RULE MAKER PORTFOLIO

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Checking in on Schering-Plough

By Phil Weiss (pweiss@homemail.com)

TOWACO, NJ (March 5, 1999) -- Last Thursday, Schering-Plough (NYSE: SGP) released its 1998 10-K. On February 1, I took a quick look at the drug maker's income statement. For Rule-Maker investors, however, the income statement by itself is not sufficient. The balance sheet is at least as important, as it tells us a lot about how a company manages its business.

Tonight, I thought that I'd use the release of Schering-Plough's 10-K as an opportunity to see how our holding is faring when held under the microscope of the Rule Maker scoring system, outlined in Rule Breakers, Rule Makers.

Here are some of its key numbers for the fourth quarter:


Schering-Plough's 4th Quarter
                 1999        1998
Sales growth      16%         --
Gross margins   80.4%      79.6%
Net margins     20.3%      19.3%
Shares out.    1489 m.   1482 m.

Cash           $1.3 b.   $0.7 b.
L-T Debt         $4 m.    $46 m.
Cash-to-Debt     315x        16x
Flow ratio       0.89       0.76

And now let's run them through the Rule-Maker system. Please remember that a few of these rankings are subjective, so I encourage you to run the numbers for yourself using our new Rule Maker Spreadsheet (links at the bottom).


1) Brand (0-1pts)
Familiarity        1
Openness           1
Optimism           1
Legitimacy         1
Inevitability      1
Solitariness       0
Humor              1
Subtotal           6

2) Position (0-2 pts)
Mass Habit         2
Gross Margins      2
Net Margins        2
Sales Growth       2
Cash-to-Debt       2
Fool Flow Ratio    2
Your Interest      2
Subtotal          14

3) Direction (0-3pts)
Gross Margins      3
Net Margins        3
Shares Out         2
Cash-to-Debt       2
Fool Flow Ratio    0
Growth Potential   3
Subtotal          13

After going through three of the four categories, our company has rung up an impressive 33 out of 39 points. In the final category we compare our company to its leading competitor(s) to see how it fares on the monopoly scoreboard.

In the book, Tom compared Schering to Merck (NYSE: MRK). I don't dispute that Merck is one of the leading pharmaceutical companies, but there are some significant ways in which its business differs from that of Schering-Plough -- primarily because of Merck's Medco unit. So, I decided to compare Schering to the five pharmaceutical companies that I personally follow: Merck, Pfizer (NYSE: PFE), Abbott Laboratories (NYSE: ABT), Drip Portfolio holding Johnson & Johnson (NYSE: JNJ), and American Home Products (NYSE: AHP). Space limitations prevent me from showing all the results, so I'll only show the comparison to Pfizer and J&J here.

NOTE: Among all five companies, Schering-Plough is the only one that has released its 10-K. I used the third quarter balance sheet data for all of the competitors. For Schering-Plough, I used the fourth quarter income statement data contained in the earnings press release and the year-end balance sheet data found in the 10-K. Also, note that this analysis was completed prior to the recent modification in our scoring standards for a company's cash and debt relative to a competitor. (For more on this change, download the Rule Maker Spreadsheet.)


Schering-Plough vs. Pfizer:

4) Monopoly (0-4 pts)
Gross Margins     0
Net Margins       2
Cash-to-Debt      4
Fool Flow Ratio   0
Convenience       2
Subtotal          8

Schering-Plough vs. Johnson & Johnson:

4) Monopoly (0-4 pts)
Gross Margins     4
Net Margins       4
Cash-to-Debt      4
Fool Flow Ratio   4
Convenience       2
Subtotal         18

Schering's score against both Abbott and Merck is 14. Its score against American Home is 18. One of the most interesting things I noted in my comparison was that although Merck and Abbott realize a much smaller gross margin on their products, they still earn net margins that are in line with those of Schering-Plough and Pfizer. J&J and American Home Products have gross and net margins that are much lower than those of all four of the other companies I follow.

Schering-Plough's average score against its competitors was 14. If you add in another point for enjoyment, than our company's score comes out at 48. This is exactly the same overall result that Tom found when he scored Schering's business in Rule Makers, Rule Breakers. Sorry about reversing the title there, but I just can't help but think that the book's title should have been the other way around. It must be because I believe a portfolio should have a solid foundation of Rule Makers before adding any Rule Breakers, or even Tweeners as we did with Yahoo! (Nasdaq: YHOO).

Schering's score is just below the 50 points required for membership among the top tier of Rule Makers. The biggest reason that I can give for the failure to crack the 50 mark at year-end is the increase in the flow ratio. Of course, it increased during a period when long-term debt fell. I'm certainly not disappointed in this result.

In my column on February 2, I added a couple of other measures that I thought should be tested in the direction section of the scoreboard. The first was quarterly sales growth. Schering's 16% growth would give it a score of 3. Schering-Plough's days sales outstanding fell by 2 days during the quarter which would give it another 2 points. If you're not familiar with how that calculation works, it's also discussed in that report.

I encourage you to take a shot at running some companies through the scoring system yourself. It takes no more than 15 minutes when using the new Rule Maker Spreadsheet. As a matter of fact, many other Fools do it on our message boards all the time. Here's a link to a post from a Fool who goes by the name of hedden and his views on whether or not Compuware (Nasdaq: CPWR) is a Rule Maker. In the meantime, if you have any questions about how all this works, please bring them to our Companies message board.

I'll see you here again three weeks from Monday, which is also the night that I expect to be watching my Duke Blue Devils play for the NCAA College Hoops Championship. If I'm right, then that game will also enable the Duke program to cement its spot as the college hoops team of the '90s as it will be Duke's 3rd National Championship this decade.

Finally, the Rule Maker managers are busy sorting out ways to make the Rule Maker scoring system the ultimate way to identify the very best long-term business models. This weekend is your last chance to answer our question of the week: "What criteria should we add to the Rule-Maker scoring methodology?" We've had a number of exceedingly Foolish suggestions. Winners (yes, more than one!) will be announced Monday.

Have a Foolish weekend,

Phil Weiss, Fool

03/05/99 Close
Stock  Change    Bid
AXP   +5 3/4   118.75
CHV   +2       81.31
CSCO  +2 9/16  100.81
KO    +1       63.94
GPS   +1 1/2   69.75
EK    +  11/16 65.13
XON   +1 13/16 69.63
GM    +2 7/8   88.63
INTC  +1 1/4   114.63
MSFT  +2 11/16 154.94
PFE   +3 11/16 136.56
SGP   +1 3/4   57.00
TROW  +1 1/4   35.13
YHOO  +8 5/16  159.81

                   Day   Month    Year  History
        R-MAKER  +2.75%   4.02%   8.43%  37.20%
        S&P:     +2.31%   3.00%   4.08%  28.80%
        NASDAQ:  +1.93%   2.15%   6.59%  41.40%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    5/1/98   55 Gap Inc.      34.37     69.75   102.94%
    2/3/98   24 Microsoft     78.27    154.94    97.96%
   6/23/98   34 Cisco Syst    58.41    100.81    72.59%
    2/3/98   22 Pfizer        82.30    136.56    65.93%
   2/13/98   22 Intel         84.67    114.63    35.37%
   2/17/99   16 Yahoo Inc.   125.81    159.81    27.02%
   8/21/98   44 Schering-P    47.99     57.00    18.77%
   5/26/98   18 AmExpress    104.07    118.75    14.11%
    2/6/98   56 T. Rowe Pr    33.67     35.13     4.31%
   2/27/98   27 Coca-Cola     69.11     63.94    -7.48%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     88.63    22.40%
   3/12/98   20 Exxon         64.34     69.63     8.22%
   3/12/98   20 Eastman Ko    63.15     65.13     3.13%
   3/12/98   15 Chevron       83.34     81.31    -2.44%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    5/1/98   55 Gap Inc.    1890.33   3836.25  $1945.92
    2/3/98   24 Microsoft   1878.45   3718.50  $1840.05
   6/23/98   34 Cisco Syst  1985.95   3427.63  $1441.68
    2/3/98   22 Pfizer      1810.58   3004.38  $1193.80
   2/13/98   22 Intel       1862.83   2521.75   $658.92
   2/17/99   16 Yahoo Inc.  2013.00   2557.00   $544.00
   8/21/98   44 Schering-P   2111.7   2508.00   $396.30
   5/26/98   18 AmExpress   1873.20   2137.50   $264.30
    2/6/98   56 T. Rowe Pr  1885.70   1967.00    $81.30
   2/27/98   27 Coca-Cola   1865.89   1726.31  -$139.58

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1506.63   $275.74
   3/12/98   20 Exxon       1286.70   1392.50   $105.80
   3/12/98   20 Eastman Ko  1262.95   1302.50    $39.55
   3/12/98   15 Chevron     1250.14   1219.69   -$30.45

                              CASH    $185.03
                             TOTAL  $33010.66

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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