RULE MAKER PORTFOLIO
Deciding Between Yahoo! and Coca-Cola

By Matt Richey (TMF Verve)

MILWAUKEE, WI (December 16, 1999) -- Last night, I ate at a great little Italian restaurant, Mimma's Cafe on the east side of Milwaukee. They had several specials, two of which -- a rolled pork loin and a mushroom-stuffed chicken breast -- I had the hardest time choosing between. I mean, how do you decide between two delectable dishes such as these? Chicken versus pork loin -- they're both great, but in their own unique ways. What a dilemma!

Now, I'm facing a similar, if not less appetizing, conundrum here in the Rule Maker portfolio. I've narrowed down my $500 candidates to two: Yahoo! (Nasdaq YHOO) and Coca-Cola (NYSE: KO). These are two of my top-o'-the-heap favorite companies, two companies that I think are quintessential examples of a true-blue Rule Maker. But we only have one $500 check, so I've got to choose.

That means it's time for a head-to-head super bout between these two champion companies. In one corner, we have the world beverage leader, Coca-Cola, with a market value of $140 billion and a stock performance history boasting returns of 14,444,400% since 1919 (15.8% annually with dividends reinvested). In the other corner is the world's leading Internet media company, Yahoo!, valued at $90 billion, and with a 6,081% historical stock return since April 1996 (225% annually).

This will be a match using the 10 core Rule Maker Criteria. I'll consider Yahoo! and then Coca-Cola on each attribute, and give one point for success on each one. Let's get started!

1. Dominant Brand

Yahoo! is the #1 destination on the Internet. In September, the site attracted over 100 million unique users, each of whom spent more than 100 minutes on the site during the month. Give Yahoo! a point for this one.

Coca-Cola is the world's #1 brand -- period. It holds more than 50% of the worldwide cola market share. From 1994 to 1998, Pepsi Cola's operating income declined nearly 21%, whereas Coca-Cola's increased nearly 37%. In addition, during those years, Coca-Cola outsold Pepsi Cola by 75%. All told, Coke's combined operating profits for the past five years were more than four times greater than Pepsi's combined beverage-related operating profits. Without question, Coke gets a point for brand.

2. Repeat Purchase Business

As a media company, Yahoo!'s business of advertising and commerce depends on repeated contact with the end-user. Yahoo! gets that repeat contact by providing the Internet's most extensive array of services -- everything from stock quotes to e-mail, from free home pages to bill pay services, from small business services to customized news -- on, and on, and on. Give Yahoo! another point.

No need to belabor this one for Coke. Just ask yourself how many Coca-Cola products you drink per week, per day, maybe even per hour if you're like me! This one's a lay-up for Big Red -- give 'em a point.

3. Convenience

Anywhere you can get connected to the Internet, you have your Yahoo! These days that can mean your PC, your TV, your PalmPilot, and if you're in San Francisco, you can even get Yahoo! in some taxi cabs. That deserves a point.

Whether you're in New York or Nairobi, finding a Coke is a cinch. No matter where you are in the world, Coke is there to quench your thirst. Another easy point for KO.

4. Expanding Possibilities

Try typing in _______.yahoo.com -- it's amazing the breadth of their existing offerings, and they're adding more every day. Personal finance services, such as bill payment, are just one of the more recent pioneering areas of growth. Yahoo! is one of those companies that can branch out as far as the imagination stretches. Definitely worth a point.

As I mentioned above, Coca-Cola already has a presence around the globe, but overseas consumption is only a fraction of the frenzied Coke chugging we do here in the U.S. Throughout this century, Coke has grown its beverage volume by 7-8% annually. As emerging economies strengthen, Coke's business should eventually resume a moderate pace of growth. I still see a point worth of expanding possibilities for Coca-Cola.

5. Your familiarity and interest

I use My Yahoo! as my home page, and thus I use it literally all day, every day. It's my information source for stocks, news of all varieties, TV guide listings, bill pay services, and weather. Easy point.

I drink my share and your share of Diet Coke everyday. 'Nuff said. 1 point.

6. Sales growth of at least 10%

Yahoo! is growing sales at north of 50%. That'll do for a point.

Here's where Coke trips up. Comparing the past 12 months versus the 12 before that, Coke has grown sales only 2.1%. But -- and this is an interesting development -- in the most recent quarter (Q3), Coke's sales improved by 9.6% over the third quarter a year ago. Nice improvement, but not enough for a point.

7. Gross Margins of at least 50%

Yahoo!'s gross margins are better than 80% because the material costs of delivering Web pages and banner ads are almost nil. 1 point.

Over the past 12 months, Coke's gross margin is 69.3%. The costs of manufacturing sugary syrup are pretty darn low. Another easy point.

8. Net Margins of at least 7%

Acquisition charges cause Yahoo!'s reported net margins to grossly understate the company's profitability. On a reported basis over the trailing 12 months, Yahoo!'s net margin is 13.1%. But if you look at Yahoo!'s cash profitability over the past 12 months, you get an entirely different -- and much clearer -- picture of the profit potential of a lightweight Internet media business. Operating cash flow margin is 42.5% and free cash flow margin is an amazing 35.6%. That's worth a point in my book.

As a mature company, Coke's net margins suffice as a perfectly adequate measure of the company's profitability. Over the past 12 months, Coke's net margin is 15.9%. Coke has been more profitable at times past, but 15.9 cents of profit on each dollar of sales is still good enough for a point here.

9. Cash no less than 1.5x total debt

No debt at Yahoo! so this one's a snap -- 1 point.

Here's another tripping point for Coke. As a mature, stable company, I think Coca-Cola's managers are smart to utilize debt to prudently reduce the company's cost of capital. Quite simply, the interest rates on debt are lower than the returns that shareholders require. That's why debt "costs less" than equity. Coke's cash-to-debt ratio currently stands at 0.26. Can't give 'em a point for that.

10. Efficient use of cash as measured by a flow ratio of less than 1.25

At 0.37, Yahoo! is one of the best of the best in working capital efficiency. 1 point.

Coca-Cola has made some marked improvements on its flow ratio in recent quarters. In the third quarter, Coke's flowie came in at 1.00, which is down from 1.07 a year ago and is the lowest showing in two years. 1 point.

Okay, the final scoring is 10 points for Yahoo! versus 8 points for Coca-Cola. So does Yahoo! get the $500? Not so fast.

Yesterday, I pointed to a post by markandsusanv on the Rule Maker Strategy board, in which he outlined his ideas for how we should go about our monthly $500 decision-making process. Among Mark's list of criteria, first on his list is business quality as measured by the Rule Maker Ranker company scoring. Mark's second criterion is a stock's relative weight in the portfolio, where he suggests that we not add to any position that makes up more than 15% of the portfolio's value.

Here's how our portfolio's current Tier 1 and Tier 2 Rule Makers (as measured on our monthly listing of Rule Maker Company Rankings) stack up by their weight in the portfolio (as of yesterday's closing values):

Company     Weight
Cisco       16.5%
Microsoft   14.7%
Yahoo!      12.0%
Intel       10.7%
Coca-Cola    3.7%
Now, our first five $500 additions have gone to our high-tech trio of Microsoft, Intel, and Cisco. Without question, each of those companies are doing great business. Even so, I believe in maintaining diversification as we dole out these $500 nuggets. Not only that, but we have some other fantastic companies in this portfolio that are worthy of consideration. Between Yahoo! and Coca-Cola, you can see in the table above that one of those companies makes up a significantly smaller portion of the portfolio.

Coca-Cola has faced rough times these past few years. The now-departed CEO Doug Ivester wasn't able to live up to his predecessor's performance. Right now, Coke's management team is getting a wake-up call: shape up, or you're outta heaya! I like that. I also like the fact that Coke made a huge jump in its performance on our Ranker with its most recent third quarter of financial results. Coke now scores 41 points on the Ranker, versus a 33 point showing earlier this year.

In sum, Coca-Cola, maker of the rules in the beverage industry, makes up only 3.7% of our portfolio. Considering that the company has shown solid operational improvements in the recent quarter, I think it's time to add another $500 to our KO holdings.

Do you agree? Let us know on the Rule Maker boards.

Rob is back for tomorrow's report. Fool on!

- Matt Richey

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Rule Maker Portfolio

12/16/99 Closing Numbers
Ticker Company Dly Pr Chg Price
AXPAMER EXPRESS-5 9/16$152.63
CHVCHEVRON CORP-1/2$89.44
CSCOCISCO SYSTEMS2$97.88
DPHDELPHI AUTOMOTIVE SYSTEMS1/2$15.13
EKEASTMAN KODAK-3/8$59.94
GMGENL MOTORS1/4$72.50
GPSGAP INC9/16$46.44
INTCINTEL CORP5/16$80.25
KOCOCA-COLA CO-1 3/8$58.50
MSFTMICROSOFT CORP1/4$113.69
PFEPFIZER, INC-1/4$34.00
SGPSCHERING-PLOUGH-1 3/8$43.81
TROWT.ROWE PRICE ASSOC-27/32$33.63
XOMEXXON MOBIL CORP11/16$83.75
YHOOYAHOO INC13 1/2$341.00

  Day Week Month Year
To Date
Since
2/2/98
Annualized
Rule Maker 1.29% 1.82% 9.75% 33.89% 66.71% 31.43%
S&P 500 .39% .12% 2.14% 15.42% 44.73% 21.86%
S&P 500(DA) .39% .12% 2.14% 16.00% 46.50% 22.66%
S&P 500(DCA) n/a n/a n/a n/a 29.85% 14.99%
NASDAQ 2.57% 2.62% 11.36% 69.43% 129.42% 55.90%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
6/23/9875CSCO32.865$97.88197.81%
2/17/9916YHOO126.309$341.00169.97%
2/3/9859MSFT49.352$113.69130.36%
5/1/9882GPS22.708$46.44104.50%
2/13/9859INTC50.624$80.2558.52%
5/26/9818AXP104.067$152.6346.66%
3/12/9820XOM64.335$83.7530.18%
2/3/9866PFE27.433$34.0023.94%
3/12/9817GM60.399$72.5020.04%
3/12/9815CHV83.343$89.447.31%
2/3/9856TROW33.673$33.63-0.14%
3/12/9820EK63.148$59.94-5.08%
8/21/9844SGP47.993$43.81-8.71%
3/12/9811DPH17.202$15.13-12.07%
2/27/9827KO69.107$58.50-15.35%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
6/23/9875CSCO$2,464.86$7,340.63$4,875.77
2/3/9859MSFT$2,911.79$6,707.56$3,795.77
2/17/9916YHOO$2,020.95$5,456.00$3,435.05
5/1/9882GPS$1,862.06$3,807.88$1,945.82
2/13/9859INTC$2,986.79$4,734.75$1,747.96
5/26/9818AXP$1,873.20$2,747.25$874.05
2/3/9866PFE$1,810.58$2,244.00$433.43
3/12/9820XOM$1,286.70$1,675.00$388.30
3/12/9817GM$1,026.78$1,232.50$205.72
3/12/9815CHV$1,250.14$1,341.56$91.43
2/3/9856TROW$1,885.70$1,883.00($2.70)
3/12/9811DPH$189.22$166.38($22.84)
3/12/9820EK$1,262.95$1,198.75($64.20)
8/21/9844SGP$2,111.70$1,927.75($183.95)
2/27/9827KO$1,865.89$1,579.50($286.39)
  Cash: $135.63  
  Total: $44,178.13  


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.