RULE MAKER PORTFOLIO

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Financial Direction vs. Financial Location
Can Direction be Overdone?

By Al Levit

Glendale, CA (March 9, 1999) --

The direction of an object tells us as much or more about the future than does its present location.
- Tom Gardner (Rule Breakers, Rule Makers, p. 259)

Yesterday, I started writing about Dell Computer Corp. (Nasdaq: DELL), who last month released what appeared to be an excellent fourth quarter earnings report. However, as soon as the report was out, Dell was taken to Wall Street's version of the wood shed. In truth, Wall Street did have some reasons for such harsh treatment of what everyone agrees is a truly marvelous company. Today, I'm going to discuss three of the more prominent complaints about Dell's fourth quarter.

First, prior to the most recent quarter, Dell's year-over-year sales growth was in excess of 50%. Since sales growth slowed to "only" 38% in the most recent period, the Street feared that Dell might not grow as fast in the future as it had in the past. In fact, there is considerable concern that Dell's sales growth will continue to slow. Then again, these sorts of growth worries have been a constant for the PC industry for several years now. Only future quarters will tell whether the concern is justified. For more on the growing concern surrounding the PC industry, check out last Monday's Bore Report.

Second, in the days leading up to the fourth quarter earnings announcement, Dell's stock price ran up in anticipation of the superior results that the company has consistently delivered in the past. As soon as these expectations were disappointed, the stock price adjusted to the new level of expectations. In addition, the stock price adjusted for a new level of risk regarding the outlook for the PC industry as a whole. This kind of adjustment is no fun, but long-time Dell shareowners have been through it before.

Finally, Dell's business is not the bulletproof type that we are most familiar with over here in Rule Maker Land. Compared to our Rule Makers, Dell and other Merchant Kings face a tougher business that offers less protection if things go wrong. By definition, then, Dell is a riskier investment than most Rule Makers. Nevertheless, Dell's consistent stellar performance may have lulled investors into ignoring this risk. When Dell finally proved that it, too, could be the corporate version of human, investors were quickly reminded just how risky a Merchant King's business can be. Thus, the fourth quarter's indication of slowing sales -- even though the absolute amount of sales was still admirable -- triggered a sell-off.

As a long-term Dell shareholder, I have to wonder whether the market overreacted. Last month, I explored declines in financial ratios from two of our Rule Making powerhouses: Cisco (Nasdaq: CSCO) and Microsoft (Nasdaq: MSFT). In looking at these companies' recent quarterly reports, I noted that sometimes, when the financial location ratios are strong enough, it may not make sense to penalize a company for small declines from outstanding levels. A few days later, Phil Weiss proposed that when a company has a gross margin, a net margin, or a flowie that's more than a certain percentage above our standard, it automatically gets a top score regardless of whether it's improved over the comparable quarter.

It could be argued, then, that Dell still exhibits strong financial direction in sales growth, even though it's not as strong as in prior quarters. Compared to its top competitors in the PC industry, Dell's 38% sales growth is still tops. To rake the company over the coals because sales growth slipped to that level may be getting a little out of hand. As noted above, time will tell, as results from future quarters emerge. For now, it's time to hear your thoughts on the Rule Maker Strategy board about whether there should be an automatic top score on financial direction.

Also on the Strategy board, we're discussing whether an anti-trust probe deserves points in our Rule-Maker scoring system. Antitrust news continues to swirl about two of our Rule Makers, Intel (Nasdaq: INTC) and Microsoft. In recent days, the market seems to have voted in favor of reconciliation with the trustbusters. Based on the market reaction, is antitrust scrutiny -- while avoiding an actual trial -- the most positive scenario for a Rule Maker? If so, how should this be reflected in our scoring methodology? Share your ideas.

As this week continues, I'll explore the topic of Merchant Kings more deeply, and I'll comment on whether it makes sense to measure a Merchant King like Dell with our Rule Maker criteria.

Until then...

Fool on,

Al

03/09/99 Close
Stock  Change    Bid
AXP   +1 11/16 118.25
CHV   -1 1/8   79.94
CSCO  +  3/4   105.31
KO    -  7/8   63.13
GPS   -  3/16  69.75
EK      ---    65.44
XON   -1       69.94
GM    +  13/16 88.44
INTC  -4 5/16  115.31
MSFT  +2 13/16 161.81
PFE   -  13/16 138.75
SGP   +  5/8   56.44
TROW  +  1/8   33.69
YHOO  -3 1/8   167.31

                   Day   Month    Year  History
        R-MAKER  -0.19%   5.13%   9.59%  38.67%
        S&P:     -0.23%   3.35%   4.44%  29.23%
        NASDAQ:  -0.20%   4.59%   9.13%  44.77%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    161.81   106.74%
    5/1/98   55 Gap Inc.      34.37     69.75   102.94%
   6/23/98   34 Cisco Syst    58.41    105.31    80.30%
    2/3/98   22 Pfizer        82.30    138.75    68.59%
   2/13/98   22 Intel         84.67    115.31    36.18%
   2/17/99   16 Yahoo Inc.   125.81    167.31    32.99%
   8/21/98   44 Schering-P    47.99     56.44    17.59%
   5/26/98   18 AmExpress    104.07    118.25    13.63%
    2/6/98   56 T. Rowe Pr    33.67     33.69     0.04%
   2/27/98   27 Coca-Cola     69.11     63.13    -8.66%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     88.44    22.14%
   3/12/98   20 Exxon         64.34     69.94     8.71%
   3/12/98   20 Eastman Ko    63.15     65.44     3.63%
   3/12/98   15 Chevron       83.34     79.94    -4.09%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3883.50  $2005.05
    5/1/98   55 Gap Inc.    1890.33   3836.25  $1945.92
   6/23/98   34 Cisco Syst  1985.95   3580.63  $1594.68
    2/3/98   22 Pfizer      1810.58   3052.50  $1241.92
   2/13/98   22 Intel       1862.83   2536.88   $674.05
   2/17/99   16 Yahoo Inc.  2013.00   2677.00   $664.00
   8/21/98   44 Schering-P   2111.7   2483.25   $371.55
   5/26/98   18 AmExpress   1873.20   2128.50   $255.30
    2/6/98   56 T. Rowe Pr  1885.70   1886.50     $0.80
   2/27/98   27 Coca-Cola   1865.89   1704.38  -$161.52

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1503.44   $272.55
   3/12/98   20 Exxon       1286.70   1398.75   $112.05
   3/12/98   20 Eastman Ko  1262.95   1308.75    $45.80
   3/12/98   15 Chevron     1250.14   1199.06   -$51.08

                              CASH    $185.03
                             TOTAL  $33364.41

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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