<THE RULE MAKER PORTFOLIO>
By Phil Weiss ([email protected])
Towaco, NJ (Feb. 2, 1999) -- As I mentioned last night, tonight I'm going to run Intel's (Nasdaq: INTC) most recent quarterly numbers using the scoring methodology Tom outlined in Rule Breakers, Rule Makers as a means of checking our chip company's recent performance. One thing you won't find in this analysis is a discussion of the recent movements in the company's stock price or its P/E ratio. These are short-term indicators; Rule Making investors focus on looking at the quality of the company for the long term. In our view, we're part owners of the businesses we invest in, so we focus on what gives us the best indications of how the business will perform over the long haul.
If you want to see where the numbers that I'm using in tonight's report come from, you can read through Intel's 4th Quarter earnings press release. It may also help to download this spreadsheet of Intel's quarterly financial performance for the last 3 years.
Okay. Time for the analysis. There will be some math involved here, but I promise it's not all that complex. The calculations are also among the keys involved in analyzing current and prospective Rule Maker stocks. Something to keep in mind is that these metrics for evaluating business momentum emphasize the value of direction over location, which has been mentioned many times before in this space.
Here is a snapshot of the income statement data that's most important to us:
(in millions) 4th Q '98 4th Q 97 Sales 7,614 6,731 Cost of Sales 3,176 3,192 Gross Profit 4,438 3,539 Net Income 2,064 1,574 Fully Diluted Shares 1,739 1,785
And away we go.
1. RISING GROSS MARGINS
First we'll look at the direction of gross margins. Gross margin is calculated by dividing gross profit into sales. Based on the above we get 53% in 1997 and 58% in 1998. Gross margins increased by a robust 5%. Looks like all those new Celeron chips didn't drag down gross margins. Best of all, since gross margins have risen, Intel scores the maximum 3 points in this category.
2. RISING NET MARGINS
We calculate net margins by dividing net income into sales. For 1997, net margin in the fourth quarter was 23%. In 1998 this number was 27%. Once again things look better now than they did a year ago. The positive direction of net margins gives Intel another maximum score of 3.
3. SHARE BUYBACKS
In the fourth quarter Intel continued a trend that has been in force all year long as its diluted sharecount fell. The total decline for the year was 3%. This is more good news for the Rule Making Investor. Chalk up another 3 points.
TWEEEET! It's halftime. Time for a health break and maybe a glass of Minute Maid Lemonade.
Let's sum up where we are so far. We went 3 for 3 on the income statement. Everything looks much better than it did at the end of last year's fourth quarter. The income statement definitely gets an A+ as far as direction goes. Even better, we like the location as well.
Here's a summary of the relevant balance sheet data:
4th Q '98 4th Q 97 Cash 7,626 9,927 Accts Receivable 3,527 3,438 Total Current Assets 13,475 15,867 Total Current Liabilities 5,804 6,020 Long-Term Debt 702 448
4. CASH OUTGROWING DEBT
The star fades a bit when we look at this one. Cash is down; debt is up. At the end of 1997 the ratio of cash to debt was 22, and now it's only 11. Still well above our threshold level of 1.5, but directionally, it doesn't look as good as we'd like to see it. Intel scores a zero here.
5. LOWERING FLOW RATIO
Quick reminder. We calculate the generic version of the flow ratio by taking total current assets (13,475 for 1998) less cash (7,626 for 1998) and dividing the result by total current liabilities (5,804 for 1998). Please note that there are other versions of this ratio, but we won't have the details to calculate these until after the company's 10-K is issued in March. The flowie at the end of 1998 was 1.01. For 1997 it was 0.99. That's relatively flat, but the standards we go by tell us any increase results in another zero. However, Intel's flowie is in line with our target of 1.0, so there's not a big cause for concern overall.
6. EXPANDING POSSIBILITIES
6. EXPANDING POSSIBILITIES
This one is more subjective than the rest. Here we try to answer questions such as "Do my friends know about and love the company's products? Is worldwide expansion believable for their stuff? Is this company accurately reflecting its performance through conservative accounting?" In the book, Tom gave Intel a 2 in this category meaning that a yes answer to these questions is not a slam dunk, but it's more likely than not. I tend to agree.
That gives Intel a score of 11 (out of 18) in Business Momentum. Although this is a big improvement over the result shown in Rule Breakers, Rule Makers, it's still not quite as good as we'd like to see it. We want to see the balance sheet get a bit stronger than it is currently. One thing to note is that if all the other scores Tom calculated for Intel in the appendix of the book have not changed, Intel's total score is now 51, meaning it's moved back above the desired Rule Maker score of 50.
There are a couple of other measures that I think should be tested here, so I'm going to take this one into overtime.
7. SALES GROWTH
When Tom wrote the business momentum section of the book, he did not assign companies a score for sales growth on a comparable period basis. Since without sales growth a company will eventually run out of ways to increase its earnings, I think that we should look at sales growth as well.
I set up the following scale. Sales growth of greater than 10% gives a company 3 points. Growth of 5 to 10 percentage points results in 2 points; 0 to 5% sales growth is worth 1 point. Negative sales growth results in a goose egg in this category. Intel gets a 3 here as sales grew by 13% over the fourth quarter of last year. This was also Intel's best result of the year.
8. ACCOUNTS RECEIVABLE TURNOVER
Another metric that I like to keep a close eye on is accounts receivable turnover. Essentially, this is a measure of how many times a company turns over its accounts receivable balance. For those of you that are unfamiliar with this ratio, we calculate it by first taking sales for the quarter and dividing it by 90. (I like to use a 360-day year for this calculation -- thus 90 days for the quarter. You can use 365 and divide by 91.25, too. It doesn't really matter which method you choose as long as you apply it consistently.) You then take this result and divide it into the average of the beginning and ending accounts receivable balance.
Here is the actual calculation:
4th Q 1998: Average accounts receivable balance = (3,527 + 3,438)/2 = 3,482.5 Sales 7,614/90 = 84.6 Accounts Receivable Turnover = 3,482.5/84.6 = 41.2 4th Q 1997: Average accounts receivable balance = (3,438 + 3,732)/2 = 3,585 Sales 6,731/90 = 74.8 Accounts Receivable Turnover = 3,585/74.8 = 47.9
I'm going to score this category by giving a company 3 points for a decline in accounts receivable of 3 or more days, 2 points for a decline of 1 to 3 days, 1 point for a decline of less than 1 day to an increase of 1 day, and no points if turnover increases by more than a day. If a company has no outstanding receivables, it automatically gets a 3 here. Intel's turnover declined by 7 days, so it scores a 3 in this category.
Adding these 2 categories gives Intel 17 out of 24 possible points on Business Momentum. I think that score is acceptable.
What do you think of the 2 additional categories that I've added? Are there any others that you'd like to see added as well? Let's continue the discussion on our Companies message board.
Stock Change Bid AXP -1 1/16 99.69 CHV +1 1/4 74.94 CSCO -2 39/64 112.39 KO + 13/16 64.88 GPS + 1/4 63.75 EK + 1/8 65.88 XON - 15/16 68.69 GM -3 15/16 89.44 INTC -3 1/4 134.63 MSFT -5 5/16 167.63 PFE + 11/16 132.69 SGP + 3/8 54.88 TROW - 25/32 33.97
Day Month Year History R-MAKER -1.12% -1.38% 7.52% 39.92% S&P: -0.87% -1.38% 2.98% 25.45% NASDAQ: -1.86% -1.69% 12.35% 47.83% Rule Maker Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 167.63 114.17% 6/23/98 34 Cisco Syst 58.41 112.39 92.42% 5/1/98 55.5 Gap Inc. 34.06 63.75 87.17% 2/3/98 22 Pfizer 82.30 132.69 61.23% 2/13/98 22 Intel 84.67 134.63 58.99% 8/21/98 44 Schering-P 47.99 54.88 14.34% 2/6/98 56 T. Rowe Pr 33.67 33.97 0.88% 5/26/98 18 AmExpress 104.07 99.69 -4.21% 2/27/98 27 Coca-Cola 69.11 64.88 -6.12% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 17 General Mo 72.41 89.44 23.52% 3/12/98 20 Exxon 64.34 68.69 6.77% 3/12/98 20 Eastman Ko 63.15 65.88 4.32% 3/12/98 15 Chevron 83.34 74.94 -10.09% Rule Maker Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 4023.00 $2144.55 6/23/98 34 Cisco Syst 1985.95 3821.28 $1835.33 5/1/98 55.5 Gap Inc. 1890.33 3538.13 $1647.80 2/3/98 22 Pfizer 1810.58 2919.13 $1108.55 2/13/98 22 Intel 1862.83 2961.75 $1098.92 8/21/98 44 Schering-P 2111.7 2414.50 $302.80 2/6/98 56 T. Rowe Pr 1885.70 1902.25 $16.55 5/26/98 18 AmExpress 1873.20 1794.38 -$78.83 2/27/98 27 Coca-Cola 1865.89 1751.63 -$114.27 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 17 General Mo 1230.89 1520.44 $289.55 3/12/98 20 Exxon 1286.70 1373.75 $87.05 3/12/98 20 Eastman Ko 1262.95 1317.50 $54.55 3/12/98 15 Chevron 1250.14 1124.06 -$126.08 CASH $120.62 TOTAL $30582.40 Note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.