Wednesday, May 13, 1998

Cash-King Portfolio Report
by Tom Gardner
([email protected])

Alexandria, VA (May 13, 1998) -- On Wednesday, we cover questions from the Foolish crowd. Today, I'd like to respond to two. The first one comes from Joel Shaw who writes:

Tom,

The Fool Portfolio just announced that the biggest blunder since their inception has been selling half of their position in America Online -- costing them more than $41,000.

I was wondering how your sale of Gap a few years ago stacks up to that? Thanks for sharing!

Joel B. Shaw

Henceforth, let the name "Joel B. Shaw" be associated with insolent, flea-bitten dogs. How dare you imply that I, or any Cash-King manager, has ever made what could be called a mistake. A pox on your name and your golf game, and may winter make a cozy home of your heart!

Next question.

No, no, of course Joel is right. And Joel, I apologize for losing myself there. You're right -- my decision, on August 13, 1996, to sell Gap from the Fool Portfolio was befitting a dunce. Though, it didn't always seem so. Our Gap stock had more than doubled by August 1996, and 3Com shares were looking undervalued to me. On the day of our Gap sale, we then purchased 3Com at $46 3/4. And within four months, our networking stock had risen to $82 while Gap's stock price was idling.

How we thanked ourselves! Our horns, we tooted.

But, since that time, 3Com bought U.S. Robotics' inventory-stuffed channels and its shares have fallen from $82 to their present resting place of (ahem) $30 1/4. That $11,700 investment in 3Com is now worth less than $7,700. And, in the meantime, Gap has been chugging up and over the hill like the big train that always could.

"I knew I could, I knew I could, I knew I could..."

Sadly, the $10,861 that came out of our Gap sale -- sold at a split-adjusted price of $23.42 -- would today be valued at $25,275. Thus, we missed about $14,400 of value by selling Gap. Let's not stop there, though. We now have lost around $4,000 in our 3Com investment. And that means that, all told, the decision to sell Gap back in 1996 really lost us about $18,400. Ouch! That's a down payment on a small beach house in Lewes, Delaware. That's summers of weekends throwing red kites into the sky and skipping shells over the surf. That's chardonnay under a crescent moon.

Ouch.

The remarkable thing is, of course, that with all of these mistakes -- holding half of the Iomega position too long, selling half of America Online too early, buying ATC Communications, buying Sonic Solutions, selling Gap, buying 3Com, shorting Paychex... even then the Fool Portfolio is up 317% vs. S&P 500 gains of 143%. For me, that serves as a nice reminder that average investors working simply to maximize the value of their portfolios will naturally beat financial managers whose primary motivations lie elsewhere. Thanks for the Foolish note, Joel.

The second question today comes from Lee Woodward who writes:

Tom,

I'm a big fan of your Cash-King portfolio [Ed. Sorry, we couldn't edit that out]. I've been using the Cash-King guidelines, and I'd like to make a few suggestions of possible future CK companies.

1. Schering-Plough (SGP)
2. Pioneer High-Bred (PHB)
3. Southwest Airlines (LUV)

Lee, thanks very much for the note, which gives me the opportunity to announce that at some point next week, we'll be opening a second Cash-King message folder dedicated to the search for CK companies. The existing Cash-King folder will be reserved for questions about the model and philosophy. [Ed. Also, our next buy report is coming soon, I promise.]

Let's take a quick look at your three suggestions.

Schering-Plough
Basic Cash-King Criteria
Trailing 12-month Sales.................$7.1 bil.
Market Capitalization....................$63.4 bil.
Gross Profit Margin.......................80.0%
Avg. Net Profit Margin...................21.3%
Cash (and short-term securities)....$622 mil.
Long-Term Debt...........................$46 mil.
Cash as % of Debt.......................13.5x
Leveraged Flow Ratio (< 1.25)......0.90
Unleveraged Flow Ratio (< 1.5).....1.08

Schering-Plough meets all of our Cash-King criteria. The question, oft debated in the Cash-King folder, is whether Schering-Plough has the pipeline of new drugs to sustain its outstanding performance of years (and decades) past. Their Flowie has been weakening over past quarters. Schering-Plough has risen from a split-adjusted $5 to $86 over the past ten years, marking an annualized growth rate of 32.9%.

Pioneer Hi-Bred
Basic Cash-King Criteria
Trailing 12-month Sales..................$1.8 bil.
Market Capitalization.....................$9.9 bil.
Gross Profit Margin.........................51.3%
Avg. Net Profit Margin....................13.4%
Cash (and short-term securities).....$578 mil.
Long-Term Debt............................$18 mil.
Cash as % of Debt..........................32.1x
Leveraged Flow Ratio (< 1.25)........1.01
Unleveraged Flow Ratio (< 1.5).......1.07

Pioneer Hi-Bred actually is a member of the Money-Heavy Portfolio mentioned in yesterday's report. The company meets all of our Cash-King criteria as well. It has extended gross margins to 51%, has loaded up on cash, and manages product flow and demand extremely well. With DeKalb Genetics being swallowed up by Monsanto the other day, agricultural genetics is turning heads on Wall Street. Jim Surowiecki wrote a fine article on this at the bottom of this recent News Report. Over the past ten years, Pioneer Hi-Bred has risen from a split-adjusted $3 to $40, marking an annualized growth rate of 29.6%

Southwest Airlines
Basic Cash-King Criteria
Trailing 12-month Sales..................$3.8 bil.
Market Capitalization.....................$5.8 bil.
Gross Profit Margin........................13.7%
Avg. Net Profit Margin.....................8.3%
Cash (and short-term securities).....$623 mil.
Long-Term Debt............................$628 mil.
Cash as % of Debt..........................1.0x
Leveraged Flow Ratio (< 1.25)........0.21
Unleveraged Flow Ratio (< 1.5).......0.21

Southwest Airlines has been a consumer hit for years, taking on the big airlines by providing low fares and top-notch service. On the financial side, the company meets nearly all of our criteria. Net margins are high enough, the Flowie of 0.21 is extremely low on account of limited inventory, and the company is well enough capitalized to spark our interest. On the flip side, the airline business is capital intensive, bringing with it heavy material costs. Southwest Air's gross margins are just 13.7%, well below our 50.0% benchmark. And the company matches every dollar of cash savings with a dollar of long-term debt.

But... directionally, it is on target. Southwest's gross margins are up from 10.9% two years ago, and in 1995, the company had just $175 million in cash alongside $583 million in long-term debt. Directionally, the company is on target. And Southwest Airlines stock has risen from a split-adjusted $2 to $26 over the past ten years, marking annualized returns of 29%.

Lee, you've found three extraordinarily fine companies. Some will say that you've done nothing more than found a few ducks that were floated by rising water. But the stock market has compounded returns well below what these three companies have returned over the past ten years. They've been monsters. And they certainly are swarming around the bullseye of the Cash-King criteria. Thanks for posting the note.

Tomorrow, I'll talk a bit about our latest investment, Gap Inc.

Tom Gardner, Fool

TODAY'S NUMBERS

Stock  Change    Bid 
 ---------------- 
 CHV   +  1/4   84.56 
 KO    -  1/2   77.25 
 GPS   +1 1/8   54.38 
 EK    +  9/16  71.63 
 XON   -  3/16  73.63 
 GM    +1 15/16 75.06 
 INTC  +  5/16  84.81 
 MSFT  +1 1/4   86.88 
 PFE   -1 11/16 110.19 
 TROW  +  5/16  36.56 
 
                  Day   Month    Year  History 
         C-K      +0.41%   0.86%   9.40%   9.40% 
         S&P:     +0.28%   0.64%  11.74%  11.74% 
         NASDAQ:  +0.32%  -0.12%  12.90%  12.90% 
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   22 Pfizer        82.30    110.19    33.89% 
    2/27/98   27 Coca-Cola     69.11     77.25    11.78% 
     2/3/98   24 Microsoft     78.27     86.88    11.00% 
     2/6/98   56 T. Rowe Pr    33.67     36.56     8.58% 
     5/1/98   37 Gap Inc.      51.09     54.38     6.43% 
    2/13/98   22 Intel         84.67     84.81     0.16% 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Exxon         64.34     73.63    14.44% 
    3/12/98   20 Eastman Ko    63.15     71.63    13.42% 
    3/12/98   17 General Mo    72.41     75.06     3.67% 
    3/12/98   15 Chevron       83.34     84.56     1.46% 
  
  
 Cash-King Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   22 Pfizer      1810.58   2424.13   $613.55 
    2/27/98   27 Coca-Cola   1865.89   2085.75   $219.86 
     2/3/98   24 Microsoft   1878.45   2085.00   $206.55 
     2/6/98   56 T. Rowe Pr  1885.70   2047.50   $161.80 
     5/1/98   37 Gap Inc.    1890.33   2011.88   $121.55 
    2/13/98   22 Intel       1862.83   1865.88     $3.05 
  
 Foolish Four Stocks 
  
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Exxon       1286.70   1472.50   $185.80 
    3/12/98   20 Eastman Ko  1262.95   1432.50   $169.55 
    3/12/98   17 General Mo  1230.89   1276.06    $45.17 
    3/12/98   15 Chevron     1250.14   1268.44    $18.30 
  
                               CASH   $3910.83 
                              TOTAL  $21880.46 
   
 *The year for the S&P and Nasdaq will be as of 02/03/98