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What Happened to Cash-King?
Cisco vs. Home Depot
Rule Maker vs. Merchant-King
by Al Levit ([email protected])
Glendale, CA (Dec. 16, 1998) -- Yesterday I promised that this would be a week of comparisons, with an approach to risk underlying the comparison. I started out by comparing the Rule Maker portfolio to Internet small-caps. In terms of risk, those two are miles apart. Today, we move from the ridiculous to the sublime, as I compare companies from two closely related investing styles -- Rule Makers and Merchant-Kings.
What started this off was a remark that Dale Wettlaufer made a few weeks ago that he consider Cisco (Nasdaq: CSCO) and Home Depot (NYSE: HD) to be of equal valuation (on his Bore ratio), and consequently leaned towards Home Depot since it was "a retailer selling products you know will probably not go obsolete," as opposed to "a rapid-growth internet capital equipment manufacturer that you know could lose five steps technologically in a very short order." At the same time Dale said this, he mentioned that the Boring portfolio wasn't going to be selling its Cisco shares anytime soon. (I was trying to get a donation, but no dice.) It did make me think there must be something really great about Home Depot to be on such a footing with Cisco.
You see, I find it truly amazing that this is the second time someone has gone one-on-one against one of our Rule Makers, AND THEY KEEP PICKING FROM THE TOP OF OUR LIST. Please don't misunderstand me. It's not that I think we have ANY dogs in our portfolio, but at the same time some of our companies are clearly doing better than others right now. First David Gardner took on Microsoft (Nasdaq: MSFT) with Merchant-King wannabe Amazon.com (Nasdaq: AMZN) (we can figure out whether Amazon.com is really a Merchant-King when it starts making money), and now Dale is pitting Cisco against Home Depot.
I'll talk about the companies in a minute, but first I'd like to review some key differences between Rule Makers and Merchant-Kings:
- Rule Makers have high profits and low turnover; Merchant-Kings have low profits and high turnover
- Rule Makers have patents; Merchant-Kings have size and execution
- Rule Makers can stumble if their patents lose value; Merchant-Kings can stumble if competitors come on the scene that can execute as well as they can
Let me expand on this last point, since I haven't developed it well before. Our Rule Makers are what they are because of some product or process that the market values that is protected by a patent. It might be Coca-Cola (NYSE: KO) syrup, Microsoft operating systems, or Pfizer (NYSE: PFE) drugs. If these products lose value, either because the world decides they don't like Coke anymore, the government makes Microsoft give Windows away, or Pfizer's patent expires, then the companies' value will decrease.
Merchant-Kings, on the other hand, are different. There is nothing to keep competitors from horning in on their territory, if their competitors can execute as well as they can.
Now let's consider the merits of one style against the other. It's my view, and one that's shared by most of my Rule Maker brethren, that there is less risk involved with a Rule Maker than with a Merchant-King. A government patent is more security than a current advantage in execution. This patent advantage is limited with the pharmaceuticals, where the patents only last 17 years, and with the technology companies (the gorillas) where a discontinuous innovation can make your patent obsolete at any time.
If they are thinking long-term, and all of our Rule Maker companies are, then both the drug companies and the tech companies will fight for their patents with research:
- The drug companies will keep developing new drugs with their own 17-year patents, and
- The technology companies will keep developing new solutions at the leading edge of the market.
Finally, it's time to take a look at Cisco vs. Home Depot. Let me start out by saying that I think they are both great companies. Last month I called Cisco the Microsoft of networking. I haven't changed my mind. Home Depot is also the leader in its field. When I first examined the Merchant-Kings a couple of months ago, Home Depot was one of the companies that demonstrated to me how good a Merchant-King could be.
That said, I should point out that Home Depot has a significant competitor on the horizon in Lowe's Companies (NYSE: LOW). Currently, Lowe's is a regional chain with many stores in the East, but it is adding many stores in the South and Midwest and just recently made a major acquisition to expand into the West. Whether this will hurt Home Depot's already thin margins remains to be seen.
Cisco, on the other hand, has been a master at protecting its networking patents to date. It owns the router market (it is responsible for 85% of the routers sold), and as the market moves to switches Cisco is moving with it. Currently, Cisco sells about 35% of all network switches sold. As switches become a larger portion of the network infrastructure, I believe that Cisco's share of that market will increase as well.
Dale poked some fun at Cisco's press release for being almost indecipherable to anyone but a network techie, and I'll admit that I didn't understand every word of it myself. However, I did understand this much, Cisco is at the very top of the game when it comes to networking, and it intends to stay that way. That's all that this Rule Maker investor needs to know (for the record, I own Cisco personally).
Thus, I see less risk in Cisco than I do in Home Depot. Interestingly enough, Zacks consensus estimate predicts that Cisco's earnings will grow significantly faster than Home Depot's over the next five years (28.6% vs. 23.2%). Normally, I'd expect less reward from the company with less risk. In this case, the consensus doesn't seem to be leaning that way, and I'll stick with the Rule Maker.
That's it for today, tomorrow I'm going to look at my favorite Merchant-King, a little computer maker from Round Rock, Texas.
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Order your copy of David and Tom Gardner's new book, Rule Breakers, Rule Makers, in advance. This Simon & Schuster beauty doesn't arrive until January, but you can reserve your copy today! The first half of the epic book, on Rule Breakers, elucidates the Fool Port's investment style; the second half, on Rule Makers, further explains Cash-King investing.
Stock Change Bid AXP -1 1/4 93.50 CHV +1 1/8 84.13 CSCO -1 1/16 82.69 KO -1 1/16 64.88 GPS - 9/16 48.25 EK +1 3/8 73.06 XON +1 3/4 75.75 GM +2 7/8 70.06 INTC -1 13/16 114.13 MSFT +1 7/8 133.75 PFE + 3/4 115.75 SGP + 7/16 54.69 TROW -2 33.00
Day Month Year History R-MAKER -0.23% 1.44% 23.51% 23.51% S&P: -0.08% -0.14% 15.50% 15.50% NASDAQ: -0.16% 3.07% 20.59% 20.59% Rule Maker Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 133.75 70.89% 5/1/98 55.5 Gap Inc. 34.06 48.25 41.66% 6/23/98 34 Cisco Syst 58.41 82.69 41.56% 2/3/98 22 Pfizer 82.30 115.75 40.65% 2/13/98 22 Intel 84.67 114.13 34.78% 8/21/98 44 Schering-P 47.99 54.69 13.95% 2/6/98 56 T. Rowe Pr 33.67 33.00 -2.00% 2/27/98 27 Coca-Cola 69.11 64.88 -6.12% 5/26/98 18 AmExpress 104.07 93.50 -10.15% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 75.75 17.74% 3/12/98 20 Eastman Ko 63.15 73.06 15.70% 3/12/98 15 Chevron 83.34 84.13 0.94% 3/12/98 17 General Mo 72.41 70.06 -3.24% Rule Maker Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 3210.00 $1331.55 6/23/98 34 Cisco Syst 1985.95 2811.38 $825.43 5/1/98 55.5 Gap Inc. 1890.33 2677.88 $787.55 2/3/98 22 Pfizer 1810.58 2546.50 $735.92 2/13/98 22 Intel 1862.83 2510.75 $647.92 8/21/98 44 Schering-P 2111.7 2406.25 $294.55 2/6/98 56 T. Rowe Pr 1885.70 1848.00 -$37.70 2/27/98 27 Coca-Cola 1865.89 1751.63 -$114.27 5/26/98 18 AmExpress 1873.20 1683.00 -$190.20 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 1286.70 1515.00 $228.30 3/12/98 20 Eastman Ko 1262.95 1461.25 $198.30 3/12/98 15 Chevron 1250.14 1261.88 $11.73 3/12/98 17 General Mo 1230.89 1191.06 -$39.83 CASH $120.62 TOTAL $26995.18 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.
*The year for the S&P and Nasdaq is as of 02/03/98
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