<THE RULE MAKER PORTFOLIO>
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 billionWith 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.
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.