Rule Breaker Portfolio

America Online
Play it again, Steve?
by Jeff Fischer
(JeffF@fool.com)

ALEXANDRIA, VA (July 8, 1998) -- Not an unusual day of volatility for the Fool Port. If you've watched America Online since 1994, you've seen its stock price vacillate like a drugged jellyfish time and again. So this is common. For Fools, some of the most important things to know when investing are: 1) Your long-term objective when you buy any stock. 2) What might cause you to sell any holding (a certain valuation, or news, and so forth). And 3) the risks involved in any investment (volatility isn't a business risk, though -- it's a risk only if you let volatility impact your investment decisions).

Some of the most important things to be, if you're investing in individual stocks, are: 1) Diversified. How much so, and in what investments, is up to you. The Fool Port likes to base the port on the Foolish Four giants and then add small- to mid-cap growth stocks that we understand, and then finally we mix in a short or two. You must also be: 2) Long-term. Any investment in the stock market should be at least initiated with a long-term mindset. News or events might change this at times, but if you're buying the right companies, much more frequently than not you won't want to sell on near-term news or events. 3) Knowledgeable. You should understand what you're investing in and why.

This sort of approach has led to the Fool Port's historical market-beating performance from month one. Although the Fool Port's philosophy has evolved over four year's time, its main and most important creed (buy and hold) has only become more prevalent.

Virtually every investment study in the world concludes with the fact that, over time, a buy and hold approach beats all other methods of stock investing (that is, of course, if you buy the right companies). There is no other investment method that tops hitching your wagon to market leaders and letting that wagon ride for as long as merited -- and that's often longer than you think. (How many millions of people have unnecessarily sold stock in the past ten years and lived to regret it?)

Buy and hold investing may or may not play out successfully with Amazon.com (Nasdaq: AMZN), but for the Foolish ribbing that the Fool Port takes on its Amazon message board, it's amusing that, actually, there has been NO better way to make a return on Amazon, to date, than to do what the Fool Port did: It bought and then it held. Simple.

Of course, this won't be true from any cost-basis -- we evaluated our cost-basis before buying. And will our early Amazon success continue? Who knows. But currently, nobody but even earlier investors is bettering the Fool Port's return, and the shorts probably never will. That's not to boast -- it's only to again remind that we all have investment options: buy, sell, sell short, do nothing, whatever. But buying and holding the right companies will beat out all other investment options over time. Period.

America Online (NYSE: AOL) is one stock that demonstrates the potential of buying and holding through all the daily noise of the bears and through the years of Barron's and Wall Street Journal chatter. AOL is the Motley Fool's best-performing investment. Today, we'll take a quick look at the company as we continue to review our holdings one by one, a review that began on Monday with Amazon.com.

America Online stock has gained 2,800% since August of 1994. Pause for a moment on that number. Think back to the hundreds of articles of criticism that the company (or actually, the stock price) has received. Yet, now it's up 2,800%. (Nice going Wise journalists! You called that one right!) Now consider that no short seller has been able to earn even close to a triple-digit return (100%) shorting the stock. Maybe some got lucky and made 70% during the 1996 slide. Wow. Big deal. Meantime, a steam train is plowing into the future with our 2,800% flag (so far) on the front of it. (Regular readers might remember that I question the integrity of shorting stocks in a world that offers truly great long-term investment opportunities -- opportunities that crush, over years, the returns that shorting can ever generate.)

Anyway, with AOL just dollars away from a new all-time high (as it's been for most of the past four years), let's look at the current situation:

 
    America Online (NYSE: AOL) 
    Stock Price: $109 
    Market Cap: $24 billion 
    Trailing Sales: $2.27 billion 
    Price/Sales: 10.5 
    Last Qtr Sales: $693 million 
    Price/Revenue Run-Rate: 8.1 
    Recent Gross Margin: 34% 
    Recent Operating Margin: 8.7% 
    5-year est. growth rate: 52% 
    Earnings Estimates: $0.60 in FY98 (ended June) 
                        $1.00 in FY99

All in One. The young company has the best model for making money on the Internet to date. It is an Internet Service Provider, a portal and aggregator, a community, and a proprietary content provider all in one. On the downside, it competes with the Internet content-wise -- an impossible task that it will eventually lose on many levels. On the upside, it provides incredibly easy Internet access and online services, which, if membership proves anything, the general public wants. And, of course, AOL is one of the few leading Internet companies that charges a subscription fee.

About fourteen million subscribers pay around $250 per year to subscribe, meaning $3 billion in annual revenue. And the company has pricing power here -- at least to a point. It raised prices $2 per month last year and subscriber numbers have only risen since.

As for other revenue streams, AOL has been growing advertising and commerce revenue related to online transactions impressively. Last quarter revenue here grew to $118 million from $68 million the year before, and backlogged revenue here topped $400 million. With $693 million in sales last quarter, AOL has $924 million in cash (before a recent $500 million stock sale, the proceeds of which should be accretive to earnings shortly) and just over $400 million in long-term debt.

Where to from here? You tell us. The Fool Port is hoping, over the years, to become a portfolio that owns more and more companies that it never needs to sell -- something a la Anne Scheiber and her investments in PepsiCo, Chrysler, and Schering-Plough, which she owned for five decades and at her passing. Perhaps the closest thing we own right now that fits this "buy and hold, and hold, and hold" profile (other than our Dow giants, theoretically) is America Online. Perhaps.

The company is still in the first inning of a ball game that will run into extra innings (that means more than nine innings, baseball haters), and that will see many dark nights and booing fans. But due to the subscriber-based valuation method that applies to AOL, the stock continues to rise higher and higher -- like a Babe Ruth homerun -- as subscriber numbers grow. That's logical. Every new "sub" means more revenue for AOL. This is nice. Like a cable television company, AOL can be much more easily valued than can most other Internet stocks, because AOL does have a reportable base of subscribers, and it's beginning to have reliable revenue streams.

We all know that AT&T (NYSE: T) recently paid too much for Telecommunications Inc. (Nasdaq: TCOMA) -- err, I mean, bought TCI at a giant premium that would indicate that long-term AOL shareholders have reason for hope. But shareholders have also reason to consider the risks. One risk is that there's going to be increasingly easy and quick ways to bring the Internet into homes, with cable and television being potential examples. With future technology changes in mind, AOL is committed to broadband Internet access (like HDSL) -- as the company shared in its recent conference call -- and it's also working on television-based technology. Yes, there will more competition on several "Internet service" fronts in the years ahead, and AOL is trying to stay atop of that. For now, AOL is the early leader in what it does.

Note the word "early." The Internet is in its infancy. In the next decade, will it be, "Play it again, Steve Case and AOL"? Or will the stock wither?

If you're investing in anything Internet-related and you don't understand the potential risks, and you aren't ready to be committed to your investment for at least five years, then (in my opinion) you shouldn't be investing here.

TODAY. The Fool Port lost 2.85% on a decline in Amazon.com, while most other holdings rose. Lucent (NYSE: LU) neared a new high, and Innovex (Nasdaq: INVX) rebounded 13%. 3Dfx (Nasdaq: TDFX) was in the news. The company announced that Gateway plans to use its Voodoo2 chipset in its family of home multimedia PCs. Great news. The stock rose $9/16. Hmm. Finally, rumors continue that Intel could buy 3Com (Nasdaq: COMS). Again -- hmm.

For more on Amazon.com and the Fool Port, don't miss tonight's "Fool on the Hill" column in the Evening News.

Fool on...

--Jeff Fischer

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Bookmark Live Fool Port Quotes

07/08/98 Close
Stock Change Bid ---------------- AMZN -15 1/16 107.06 AOL - 1/8 108.88 T + 7/8 57.06 DJT + 1/8 7.44 DD + 1/2 77.13 XON + 7/16 73.19 INVX +1 7/8 15.63 IP + 3/16 43.75 IOM - 1/16 5.88 KLAC --- 27.56 LU +1 3/4 87.19 SBUX +1 57.06 COMS + 13/16 29.50 TDFX + 9/16 16.81

Day Month Year History Annualized FOOL -2.85% 3.76% 48.06% 396.90% 50.48% S&P: +1.01% 2.87% 20.19% 154.44% 26.88% NASDAQ: +1.43% 2.15% 23.25% 168.74% 28.66% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 108.88 2894.00% 9/9/97 580 Amazon.com 19.11 107.06 460.22% 5/17/95 1960 Iomega Cor 1.28 5.88 358.84% 10/1/96 84 LucentTech 23.81 87.19 266.21% 8/12/96 130 AT&T 39.58 57.06 44.18% 2/20/98 215 DuPont 59.83 77.13 28.90% 2/20/98 200 Exxon 64.09 73.19 14.19% 4/30/97 -1170*Trump* 8.47 7.44 12.18% 7/2/98 235 Starbucks 55.91 57.06 2.06% 2/20/98 270 Int'l Pape 47.69 43.75 -8.26% 1/8/98 425 3Dfx 25.67 16.81 -34.50% 8/13/96 250 3Com Corp. 46.86 29.50 -37.05% 8/24/95 130 KLA-Tencor 44.71 27.56 -38.35% 6/26/97 325 Innovex 27.71 15.63 -43.61% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 77301.25 $74719.38 9/9/97 580 Amazon.com 11084.24 62096.25 $51012.01 5/17/95 1960 Iomega Cor 2509.60 11515.00 $9005.40 10/1/96 84 LucentTech 1999.88 7323.75 $5323.87 2/20/98 215 DuPont 12864.25 16581.88 $3717.63 8/12/96 130 AT&T 5145.11 7418.13 $2273.02 2/20/98 200 Exxon 12818.00 14637.50 $1819.50 4/30/97 -1170*Trump* -9908.50 -8701.88 $1206.63 7/2/98 235 Starbucks 13138.63 13409.69 $271.06 2/20/98 270 Int'l Pape 12876.75 11812.50 -$1064.25 8/24/95 130 KLA-Tencor 5812.49 3583.13 -$2229.37 1/8/98 425 3Dfx 10908.63 7145.31 -$3763.31 6/26/97 325 Innovex 9005.62 5078.13 -$3927.50 8/13/96 250 3Com Corp. 11715.99 7375.00 -$4340.99 CASH $11876.47 TOTAL $248452.09

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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.