Rule Breaker Portfolio

Fool Buys AOL
August 04, 1994


**This trade is being made under the regular portfolio policy, namely, once The Fool announces an intention to trade, that trade will be made within the next WEEK, as opposed to the next day. For more detail, please read the "New Trades" section of the Fool Portfolio.**

America Online
NASDAQ: AMER
TYPE: Mid-Cap Growth
Phone: (703) 448-8700
Closing prices, August 4th, 1994: Bid $57 1/4, Ask $57 3/4

Trailing 12-month revenues: $104.4 million
Trailing 12-month EPS: 76 cents
Last quarter reported: June 1994 (FY: June)
Next quarter report date: About October 28th, 1994
Consensus EPS estimate for quarter: $0.27e vs. $0.14

FOOL ratio: 1.16
TRADE: Buying 85 shares, August 5th

America Online, based in Vienna, Virginia, is the premier investment play on cyberspace. Having started as a Mac platform about a decade ago, the company has since evolved into the fastest-growing and most dynamic player in its industry. Besides showing an extreme lack of wisdom in introducing Folly Online, America Online has also signed up such partners as NBC, Cap Cities/ABC, The New York Times, Smithsonian, Scientific American, and a large number of other partners as "information providers." More information providers are signing on every month, broadening the service's offerings and improving America Online's early chances of winning the battle fought over America's modem lines.

OUR EMPLOYER. There is a certain amount of faith and loyalty involved in our purchasing this stock. Heck, we figure we just crashed this party. . . might as well pay the doorman. We need to take pains here to assert that our decision to recommend AMER is totally, 100% our own decision. We're buying the stock because we think AOL is the best cyberspace locale, period, and we think cyberspace is an incredibly powerful medium whose power is only now being fully realized in small ways. Most people are still NOT online, and really don't know what they're missing. How long do you think that situation will persist?

UPPED EARNINGS ESTIMATES. Except for a disappointing fiscal fourth-quarter in 1993, AOL has consistently beaten its earnings estimates. And we agree with brokerage house Alex Brown's assessment of the stock a few days ago, when it upgraded AMER to a strong buy, with a one-year target of $75 to $100 a share. Two days ago, AOL reported fiscal fourth-quarter 1994 earnings of 25 cents per share, fully diluted, trouncing the year ago quarter and exceeding estimates by 2 cents. That brought EPS to 76 cents for the year ended 6/94, with revenues up from $40 million last year to $100 million this year. Earnings estimates for next year sit at $1.41 per share--fantastic growth, only we're expecting even more. Zacks shows a 5-year growth rate of 41% for the company, one of the strongest in America. But we expect that number to go be significantly higher for at least the next 2-3 years.

THE STOCK. The stock traded up to a high of over $90 per share during the heady days at the end of this March. One analyst at that point put America Online's takeout value at $200 per share. With the general decline of growth stocks since then, America Online has come down to a more reasonable valuation today, here at $57 and change. Of course, our Fool Ratio is still quite high for the stock, suggesting (based on conservative estimates) that AOL is overpriced here. We don't care. We continue to believe America Online will beat those estimates, and we see at least a decent chance that AOL could dominate cyberspace in the coming decade, as Microsoft has come to dominate software. There's a lot of intangible value in having already cut deals with so many top-line business partners.

BUY AND HOLD, HOLD, HOLD. Because of its high Fool Ratio, America Online could get clipped in the near-term, making it a risky play. If the Market remains weak and hostile to technology, AOL shareholders might feel some pain. But we are buying, and we are holding. And holding. And holding. Because when we come to like a company and its situation this much, we're very unlikely to let go, inside of a decade.

THE FOOL FACTOR. Finally, we're now helping to boost the company's revenues. You think analysts have factored in The Fool yet? We don't think so. We certainly haven't gotten any calls from Alex Brown yet. Is that inside info or what?!