Friday, April 24, 1998

Cash-King Portfolio Report
by Tom Gardner

Alexandria, VA (Apr. 24, 1998) -- The Cash-King Portfolio declined only a tad today, even though all of our stocks fell except for Pfizer, which rose another $2. Helping us today is the fact that we added our dividend and interest payments since inception to the portfolio's numbers. They toted up to $135.34, which initially pushed our account ahead 0.62% on the day.

And now, with over 25% of our initial investment sitting in cash, nonetheless, our C-K holdings are on the verge of overtaking the S&P 500. At day's end, the S&P is up 10.65% since February 20, versus C-K returns of 9.13%.

For today's report, well, Rob has asked for the day off. And I've obliged, due to his three excellent reports on Intel's business this week. If you didn't get a look at those reports, here they are. If you're an Intel shareholder, I highly, highly recommend them.

1. INSIDE INTEL: The microprocessor manufacturing process
2. MOORE'S LAW: Shrinking chips to speed them up
3. HOW INTEL MAKES MONEY: Prime economies of scale

Now, what Rob didn't realize when he asked for the day off is that I might just use his column to drive him batty! And that's exactly my plan.

I'll start by promoting myself in the middle of his report. Next week, I'll be stepping up for my C-K cuts, taking over as writer for the week -- tune in for a fairly thoroughgoing review of those of our companies which have recently reported earnings.

And, to really incense Rob, I'm giving over today's report to Microsoft's 3rd quarter earnings report. Contributors to and readers of our Cash-King Web Message Board know that Rob is to Microsoft what Michael Moore is to Corporate America, what Rush Limbaugh is to the Federal Government.

You get the picture. He's not going to be happy with me for writing this on Softy!

Unfortunately for its detractors, and fortunately for its shareowners, Microsoft reported another extraordinary quarter this week. On Wednesday, after market close, Mr. Softy posted third quarter earnings per share of $0.50 versus Wall Street estimates of $0.48 (which had recently been upped from $0.44, after public guidance from the company). Let's take a look at a simplified version of their earnings box:

               3rd Quarter 
 Sales         $3.77 billion 
 Gross Margins   91.6% 
 Earnings      $1.33 billion 
 Net Margins     35.2% 

Compared to the same period last year, Microsoft drove sales up by 17.6% and grew their earnings by 28.5%. Allow me to suggest that what you're looking at is almost unthinkable. An unthinkably good performance. Their sales of $3.77 billion on the quarter sported after-tax profit margins of over 35%? You have to be kidding me.

Let's take a look at the balance sheet:

                       3rd Quarter 
 Cash & Equivalents   $12.3 billion 
 Long-Term Debt        $0.0 billion 
 The Flow Ratio         0.29 

I do want to start with the Flow Ratio, which I hope all of you have sorted through in our 11 Steps to Cash-King Investing. In my mind, investing in this sort of portfolio demands that you understand the Flow Ratio -- a calculation based on 5th-grade mathematics.

In simple terms, The Flow Ratio measures a company's management of its product and cash flow. And, in our dream world, the companies that we own hold their inventories and outstanding bills down to a bare minimum. We end up looking for Flow Ratios below 1.00 (again, further explanation of this is available in our 11 Steps).

Microsoft's Flow Ratio of 0.29 is the single best in our portfolio, and upon first glance, the strongest Flow Ratio in the public markets (we're still searching). The company carries no inventory and holds receivables down aggressively (Microsoft gets paid upfront). This makes for a Product-Flow and a Cash-Flow King.

Our company also has over $12 billion in cold cash and not a single dollar of long-term debt. Compare this to Microsoft's generally-accepted top-five competitors. The combination of America Online, Sun Microsystems, Netscape, Oracle, and IBM have the following:

      Microsoft's Competitors 
       Cash & Equivalents $10.5 billion 
       Long-Term Debt     $14.4 billion 
       Cash & Equivalents $12.3 billion 
       Long-Term Debt      $0.0 billion 

Without IBM, the four competitors have $4.4 billion in cash and $800 million in long-term debt. And that reminds me of the basic poker principle, which holds that among equally-skilled players, the one with the most money wins.

In other words, leave out all of the industry dynamics, leave out Microsoft's powerful position as runaway leader in operating systems, leave out their slew of talented programmers and marketers, make them just equal to their competitors, and just look at the financial underpinnings of the business. With $12 billion in cash and no debt, Microsoft is financially sturdier than its top five competitors combined. (Mind you, Microsoft has a potentially fierce sixth competitor in Janet Reno. That is, if they don't hire her... or haven't already!)

So, generally, you don't want to find yourself slouching over a hand of cards and puffing clouds of cigar smoke at Mr. Softy. One of the keys to business success in our technology world today is "betting" as much of your money on non-Microsoft tables as possible.

Running contrary to that, Netscape has generally bet it all, hand after hand, against the Redmond Tornado. This strikes me as comparable to Icarus' sunward flight. In fact, I think one can make a reasonable argument that Escape-Net (err, Netscape) should have, instead, taken all of its financing and hopped a bus to Vegas.

I don't mean to be harsh there at all. But to support my line of thinking, imagine if executives of public companies couldn't cash out their options and stock for fully ten years after their offering. Would you raise money to battle the operating-systems giant in the browser market? Over that ten-year period, the prospects start looking bleak; Vegas grows more attractive.

To close, I'll leave open the question of whether Microsoft is illegally monopolistic and, if so, where. But, Fools, remember that our public markets do incentivize Microsoft to act as they have -- to create storms of consumer demand, to fashion a sturdy name brand, to save up hoards of cash, to tighten control over their product flow, and to patiently drive competitors out of their business.

Even if Microsoft is broken up or regulated in some fashion, who will say that what they've done up until now was wrong? The public markets inspire all its businesses to pursure control of their industry. Microsoft has gained it. And the marketplace has recently begun to realize that. Yeesh, what a bummer if you spent the last ten years valuing growing technology businesses based on book value.

Fool on!

Tom Gardner


Stock  Change    Bid 
 CHV   -1 13/16 82.44 
 KO    -1 1/8   73.63 
 EK    -  9/16  72.19 
 XON   -  1/4   73.50 
 GM    -  13/16 67.50 
 INTC  -1 3/16  82.00 
 MSFT  -2 3/8   92.06 
 PFE   +2 1/16  117.63 
 TROW  -1 7/16  76.38 
                  Day   Month    Year  History 
         C-K      -0.14%   4.99%   9.13%   9.13% 
         S&P:     -1.04%   0.56%  10.65%  10.65% 
         NASDAQ:  -0.66%   1.81%  13.07%  13.07% 
     Rec'd    #  Security     In At       Now    Change 
    2/3/98    22 Pfizer        82.30    117.63    42.92% 
    2/3/98    24 Microsoft     78.27     92.06    17.62% 
    3/12/98   20 Eastman Ko    63.15     72.19    14.32% 
    3/12/98   20 Exxon         64.34     73.50    14.25% 
    2/6/98    28 T. Rowe Pr    67.35     76.38    13.41% 
    2/27/98   27 Coca-Cola     69.11     73.63     6.54% 
    3/12/98   15 Chevron       83.34     82.44    -1.09% 
    2/13/98   22 Intel         84.67     82.00    -3.16% 
    3/12/98   17 General Mo    72.41     67.50    -6.77% 
     Rec'd    #  Security     In At     Value    Change 
    2/3/98    22 Pfizer      1810.58   2587.75   $777.17 
    2/3/98    24 Microsoft   1878.45   2209.50   $331.05 
    2/6/98    28 T. Rowe Pr  1885.70   2138.50   $252.80 
    3/12/98   20 Exxon       1286.70   1470.00   $183.30 
    3/12/98   20 Eastman Ko  1262.95   1443.75   $180.80 
    2/27/98   27 Coca-Cola   1865.89   1987.88   $121.99 
    3/12/98   15 Chevron     1250.14   1236.56   -$13.58 
    2/13/98   22 Intel       1862.83   1804.00   -$58.83 
    3/12/98   17 General Mo  1230.89   1147.50   -$83.39 
                               CASH   $5801.16 
                              TOTAL  $21826.60 
 *The year for the S&P and Nasdaq will be as of 02/03/98