Boring Portfolio

Boring Portfolio Report
Thursday, February 26, 1998
by Mark Weaver, MD (MWEAV@aol.com)


St. Louis, MO (Feb. 26,1998) -- This day is notable for a small victory for good sense. Oprah Winfrey won her "battle" with Texas ranchers for remarks made during one of her shows. What a colossal waste of money. It probably wouldn't surprise anybody that I, as a member of the medical profession, might think our legal system more than a bit screwed up. Maybe one day the trial lawyers will lose their grip over our legislators and some meaningful and cost saving reforms could be implemented. While I am not holding my breath for such an enlightened event, I am giving this small cheer for the sensible jurors in Texas.

I am composing this piece a bit early today because I have a family commitment that precludes post-market activities. Family commitments win out over the markets for this Fool. At this writing the S&P and Nasdaq Composite are up in the neighborhood of 0.5% while it appears that the cash heavy Borefolio will lag the indices.

Scanning the wires I find no news of significance involving our stocks. We may have an entire week without news if we can make it one more day!

Over the past couple of days Greg has discussed our philosophy of finding good stocks and buying them at good prices. This is a project which is easily discussed but difficult to execute. Let's face it, thousands of investors are screening the universe of stocks each and every day. All of these investors are looking for the same thing -- earnings growth, return on equity, return on assets, price-to-cash flow relationships, price/sales ratios, dividend yield, price-to-book ratios and all of the rest. (See the Fool's School, "How to Value Stocks.") Thousands of investors are calculating PEGs, YPEGs, and any number of other measures of valuation. Is it any wonder that everyone piles on the same shares and drives prices to the lofty levels we see today?

As Greg has stated, in spite of this we believe there are values out there and that there are undiscovered or underappreciated "diamonds in the rough." Greg and I use various valuation methodologies to sift through the pile. I usually like to start out with the relationship between forward earnings estimates and earnings growth estimates. This relationship has been dubbed the YPEG and is a useful starting point. However, I think an investor has to realize that earnings estimates and especially earnings growth estimates are horribly inaccurate. Analysts long-term earnings growth estimate, for any company, is so often 20% as to be laughable. It is a mighty naive investor that believes that long-term profit growth can be estimated with any meaningful accuracy.

Given the vagaries of long-term growth estimates I like to look at forward earnings versus historical averages of PE ratios. If a company has an average PE over the past 5 years of 25 but long-term growth estimates are listed as the 20% ballpark I will use the average PE as my multiple. I also look at where the stock stands in relation to its historic price/sales ratio and price/cash flow ratio. We find most stocks today are trading at the top of those ranges. Most that is, but not all.

If nothing else Greg and I are eclectic. We will consider any well-standardized valuation method in an attempt to find value. With boring industrial companies PEGs and YPEGs often don't apply. One such alternative valuation method that I have mentioned is the cash-on-cash return. This simply takes the free cash flow and divides by the Enterprise Value (market cap + long-term debt - cash). This is the ultimate "yield" of the company. The theory is that as a company churns out cash it will ultimately end up in the shareholders' pocket in some form. Companies with high cash-on-cash returns reward patient investors with above average returns.

Geraldine Weiss has one of the historically best performing stock newsletters over the past decade. Her newsletter Investment Quality Trends is chock full of very boring companies. One of her principal methodologies is to use historical dividend yields to determine value. If a stock is trading at the upper end of its historic dividend range and has a decent business, chances are that the pendulum will swing back to lower yields and higher prices. This is contrarian investing. Buy when the stock is out of favor or is the victim of a misperception.

I like to look for high quality companies that are trading at historically average or below average multiples of cash flow and earnings. As long as the business is intact, these stocks will trade up to the higher end of their valuation range and at that robust valuation we would hope to pass our shares on to a "greater fool" (small f).

When Greg says there is value in our current holdings I couldn't agree more. Here are some examples.

Borefolio holding Felcor Suites Hotels (NYSE: FCH) isn't getting much respect in spite of above industry average performance and a nice dividend. The reason it is lagging is the fear that it won't be able to do deals. The company assures us, and thus far has demonstrated, that there are indeed deals to be done. Fear has created opportunity. At current prices the company trades right at its five-year average price/cash flow and at the low end of its historic PE ratio. There is plenty of upside by any valuation criteria.

Take Andrew (Nasdaq: ANDW) for another example. While Zack's reports long-term growth estimates of 19% the current PE is 27 times trailing earnings and 16 times year ahead earnings per share. While a simple YPEG analysis would show ANDW fully valued at $31 per share, the fact is that ANDW hasn't traded below a trailing PE of 22 at any time during the past 5 years. In fact, it has sported a PE of 36 as recently as 1996 in a particularly euphoric phase. In this market a stock selling at its historic mean PE, PSR, Price/Book and Price/cashflow is a rare animal indeed. If Andrew earns its expected $1.67 next year and trades at its historic average multiple of earnings, $45 would be the resulting stock price. That's a pretty nice upside from here.

Greg touched on Cisco Systems (Nasdaq: CSCO) last night. While analysts peg long term growth at 30%, the fact is, the lowest multiple of earnings that Cisco has changed hands for in the past 5 years is 32. Its average PE is nearer 48. Putting those multiples together with estimates of $2.14 in the next fiscal year and you could see prices in excess of $100 for Cisco. I should also mention that Cisco is currently trading BELOW its historical average price/sales, price/book and price/cash flow. You get the idea... we think there is still compelling value in the Borefolio.

FoolWatch -- It's what's going on at the Fool today.


TODAY'S NUMBERS
Stock  Change    Bid 
 ANDW  -  1/16  27.94 
 CGO   +  5/8   30.13 
 BGP   -  1/16  31.88 
 CSL   -  7/8   48.44 
 CSCO  -  5/16  66.44 
 FCH   +  3/8   36.44 
 
                   Day   Month    Year  History 
         BORING   -0.14%   3.66%   0.10%  25.96% 
         S&P:     +0.55%   6.97%   8.06%  68.70% 
         NASDAQ:  +0.60%   9.74%  13.17%  70.72% 
  
     Rec'd   #  Security     In At       Now    Change 
   2/28/96  400 Borders Gr    11.26     31.88   183.18% 
   6/26/96  150 Cisco Syst    35.93     66.44    84.89% 
   8/13/96  200 Carlisle C    26.32     48.44    84.00% 
    3/5/97  150 Atlas Air     23.06     30.13    30.65% 
   1/21/98  200 Andrew Cor    26.09     27.94     7.08% 
   11/6/97  200 FelCor Sui    37.59     36.44    -3.07% 
  
     Rec'd   #  Security     In At     Value    Change 
   2/28/96  400 Borders Gr  4502.49  12750.00  $8247.51 
   6/26/96  150 Cisco Syst  5389.99   9965.63  $4575.64 
   8/13/96  200 Carlisle C  5264.99   9687.50  $4422.51 
    3/5/97  150 Atlas Air   3458.74   4518.75  $1060.01 
   1/21/98  200 Andrew Cor  5218.00   5587.50   $369.50 
   11/6/97  200 FelCor Sui  7518.00   7287.50  -$230.50 
  
                              CASH  $13182.97 
                             TOTAL  $62979.85