Rule Breaker Portfolio
All About Numbers
The devil in the details

By Selena Maranjian (TMF Selena)

ALEXANDRIA, VA (Jan. 18, 2000) -- Numbers. They frighten or intimidate many of us, but they're necessary in our lives. Especially in investing. Rule Breaking investors may tend to be much less focused on numbers than other kinds of investors, but numbers still matter. After all, it's probably not a good idea for anyone to be invested purely in Rule Breakers. These are risky beasts, you know. But back to digits, as I want to offer some thoughts on them.

Numbers can be very misleading, depending on how they're used and presented. As an example, consider the term "record earnings." Think about what this really means. Below are two companies, and their earnings per share (EPS) for several years:

                          1996  1997  1998  1999
Scruffy's Chicken Shack  $1.00  1.50  2.25  3.50
Buzzy's Broccoli Beer     1.00  1.01  1.02  1.03

Scruffy's is clearly increasing its earnings sharply from year to year. If 1996 earnings were a record, then each of the following years' earnings were records, as well. If we assume the same for Buzzy's, that 1996's $1.00 EPS was a record, then technically, 1997, 1998, and 1999 earnings were also records. So either company is in the right touting its "record earnings!!!" -- but a savvy investor will take a close look to see just how these earnings are growing.

Similarly, a company might be talked up for having increased its revenues 200% over the past year. Know that without more information, this isn't terribly informative. Did the revenues increase from $50 to $150? From $1 million to $3 million? From $200 million to $600 million? It makes a large difference.

Another example of a number you have to be careful about is an annualized rate of growth. Consider the companies below:

                             annualized
                               earnings
                            growth rate
In Your Face Telemarketing          25%
Iditarod Express Delivery        1,500%

Iditarod Express probably looks a lot more enticing. But there are some factors you should consider. In the first place, the numbers above don't really mean much until we add a little more context. You need to ask over what period the growth rate has been annualized. To construct the examples above, I assumed that In Your Face Telemarketing increased its EPS from $0.12 in one year to $0.37 five years later. That amounts to tripling in five years, or an annualized growth rate of about 25%.

For Iditarod Express, I assumed that EPS had risen from $0.01 in the company's first quarter to $0.02 in its second quarter. That's it. So the earnings doubled over one quarter. Continue at that rate for the next few quarters and in one year you'll have gone from $0.01 to $0.16. That's 1,500% growth. It's impressive, but is it really realistic? Maybe, maybe not. Some dynamic companies do grow that quickly. Know, though, that most companies don't see their earnings growing in a straight line. Some quarters may be good ones, some might reflect temporary slumps in business. If you annualize numbers over any short-term period, the big picture can get very distorted. This is true for mutual funds, as well.

Another point related to growth rates: They tend to slow down over time. And actually, they have to slow down. If a company has been doubling its revenues for five years running, that's pretty amazing and impressive. But don't invest in the firm just because of this one factoid, assuming the trend will continue. Below are two examples of companies doubling their revenues for 10 years. One starts with $25,000 in revenues, the other with about $51 million. Note that doubling becomes a lot harder to keep up or even imagine once the numbers grow large:

       Rent-to-Own    Carrier Pigeon
         Underwear    Communications
1990:      $25,000       $51,200,000
1991:       50,000       102,400,000
1992:      100,000       204,800,000
1993:      200,000       409,600,000
1994:      400,000       819,200,000
1995:      800,000     1,638,400,000
1996:    1,600,000     3,276,800,000
1997:    3,200,000     6,553,600,000
1998:    6,400,000    13,107,200,000
1999:   12,800,000    26,214,400,000
2000:   25,600,000    52,428,800,000

For perspective, note that Microsoft's (Nasdaq: MSFT) 1999 revenues were about $20 billion. America Online (NYSE: AOL) raked in almost $5 billion. Wal-Mart (NYSE: WMT) reported a whopping $138 billion for fiscal 1999, while Chevron (NYSE: CHV) took in about $10 billion in its last quarter. Carrier Pigeon Communications might be a very exciting company, and might have grown at an astounding clip over the past few years. But is it on track to outpace the giants I just listed? Perhaps, but perhaps not.

You might also want to rethink average return percentages that are bandied about, even here at the Fool, even by Fools like me. Yes, it's true that for most of this century, the stock market has returned an average of about 11% per year. But if you're investing for, say, 23 years, it still does make a difference which 23 years you invest in. There isn't much we can do about the uncertainty surrounding the returns we'll eventually earn. But it's helpful to understand how they vary. For more thoughts on this, check out this article by Scott Burns.

Another number to consider closely is our familiar friend, the price-to-earnings ratio (P/E). As you probably know, it's simply calculated by taking a stock's current price and dividing it by the company's EPS. Ah -- but which EPS? Its EPS for the year just ended? For the trailing 12 months? Its estimated EPS for the current year? For next year? Below is an example of how the Free-Range Onion Company's P/E differs, based on various EPS. The company's stock is currently trading at $50 per share:

                                 P/E ratio
Last fiscal year EPS:    $1.80     27.8
Trailing 12-month EPS:   $2.00     25.0
Estimated EPS for 2000:  $2.90     17.2
Estimated EPS for 2001:  $3.75     13.3
Estimated EPS for 2002:  $5.00     10.0

For those who hadn't thought about it before, note how a company's projected P/E drops as you move farther out in time (assuming its expected earnings are growing). This is why some might argue that, yes, a company like Amazon.com (Nasdaq: AMZN) or eBay (Nasdaq: EBAY) might have an astronomical P/E now, but if it continues to grow rapidly, you may not be paying that much for the company's earnings a year or two out.

For example, if the Stained Glass Windshield Company is trading at $100 per share, with a sky-high P/E of 200 based on its trailing 12-month EPS, that means that it has earned $0.50 per share in the past year. This does seem to be a steep valuation. But if according to your calculations, the company should report EPS of $2.00 next year, all of a sudden you're looking at a P/E for 2000 of 50 -- considerably less. So whenever you're looking at a company's P/E, make sure you find out what period the EPS relates to. In the Fool's Quotes and Data area, for example, if you call up a company's snapshot, you'll see that the P/E offered is a trailing 12-month figure.

Paying closer attention to numbers can be good for your portfolio all around. (For yet more numbers, check out eBay's Web-leading usage numbers released today.) Here are some places where you can learn more about investing details:

  • Our Investing Basics area.
  • Our How to Value Stocks area.
  • Our free weekly Fool School: Investing Basics e-mails.
  • Our weekly syndicated newspaper feature, which offers regular educational fare. Click on the link to learn more about how to get it in your local paper.
  • Rule Maker Portfolio reports. (It might seem weird that I'm highlighting Maker material in a Breaker report. But a typical portfolio is probably best off sporting a mix of Makers and Breakers -- or some other kind of mix -- rather than just investing in Breakers. So it's good to learn about a variety of investing methods and to find the styles that sit best with you.) This link goes to the 1999 archives for the Maker Port. Scan through there and you'll find useful articles discussing cash flow statements, options, research and development costs, and more.

I also invite you to pop over to the Rule Breaker Strategies message board to continue this discussion. I just covered the tip of the iceberg here. Please chime in with your thoughts on other kinds of numbers of interest to investors.

Finally, since I've got the podium, let me share a few nifty websites that might be of interest to you: At www.thehungersite.com, you can feed the hungry simply by clicking on a button. (Bookmark it and click on it once a day, if you wish.) The Arts and Letters Daily is a wonderful compilation of interesting articles from all over. The Encyclopedia Britannica is now online and free and merits much browsing. As a timely example of its offerings, here's a thoughtful article on Martin Luther King, Jr.

Fool on, folks!






Rule Breaker Portfolio

1/18/00 Closing Numbers
Ticker Company Dly Pr Chg Price
AMGNAMGEN INC3/4$69.06
AMZNAMAZON.COM-1/8$64.13
AOLAMERICA ONLINE-2 1/4$61.00
ATHMAT HOME CORP CL A1/16$40.63
CATCATERPILLAR INC-2$49.94
CHVCHEVRON CORP5/16$89.31
CRAPE CORP - CELERA GENOMICS GRP-11$221.00
DDDU PONT (EI) DE NEMOURS-1 7/8$65.50
EBAYEBAY INC11/16$139.50
GTGOODYEAR TIRE & RUBBER CO1/16$27.56
SBUXSTARBUCKS CORP-3/8$26.06

  Day Week Month Year
To Date
Since
8/5/94
Annualized
Rule Breaker -1.82% -1.82% -3.87% -3.87% 1,462.46% 65.50%
S&P 500 1.24% -.68% -.96% -.96% 217.44% 23.58%
S&P 500(DA) 1.24% -.68% -.96% -.96% 231.70% 24.58%
NASDAQ 1.64% 1.64% 1.51% 1.51% 473.58% 37.73%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
8/5/944020AOL0.460$61.0013,172.02%
9/9/972640AMZN3.188$64.131,911.76%
12/16/981160AMGN21.444$69.06222.05%
12/17/99630CRA79.513$221.00177.94%
12/4/98900ATHM28.040$40.6344.88%
2/26/99300EBAY100.527$139.5038.77%
2/23/99180CHV79.169$89.3112.81%
2/20/98260DD58.844$65.5011.31%
2/23/99300CAT46.964$49.946.33%
7/2/98470SBUX27.955$26.06-6.77%
2/23/99290GT48.715$27.56-43.42%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
8/5/944020AOL$1,847.65$245,220.00$243,372.40
9/9/972640AMZN$8,415.03$169,290.00$160,875.00
12/17/99630CRA$50,093.00$139,230.00$89,137.00
12/16/981160AMGN$24,875.50$80,112.50$55,237.00
2/26/99300EBAY$30,158.00$41,850.00$11,692.00
12/4/98900ATHM$25,236.13$36,562.50$11,326.38
2/23/99180CHV$14,250.50$16,076.25$1,825.75
2/20/98260DD$15,299.44$17,030.00$1,730.56
2/23/99300CAT$14,089.25$14,981.25$892.00
7/2/98470SBUX$13,138.63$12,249.38($889.25)
2/23/99290GT$14,127.38$7,993.13($6,134.25)
  Cash: $359.36  
  Total: $780,954.40  



Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.