Rule Maker Portfolio Potential Buys

In 2002, the Rule Maker Portfolio cast off four technology companies, acquired a warehouse shopping company and a defense contractor, as well as added to two existing positions. What is the Rule Maker manager looking at now? Well, we've got a list, and, of course, it includes a company that we already own.

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By Bill Mann (TMF Otter)
January 15, 2003

OK, OK. Last week, we went on a little bit of a diatribe about President Bush's proposal to end double taxation on dividends. It was important. It is important. So much so that I took another bite at that apple in today's Fool on the Hill. Yep, Bill Mann's been busy.

I can't believe I just referred to myself in the third person. But let's move on.

As a quick catch-up, here are the positions we eliminated in 2002:

Yahoo! (Nasdaq: YHOO)
Cisco (Nasdaq: CSCO)
Intel (Nasdaq: INTC)
Microsoft (Nasdaq: MSFT)

And here are the ones we added:

Nokia (NYSE: NOK)*
Johnson & Johnson (NYSE: JNJ)*
Costco (Nasdaq: COST)
General Dynamics (NYSE: GD)

*added to existing positions

I'm very happy with each of these moves. Our $35 purchase price for Costco could have been a little better, but then a look at the company's strategy, its leadership position, and its bodacious operating cash flows makes me think that if this management team can produce, the difference between 35 and 30 will be minimal a few years out. I don't feel this way about many companies, but Costco sits in this category.

Needless to say, then, Costco is still a company I find at a compelling valuation. Its stock got whacked pretty good when it announced that its same-store sales growth for November was up less than expected. One stinking month and Costco was greeted by the usual ration of downgrades and a quick drop in share price. But it continues to beat up on its competition, and its economics remain as they were when we first bought some 20% higher. We oughta be buying now. And heck, we've got plenty of spare shekels lying around in the Rule Maker Portfolio -- we just might.

Some other companies that interest me all fall in what might be termed by my friends over in the Foolish Collective (free trial required) as "wounded elephants." They are:

Disney (NYSE: DIS)
There may have been no better buying signal for any company in a long time than when the stock market sent the Mouse spiraling downward more than 10% based on poor opening week numbers from its latest animated movie, Treasure Planet, in early December. Well, we're only a few points higher than we were on the day following the warning, and Disney remains terribly interesting at this price. It was harmed worse than any other non-airline company by the terrorist attacks, but its theme parks are still extremely valuable, as are its broadcasters ABC and, especially, ESPN. People seem to be worried about further declines in revenues, but at 18 bucks a stub, I'm less concerned than I would have been at 50. There's a heck of a lot of doom priced in at Disney.

Home Depot (NYSE: HD)
This stock started getting interesting to me when it hit 28. It currently sits another 30% lower than that, which insinuates the company is about to be taken to the cleaners by its main competition, Lowe's (NYSE: LOW). I think that this problem is partially one of perception. Home Depot is growing quickly -- its top-line growth still exceeds 15% per year. It has a much better capital structure than Lowe's, and it serves, when it comes right down to it, a different segment than Lowe's. Home Depot may not have the same growth opportunities in front of it than before, but the company is priced as if it were in some sort of decline into inferiority.

Comcast (Nasdaq: CMCSA)
What's the P/E on Comcast? Not applicable. What about its EBITDA? Well, for 2002 alone, it may approach $3.6 billion. Now, I know what you're saying: "Don't you always rage against people using EBITDA?" Yep, we do. But in the case of cable companies, which have massive capital outlays that precede potential cash flows, it is an appropriate measure. For the first nine months of 2002, the amount of depreciation Comcast had to charge against earnings exceeded $853 million on revenues of $4.4 billion. Cable companies, including Comcast, are spending billions of dollars upgrading their systems to digital from analog. These expenditures make the companies' current performance seem awful, but they raise significantly the expected value per subscriber. The cost of providing homes with Internet access, pay-per-view, and telephony on that digital backbone is negligible.

MGIC (NYSE: MTG)
An original Nifty 50 investment comes back to life! I won't steal his thunder too much here, but Fool Community member admiraltroll has created a very compelling description of this company that I'd like to reproduce here. MGIC provides mortgage insurance, which is required by lenders in cases where home buyers place less than 20% down on their purchase. The company has been taken down by more than $2.5 billion in market cap over concerns about its loan loss reserving practices and portfolio quality -- a potentially toxic combination to be sure. This may well be an overreaction, admiraltroll argues.

AOL TimeWarner (NYSE: AOL)
Yes, this stock sits in our Rule Breaker Portfolio. But I don't care. AOL is no longer a Rule Breaker; it's a Rule Maker, based not only on AOL's position as the dominant Internet service provider but also, much more importantly, on Time Warner's participation in various oligopolies. New CEO Richard Parsons is a straight shooter, and has pledged to whip AOL into shape, even to the point of selling assets to take a bite out of the company's $28 billion debt. I've never been a fan of AOL as an investment, but at present it seems that investors are punishing the whole company for the sins of the ISP. TimeWarner is, just like Comcast, a cable company, and should enjoy good returns on investment there. It is, like Disney, a broadcaster, and its HBO and CNN franchises are nearly as valuable as Disney's ESPN. And let's not forget the $7 billion in base revenues (before customers engage in any e-commerce) the company gets from its Internet property.

McDonald's (NYSE: MCD)
I also have an alternate view of McDonald's. Yes, previous management screwed up with its expensive "Made for You" fiasco, and it cost CEO Jack Greenberg his job. But McDonald's didn't have a whole lot of choice but to respond to the environment in which it operated, which was one of incredible increases in options for low-cost, quick-serve eateries. McDonald's is priced as if it were in permanent decline, but its brand power and competitive positioning are stronger than people give it credit. Besides, McDonald's new management is addressing the problem, and I suspect that some of its salvation is in its new concepts: Chipotle, Donato's, Aroma, and Boston Market. I place Yum! Brands (NYSE: YUM), owners of Pizza Hut, Taco Bell, and KFC (or Kentaco Hut, for short) in the same category.

This is a beginning list. There are others, including Waste Management (NYSE: WMI), Patterson Dental (Nasdaq: PDCO), Kinder Morgan Energy Partners (NYSE: KMP), and Washington Mutual (NYSE: WM) that I'll also try to cover in upcoming weeks.

Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards

Any resemblence between Bill Mann and Potsie is entirely coincidental. Bill owns shares in Costco and has beneficial interest in Cisco. He is managing editor of The Motley Fool Select, where you can find his best Foolish stock ideas you won't find anywhere else. The Motley Fool has a disclosure policy.

The Rule Maker Portfolio has had a cumulative investment of $44,500. As of January 14, 2003, its current value of all cash and equities is $32,287.84. This equals an internal rate of return of -10.2% since the launch of the portfolio in February 1998.


 

Rule Maker Portfolio

  Ticker Company Price
 Change
 Daily Price
 % Change
 Price 
  AXP AMERICAN EXPRESS COMPANY (0.76) (1.98%) 37.67 
  KO THE COCA-COLA COMPANY (0.83) (1.82%) 44.90 
  NOK NOKIA CORP. (0.09) (0.54%) 16.47 
  JNJ JOHNSON & JOHNSON (1.36) (2.41%) 55.00 
  PFE PFIZER INC (0.57) (1.84%) 30.45 
  GD GENERAL DYNAMICS CORPORATION (1.44) (1.83%) 77.11 
  TROW PRICE T ROWE GROUP INC (0.84) (2.78%) 29.41 
  SGP SCHERING-PLOUGH CORPORATION (0.75) (3.35%) 21.67 
  COST COSTCO WHSL CORP NEW (0.54) (1.74%) 30.45 
      
  Trade Date # Shares Ticker Cost/Share Price  Total % Ret  
 05/26/98 95 AXP 35.38 37.67  6.48%
 02/27/98 27 KO 69.11 44.90  -35.03%
 02/15/00 250 NOK 27.21 16.47  -39.47%
 04/03/01 30 JNJ 47.28 55.00  16.32%
 02/03/98 66 PFE 27.43 30.45  11.00%
 10/24/02 25 GD 79.98 77.11  -3.59%
 02/06/98 75 TROW 34.12 29.41  -13.80%
 08/21/98 44 SGP 47.99 21.67  -54.85%
 07/24/02 41 COST 35.89 30.45  -15.16%
      
  Trade Date # Shares Ticker Total Cost Current Value  Total Gain  
 05/26/98 95 AXP 3,360.87 3,578.65  217.78 
 02/27/98 27 KO 1,865.89 1,212.30  -653.59 
 02/15/00 250 NOK 6,802.85 4,117.50  -2,685.35 
 04/03/01 30 JNJ 1,418.50 1,650.00  231.50 
 02/03/98 66 PFE 1,810.58 2,009.70  199.12 
 10/24/02 25 GD 1,999.50 1,927.75  -71.75 
 02/06/98 75 TROW 2,559.06 2,205.75  -353.31 
 08/21/98 44 SGP 2,111.70 953.48  -1,158.22 
 07/24/02 41 COST 1,471.49 1,248.45  -223.04 
Cash:11,132.36 
Total:30,035.94 


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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.