RULE MAKER PORTFOLIO

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Stellar Results from 'Soft

by Matt Richey (TMF Verve)

ALEXANDRIA, VA (April 21, 1999) -- Microsoft (Nasdaq: MSFT) continued to walk on water with its latest round of earnings. Last night, the software giant reported fiscal third quarter diluted earnings per share of $0.35, up from $0.25 a year ago. Strong growth across all product lines, higher gross and net margins, a Flowie under 0.3, over $21 billion in cash on the balance sheet, and seemingly endless opportunities for expansion make this company a Rule Maker par excellence.

Today, let's take a closer look at this phenomenal company's quarter, and see how it stacks up to three rivals: America Online (NYSE: AOL), Oracle Corp. (Nasdaq: ORCL), and Sun Microsystems (Nasdaq: SUNW). I'll be walking through the Rule Maker rankings, as described in Rule Breakers, Rule Makers. All the numbers are here in this post. You might want to open that link in a separate window as we give the company its regular quarterly check-up.

First up, let's assess the strength of the company's brand. The scoring here is simple -- 1 point if the attribute is met; 0 if it's not. Is Microsoft familiar, open, optimistic, and legitimate? No doubt about it. One point for each of those attributes. How about inevitable? In other words, are the company's software and Internet products becoming a necessary purchase? Yes, with control of the Windows operating system and the most popular suite of desktop applications, the company gets another point. Next, is the company the standout category king of its industry? Absolutely -- score another point for being "solitary." Finally, has the company surprised us in the last five years? Microsoft's animated paperclip that offers helpful advice in Word and Excel proves the company has a sense of humor. Give it another point. That's it for brand -- a perfect 7 out of 7. One section down, three to go.

Of greater importance than brand, and therefore worth up to 2 points, is the financial location section. The best Rule Makers bolster their financial position by selling their products on a frequent basis to consumers. Through Microsoft's numerous Internet properties, the company generates advertising revenue through daily page views. In fact, for the month of March, four of Microsoft's websites -- msn.com, microsoft.com, hotmail.com, and msnbc.com -- were among the top 25 on the Internet. For the quarter, the company's Interactive Media division grew revenues by 22%. But even so, this division accounts for less than 10% of total revenues.

Considering that most of Microsoft's products are purchased much less frequently, I'll compromise and give the company 1 point for its "mass market habit," as we call it. The rest of this section is easy. Microsoft's incredibly high gross margins, net margins, and cash-to-debt ratio are worth 2 points each. Give the company another deuce for its low, low, low Flow Ratio. Finally, sky-hook another 2 pointer for my keen interest in this amazing company. Altogether, that's 11 out of 12 for the company's current financial position.

One of the fundamental themes of Rule Maker investing is that a company's direction is more important than its present location. So, each of the financial direction metrics that compare year-over-year growth is worth up to 3 points. Revenue growth for the quarter was a solid 14.8%, worth 2 points on our scale. Each of those dollars of revenue were more valuable as the company improved gross and net margins. Back-to-back 3-pointers! Diluted shares outstanding increased a little bit, but not too much -- 2 points. Microsoft continued to pile up cash during the quarter, with the balance now exceeding $20 billion. But $980 million of preferred stock prevents the company from achieving the top score. Give it 2 points.

Microsoft's outstanding Flowie of 0.29 was flat year-over-year. While this is perfectly fine, our rigorous scoring system deems this accomplishment not worthy of any points -- zilch. Finally, the company deserves an unambiguous 3 points for its expansion potential. Microsoft is front and center in the high-growth industry of digital media and electronic commerce. Out of 21 tough-to-get points, the software giant earns an admirable 15.

Last of all, we must assess Microsoft's competitive position against three of its rivals -- AOL, Oracle, and Sun Micro. Each of the metrics in the monopoly status section are worth up to 4 points. These metrics are worth the most points because they represent the degree to which Microsoft has a sustainable competitive advantage. Here, the company truly demonstrates its dominance by soundly beating its competitors on gross margins, net margins, net cash, the Flow ratio, and convenience. Yep, 4 points for every one of those -- a resounding 20 out of 20.

Adding in a final point for my enjoyment of this little exercise, and Microsoft's total score rings in at 54 -- an outstanding score. Only the very best companies can score this highly. Kudos to Microsoft for another quarter of financial excellence.

For all of the dirty details about Microsoft's fiscal third quarter results, check out the company's comprehensive earnings release and conference call replay.

Want to discuss Microsoft's quarter? Join us on the Microsoft board or the Rule Maker Companies board (linked below). I'll be posting more of my thoughts on the quarter in the coming days.

Elsewhere in Fooldom, this week's Dueling Fools is shaping out as a war -- a Cola War, that is, between Coca-Cola and PepsiCo, where I'm slinging guns for the Big Red Machine.

Fool on!

04/21/99 Close
Stock Change    Bid
AXP   +7 1/8    134.63
CHV   -  11/16   96.38
CSCO  +6 3/8    107.94
EK    -1 1/8     74.31
GM    +1 7/8     89.06
GPS   +3 1/8     69.50
INTC  +1 7/8     58.44
KO    +2 5/16    67.56
MSFT  -1 1/8     82.00
PFE   +4 11/16  123.38
SGP   +2 1/4     52.63
TROW  +2 29/32   39.56
XON   -2 5/16    78.44
YHOO  +3 7/8    174.88


                  Day     Month  Year    History
        R-MAKER  +2.96%   1.37%  12.91%  42.87%
        S&P:     +2.29%   3.87%   9.01%  34.85%
        NASDAQ:  +3.26%   1.08%  13.48%  50.54%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     82.00   109.53%
    5/1/98   55 Gap Inc.      34.37     69.50   102.21%
   6/23/98   34 Cisco Syst    58.41    107.94    84.79%
    2/3/98   22 Pfizer        82.30    123.38    49.91%
   2/17/99   16 Yahoo Inc.   126.31    174.88    38.45%
   2/13/98   44 Intel         42.34     58.44    38.03%
   5/26/98   18 AmExpress    104.07    134.63    29.36%
    2/6/98   56 T. Rowe Pr    33.67     39.56    17.49%
   8/21/98   44 Schering-P    47.99     52.63     9.65%
   2/27/98   27 Coca-Cola     69.11     67.56    -2.23%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     89.06    23.01%
   3/12/98   20 Exxon         64.34     78.44    21.92%
   3/12/98   20 Eastman Ko    63.15     74.31    17.68%
   3/12/98   15 Chevron       83.34     96.38    15.64%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   48 Microsoft   1878.45   3936.00  $2057.55
    5/1/98   55 Gap Inc.    1890.33   3822.50  $1932.17
   6/23/98   34 Cisco Syst  1985.95   3669.88  $1683.93
    2/3/98   22 Pfizer      1810.58   2714.25   $903.67
   2/17/99   16 Yahoo Inc.  2020.95   2798.00   $777.05
   2/13/98   44 Intel       1862.83   2571.25   $708.42
   5/26/98   18 AmExpress   1873.20   2423.25   $550.05
    2/6/98   56 T. Rowe Pr  1885.70   2215.50   $329.80
   8/21/98   44 Schering-P   2111.7   2315.50   $203.80
   2/27/98   27 Coca-Cola   1865.89   1824.19   -$41.70

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1514.06   $283.17
   3/12/98   20 Exxon       1286.70   1568.75   $282.05
   3/12/98   20 Eastman Ko  1262.95   1486.25   $223.30
   3/12/98   15 Chevron     1250.14   1445.63   $195.49

                              CASH     $70.09
                             TOTAL  $34375.09

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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