RULE MAKER PORTFOLIO

<THE RULE MAKER PORTFOLIO>

Macro-Soft
Winning the world

By Tom Gardner (TomGardner@aol.com)

ALEXANDRIA, VA (Jan. 25, 1999) -- Last week, Microsoft (Nasdaq: MSFT) announced its 1999 second-quarter earnings. It's time to strike up the broken record and dance. Your Rule-Making managers have said it before, and I'll write it out again today:

"Microsoft's recent report represents the strongest earnings performance in the history of our public markets."

If you've heard me share this thinking before or have read our new book Rule Breakers, Rule Makers, please bear with me through tonight's column. I want to outline why I believe that Microsoft is this century's commercial leader and how one could have capitalized -- and I believe can still capitalize -- on the company's extraordinary, enduring success. (And please feel free to forward this report to anyone you know who is on-the-fence over whether to directly own shares in a company versus buying and holding managed mutual funds. Imagine paying 2% annual fees to lose to the market when enduring success is so easy to invest in via the stocks of great Rule Makers.)

On January 19th, Microsoft announced sales of $4.9 billion for the last three months of business. Profits for the quarter came in at $1.98 billion. This means that for every one dollar of sales, Microsoft made forty cents in after-tax earnings. This is amazing. To provide some context, compare the rate of profitability at Microsoft to other companies in the world of media and technology:


Net Profit Margin
Microsoft  40%
Yahoo!     33%
Gannett    19%
Oracle     14%
AT&T        9%
Disney      8%
IBM         8%
AOL         6%
CBS       - 1%

Microsoft earns significantly more reward on each dollar of sales than any of its competitors -- indeed, than any other large company in the world. In the language of Rob Landley's excellent article last Thursday (Money-Making Machines), Microsoft is printing four dollars of pure value for every ten dollars of sales. Comb the public markets and you won't find a company facing such tremendous demand for its products that can match it with this profound level of earnings efficiency.

What do the software company's high profit margins mean?

Flip over onto the balance sheet and you'll see that Microsoft's cash holdings have increased dramatically over the past year. This time last year, Microsoft had $13.9 billion in cash. Today, Microsoft has over $19.2 billion in cash. Take a moment and study its capital underpinnings relative to other companies in the marketplace:


Capital Structure
                             LT-         Cash/Debt
            Cash             Debt        Ratio      
Microsoft  $19.2 billion     $0           ---
Yahoo!      $1.4 billion     $0           ---
Oracle      $1.9 billion   $0.3 billion    6x
AOL         $1.3 billion   $0.4 billion    3x       

AT&T        $4.1 billion   $6.1 billion   in debt 
IBM         $5.8 billion  $15.2 billion   in debt
Gannett     $0.1 billion   $1.3 billion   in debt    

CBS         $0.1 billion   $4.8 billion   in pain
Disney      $0.1 billion   $9.6 billion   in pain   

A couple of interesting notes here. Microsoft has more cash than the other eight listed media and technology companies combined. And with no debt, Mr. Softy isn't burdened by heavy interest payments. Not only is there no cost to Microsoft's capital -- there's a compounding benefit to it.

Compare that situation with Disney, at the bottom of the capital ladder. I think you'll likely agree that the likelihood is slim that Disney's go.com will seriously compete with Yahoo! and Microsoft in the portal battle. And what does it say about America Online's recently tightening position with CBS? Who holds the cards in that hand?

Here I'd suggest noting that the business and customer momentum -- evident in user growth, net margins, and cash stockpiling -- is all with the technology industry and all away from the traditional media. The technology companies have rising margins, a much stronger underlying financial position, and new-user growth out the wazoo.

That's why technology valuations appear to be "going through the roof," while the traditional media companies are stalling out. The markets are anticipating the continuation of this business momentum. And the markets aren't far off. Investors have recognized that the leading technology companies are financially far sturdier than the installed media.

Okay, now look at the market capitalization of these nine technology and media companies.


Market Capitalization  
Microsoft  $405 billion
IBM        $167 billion
AT&T       $160 billion
Disney      $74 billion
AOL         $66 billion
Oracle      $49 billion
Yahoo!      $31 billion
CBS         $25 billion
Gannett     $18 billion 
With Microsoft rising more than $5 per share today, our software giant became the first $400 billion company on the planet. What I find interesting is the general ascent of the technology companies in this grouping. Yahoo! is now worth more than CBS. America Online appears on target to surpass Disney over the next year. And our Microsoft is worth the combination of Disney, AOL, Oracle, Yahoo, CBS, and Gannett (USA Today) -- with $140 billion in value left to spare.

To close our numbers game for the night, put all three of these numbers in perspective -- margins, capital, and capitalization. I will leave the drawing of conclusions about these numbers for discussion in the Rule Maker Companies folder. What I can say is that Microsoft is the clear, runaway, powerhouse leader in a collection of companies that will serve an enormous worldwide demand for interactive services.

The nine companies are ranked in the order of their market values today. But, Fool, think for a second about where the world is going from here. Factor in the two simple financial metrics, and imagine what this grouping might look like in five years -- from highest value to lowest. What do the direction of location of the financials suggest about who will likely be Making the Rules five years hence?


Final Tally
           Net     Cash-    Market
           Margin  to-Debt  Cap      
Microsoft  40%     Dream    $405 bil.
IBM         8%     In debt  $167 bil.
AT&T        9%          1x  $160 bil.
Disney      8%     In pain   $74 bil.
AOL         6%          3x   $66 bil.
Oracle     14%          6x   $49 bil.
Yahoo!     33%       Dream   $31 bil.
CBS        -1%     In pain   $25 bil.
Gannett    19%     In debt   $18 bil.
Tomorrow night, more Foolishness on the way.

Tom Gardner

01/25/99 Close
Stock  Change    Bid
AXP   +3 5/16  101.50
CHV   -  1/8   79.88
CSCO  +  5/8   103.44
KO    +2       62.88
GPS   -  5/16  59.13
EK      ---    65.00
XON   +  5/8   72.00
GM    -1 1/4   89.75
INTC  +1 3/4   130.63
MSFT  +5 5/8   161.88
PFE   +1 5/8   117.63
SGP   -  1/16  51.94
TROW    ---    32.00

                   Day   Month    Year  History
        R-MAKER  +1.08%   3.12%   3.12%  34.20%
        S&P:     +0.68%   0.38%   0.38%  22.66%
        NASDAQ:  +1.30%   8.05%   8.05%  42.19%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    161.88   106.82%
   6/23/98   34 Cisco Syst    58.41    103.44    77.09%
    5/1/98 55.5 Gap Inc.      34.06     59.13    73.59%
   2/13/98   22 Intel         84.67    130.63    54.27%
    2/3/98   22 Pfizer        82.30    117.63    42.92%
   8/21/98   44 Schering-P    47.99     51.94     8.22%
   5/26/98   18 AmExpress    104.07    101.50    -2.47%
    2/6/98   56 T. Rowe Pr    33.67     32.00    -4.97%
   2/27/98   27 Coca-Cola     69.11     62.88    -9.02%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     89.75    23.96%
   3/12/98   20 Exxon         64.34     72.00    11.91%
   3/12/98   20 Eastman Ko    63.15     65.00     2.93%
   3/12/98   15 Chevron       83.34     79.88    -4.16%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3885.00  $2006.55
   6/23/98   34 Cisco Syst  1985.95   3516.88  $1530.93
    5/1/98 55.5 Gap Inc.    1890.33   3281.44  $1391.11
   2/13/98   22 Intel       1862.83   2873.75  $1010.92
    2/3/98   22 Pfizer      1810.58   2587.75   $777.17
   8/21/98   44 Schering-P   2111.7   2285.25   $173.55
   5/26/98   18 AmExpress   1873.20   1827.00   -$46.20
    2/6/98   56 T. Rowe Pr  1885.70   1792.00   -$93.70
   2/27/98   27 Coca-Cola   1865.89   1697.63  -$168.27

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1525.75   $294.86
   3/12/98   20 Exxon       1286.70   1440.00   $153.30
   3/12/98   20 Eastman Ko  1262.95   1300.00    $37.05
   3/12/98   15 Chevron     1250.14   1198.13   -$52.02

                              CASH    $120.62
                             TOTAL  $29331.18

  
Note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.


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