<THE RULE MAKER PORTFOLIO>
Intel for the Next $500
By Phil Weiss (TMF Grape)
TOWACO, NJ (July 28, 1999) -- Last night, when I sat down to write my article on where we should put our next $500, I was nearly overwhelmed by all the new posts on our Companies Message Board from readers offering thoughts about where we should invest our next $500. More amazing to me, though, was how many different companies had been nominated. The nominees included potential Rule Makers (including America Online, Hewlett Packard, Sun Microsystems, Worldcom, and Wal-Mart, to name a few), potential Rule Breakers, and a number of other small-cap companies that I've never even heard of.
While each of these stocks may well be a good candidate for investment in its own right, it's quite unlikely that we'll be adding any new stocks to our portfolio right now. We own ten stocks that we consider to be Rule Makers, plus the Fool Four stocks and Delphi Automotive, which was spun off from Fool Four holding General Motors. To me that's a pretty good number of stocks for us to own, and it's right in line with the guidelines for portfolio size that we laid out in our Rule Maker steps (see the conclusions in Step 3).
In some ways I'm the wrong person to write about this subject. As I've mentioned a number of times before, due to past decisions I still own more stocks than I really should. I am working on cutting the number down and have made progress over the last two years. On the other hand, the fact that I am in this predicament may make me just the right person to talk about portfolio size.
Each quarter, when earnings come out, I add the recent results to those results that I have accumulated and recorded in the past. Because I own as many stocks as I do, I know that it takes me a long time to finish updating all of my holdings in my spreadsheet. As a matter of fact, it often seems as if as soon as I finish entering the data for one quarter, the next one has rolled around, and it's time to start all over again.
The bottom line is that if you own too many stocks, you lose one of the biggest benefits that you can get by taking a Rule Maker approach to investing -- the advantage of having more time to do other things with your life than follow your investments.
It seems like almost every day I read about a company that sounds like it's a great investment opportunity. In the past, I'd research the company and if it looked good, I'd go ahead and establish a position. In theory, that sounds Foolish, but if your portfolio grows too big, then it's really foolish (note the small "f"). Each of us has only so much time to spend on our investments. We also can come up with only so many good ideas. It's better to put together a relatively small portfolio containing a limited number of companies that you know well than it is to have a large one filled with each and every one of the latest and greatest investments that you come across.
With the passage of time you'll learn more and more about your existing holdings and will be able to concentrate more of your capital and your time on the best ones.
Nevertheless, just because I've said all this, it doesn't mean that you shouldn't ever be open to new opportunities. But when your portfolio includes what you consider to be an optimal number of stocks, then as a general rule I think you should only add new ones when you think that the new company is a better investment than one of your existing holdings.
Okay. Now let's get to the question of the week. My choice for this month's $500 investment is none other than Intel (Nasdaq: INTC).
There are a number of reasons that I think now is a good time to add money to our Intel investment. One of these relates to the fact that the company seems to be back on course this year after its rough year in 1998. Since the third quarter of 1998, Intel's gross margin has increased from 49% to 59%, and its net margin has increased from 23% to 26%.
Moving to the balance sheet, we see that Intel's Flow Ratio has decreased from a high of 1.41 in the second quarter of 1998 to its present 1.18 and its ratio of cash-to-debt has increased from 10.78 to 13.24 during the same period.
There's more to a good investment than a few good numbers, though. What you have to consider is how the company runs its business (something that the balance sheet and income statement numbers that we look at do help us to understand) and what its prospects are for the future.
One of the first things that I like when I consider Intel's business is the size of the moat that protects it. Intel has more than 80% of the microprocessor market. It's estimated that it costs about $1 billion to build a new fabrication line. Not many companies have Intel's financial wherewithal, so it's difficult for me to imagine any significant competition in the marketplace any time soon.
Over the last year, the average selling price (ASP) of microprocessors has fallen substantially. Nevertheless, the company has been able to improve gross margins by constantly working to drive down its manufacturing costs. Intel will be moving its chips to 0.18 micron technology and then to 0.13 microns. That will help sustain the downward trend in production costs.
Later this quarter, Intel is expected to release its first "Merced" chips, which will begin the migration from 32-bit to 64-bit technology. MicroDesign Resources expects a complete transition to 64-bit chips by the end of 2005. I've heard quite a bit about these new chips, but I hadn't read a lot about their advantages until last week.
I finally got a chance to read some material from the Hewlett-Packard website about the IA-64 chip architecture (Intel is co-developing these chips with HP) that I had printed out in mid-May:
These papers did a real good job of explaining the difference in the logic used by the new architecture and how it increases the efficiency of the processor using an example comparing the decision process of a chip to that involved in a visit to your neighborhood bank. While I know that the viewpoint in what I read was not an unbiased one, after reading the material linked above and some other materials, I'm even more excited about the next generation of chips. As these chips move into wide scale production I think that Intel will move to the forefront of the server market. This is particularly important because of the fact that the selling price and margins earned on such chips are much higher than what is earned on the chips found in typical PCs.
And, if you follow Philip Fisher's (author of Common Stocks & Uncommon Profits) school of thought, then it's often a great idea to purchase a stock while the company is changing its manufacturing process or preparing to start a new product line.
I also like Intel's attempts to expand its business into several new areas. I look at these investments the same way I look at my own. That means that I use the Peter Lynch theory that goes something like this: For every five investments you make, three will match the market, one will underperform and one will outperform. The key to being successful is that the one good one has to outshine the bad one. When you have the financial resources that Intel does, you also have a greater chance of hitting it big.
To do a relatively simple test of how Intel's investments have performed, I decided to use the "one dollar premise" that's found on Page 264 of The Warren Buffett Way by Robert Hagstrom. The purpose of this test is to see how much each dollar that a company has reinvested in its business returns in market value to its shareholders. With the help of Value Line and Intel's annual report, as well as some estimates of Intel's market capitalization, I calculated that from 1989 through the end of last year, Intel generated $7.11 of market capitalization for each dollar of earnings reinvested in its business. I also ran a similar test comparing Intel's investment in research and development (R&D) to its net income for the same period. I calculated that Intel has generated $2.34 of income for every $1 of R&D. Both of those numbers give me further assurance that Intel and its dominant brand (ranked 7th globally according to Interbrand) will continue to be successful over the long term.
Phil Weiss, Fool
[And by the way -- if you know of some friends who might like to learn more about Intel, scroll up and click on the "E-mail this to a friend" link in the upper-right-hand corner.]
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Day Month Year History R-MAKER +1.14% 0.05% 13.55% 43.00% S&P: +0.19% -0.54% 11.66% 38.10% NASDAQ: +0.99% 0.75% 23.40% 63.70% Rule Maker Stocks Rec'd # Security In At Now Change 6/23/98 68 Cisco Syst 29.21 63.31 116.79% 5/1/98 82 Gap Inc. 23.05 47.81 107.40% 2/3/98 54 Microsoft 45.13 90.00 99.40% 2/13/98 44 Intel 42.34 70.31 66.08% 5/26/98 18 AmExpress 104.07 141.25 35.73% 2/3/98 66 Pfizer 27.43 35.13 28.04% 6/3/99 11 *Delphi Au 17.19 19.25 11.98% 8/21/98 44 Schering-P 47.99 51.63 7.57% 2/6/98 56 T. Rowe Pr 33.67 35.50 5.43% 2/27/98 27 Coca-Cola 69.11 61.38 -11.19% 2/17/99 16 Yahoo Inc. 126.31 143.00 13.21% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 78.94 22.70% 3/12/98 20 Eastman Ko 63.15 70.63 11.84% 3/12/98 15 Chevron 83.34 92.25 10.69% 3/12/98 17 *General M 61.28 65.75 7.29% Rule Maker Stocks Rec'd # Security In At Value Change 2/3/98 54 Microsoft 2437.28 4860.00 $2422.72 6/23/98 68 Cisco Syst 1985.95 4305.25 $2319.30 5/1/98 82 Gap Inc. 1890.33 3920.63 $2030.30 2/13/98 44 Intel 1862.83 3093.75 $1230.92 5/26/98 18 AmExpress 1873.20 2542.50 $669.30 2/3/98 66 Pfizer 1810.58 2318.25 $507.67 8/21/98 44 Schering-P 2111.7 2271.50 $159.80 6/3/99 11 *Delphi Au 189.09 211.75 $22.66 2/27/98 27 Coca-Cola 1865.89 1657.13 -$208.77 2/6/98 56 T. Rowe Pr 1885.70 1988.00 $102.30 2/17/99 16 Yahoo Inc. 2020.95 2288.00 $267.05 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1412.50 $149.55 3/12/98 15 Chevron 1250.14 1383.75 $133.61 3/12/98 20 Exxon 1286.70 1578.75 $292.05 3/12/98 17 *General M 1041.80 1117.75 $75.95 CASH $255.59 TOTAL $35205.09
Notes: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.
*Although DPH is not a Foolish Four stock, it was spun-off from GM on June 3, 1999