from last week are linked below. On Tuesday, George Smyth concluded his three-part series on different kinds of Drips. On Wednesday, guest Fool Paul Litvak returned. On Thursday, Vince provided more company performance measurement tools that complements his series of columns on the balance sheet. We're going to package all of Vince's great educational columns into one area that will stand permanently in the Drip Port. It'll be a great reference tool.

Finally, next week we'll send our next $100 to Johnson & Johnson. Now, around $71 per share, the stock trades at 21 times year 2000 estimates and 18.5 times year 2001 estimates. The stock could, of course, still go lower (anything can happen), but the risk/reward scenario is now more positive than it was. What is most important overall, Fools, is that you believe in the long, long-term potential (10 years or more) of your favorite investments, and we certainly do.

Fool on and have a great weekend!

Drip Portfolio

2/25/00 Closing Numbers
Ticker Company Dly Pr Chg Price

  Day Week Month Year
To Date
Drip -.72% 1.87% -.64% 4.88% 36.26% 12.73%
S&P 500 -1.48% -.95% -4.38% -9.25% 42.03% 14.56%
S&P 500(DA) -1.48% -.95% -4.38% -9.25% 44.65% 15.37%
S&P 500(DCA) n/a n/a n/a n/a 18.13% 6.67%
NASDAQ -.59% 4.05% 16.50% 12.81% 192.47% 51.54%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg

Trade Date # Shares Ticker Cost Value LT $ Val Ch
  Cash: $24.41  
  Total: $4,618.89  

• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August o