Thursday, May 28, 1998

Cash-King Portfolio Report
by Tom Gardner

Alexandria, VA (May 28, 1998) -- I'll start with a confession: My two favorite American businesses are Microsoft and Coca-Cola. And I believe that these two companies provide the firmest foundations for the Cash-King Portfolio -- looking forward one decade and two. Both businesses operate in expanding global markets; both have high and ascending gross and profit margins; both have loads more cash than long-term debt; both have superior rates of return on equity and invested capital; and both are riding Flow Ratios well below 1.0 (Coke at 0.61 and Microsoft at 0.31).

And both companies have done extremely well at creating value for their public shareholders -- their owners -- as evidenced in their ten-year (or longer) performance charts:

1. Coca-Cola since 1970 (click and maximize screen)
2. Microsoft since 1988 (click and maximize screen)

Focusing on the past ten years, Coca-Cola (NYSE: KO) has risen from around $4 in 1988 to $78 1/4 today, marking ten-year compounded annual growth of around 34.5%. Over the same period, Microsoft (Nasdaq: MSFT) shares have risen from around $1 to $86, notching compounded annual growth of around 56.1%. $20,000 split evenly between the two in 1988 is valued at $1.05 million today -- with Microsoft creating about 82% of that value.

Given their present financial standing and the levels of expandability of their respective markets, I think the software maker holds the greater potential of the two. The Internet is exploding with new users just as half of the planet's population is methodically cracking its way out of the eggshell and into democracy. And Microsoft has $12 billion in cash, no debt, and a young management team that has constructed a model yielding gross margins above 90% (and inching higher) and net margins above 30% (and inching higher). Patience and perseverance have been and are winning in the technology space.

But today, I want to talk more about Coca-Cola because, after all, its 34.5% per year growth over the past decade nearly doubles the market's average returns per year. That's growth that has come without the tax bite of Foolish Four investing. How has Coca-Cola done it? By restructuring its relationship with its bottlers (distribution), by dropping vending machines in the hallways of the world (access), and by heavily committing creative energy and capital resources to build its brand name (familiarity).

These are three primary ingredients to a successful consumer franchise (though there are certainly others), and Coca-Cola has been a leader in fostering each of them in the 20th century. Sometimes with great foresight, other times only after wayward thinking, Coca-Cola's managers have tried over time to gain greater financial control of their destiny, to move bottles and cans and cups of their concentrate closer to the consumer, and to tie their brand name to refreshment, optimism, spirit, victory, and -- again -- ubiquity. In this century, Coke's management has outlined a mission to ensure that Coca-Cola products will always be there.

By the way, a fine illustration of that model of building consumer mindshare is in evidence every day on the Internet. Companies like America Online, Yahoo!, and (yep) The Motley Fool are committing substantial resources to win over mass-market mindshare. To be there, each day, an arm's length away, across the world. Even though all three of these examples are profitable companies, the great lesson of consumer name-brand business building in the 20th century is that early-stage spending to create brand power in a growing mass market is critical.

Detractors of the Internet today truly are detractors of any start-up consumer business. In technology, they've focused on "the losses" racked up by many of early-stage leaders -- rather that trying to estimate whether the numbers represent losses or investments. One wonders what they'd have been saying in 1886 when Coca-Cola's founder, John Pemberton, announced sales of $50 for the year alongside advertising costs of $76. For every $1.00 of sales, the company was losing $1.52 just in advertising costs. But as much as the business, in embryonic form, may have appeared to be spilling red ink, clearly it was making investments in its long-term expansion.

Clearly, in retrospect. That's the great challenge of early-stage investors: To determine the size of the potential market and the commitment of management to long-term success. In the case of Coke, capitalized at $100,000 at its incorporation in 1892 and valued at $25 million when it was sold in 1919, the losses really were investments -- management was ever taking the longer view. Today, the company is valued at $192 billion.

I'd like to close tonight's surface level reminder of Coca-Cola's business model with two excellent recent articles on the company. The first is an interview with Vice President and Chief Financial Officer (CFO) James Chestnut, which appeared in CFO Magazine. I very highly recommend it to all existing and potential Coca-Cola shareholders. (Click here: Interview with Coke's CFO.)

And the second article is Fortune's May 25th cover story on Coke CEO Douglas Ivester's walking tour of Shanghai (but more intently on his ascent to leadership at the company). My favorite of his quotations in the article reads:

"Look," [Ivester] says bluntly, "if our shareholder base said, 'We want to manage this business for the short-term results,' I could do it. I know how all the levers work, and I could generate so much cash I could make everybody's head spin. As long as you know I could do that, I don't need to. We won't take any short-term actions that are reactionary in nature. We won't change our fundamental course. We are not managing for the next quarter."

The full article can be accessed for free by clicking: Coke CEO Doug Ivester.

Now, that's a lot of reading to leave you with, but I'm going to add two final links -- to our buy reports on Microsoft and Coca-Cola: 01/29/98: Cash-King Buying Microsoft and 02/20/98: Cash-King Buying Coca-Cola. Whether or not you choose to be an investor in these companies, if you would like to gradually master the Cash-King approach to investing, I think it's critical that you have a baseline understanding of Coca-Cola's and Microsoft's approaches to business and their underlying financial models. That may seem overlarge and incomprehensible, but all I'm speaking of here is their focus on gradually increasing margins, on gradual global expansion, and on gradually increasing brand exposure.

Fool on!

Tom Gardner, Fool

P.S. The winners of the "Qualities of a Foolish Investor" contest will be announced tomorrow.


Stock  Change    Bid 
 AXP   +2       103.38 
 CHV   +  1/2   80.25 
 KO    +  11/16 78.94 
 GPS   +  7/8   53.44 
 EK    +  5/16  70.69 
 XON   +  9/16  70.94 
 GM    -  5/16  73.19 
 INTC  -  7/8   73.44 
 MSFT  +  1/4   86.25 
 PFE   -1 3/16  106.38 
 TROW  +  3/8   34.38 
                  Day   Month    Year  History 
         C-K      +0.42%  -2.10%   6.19%   6.19% 
         S&P:     +0.49%  -1.28%   9.62%   9.62% 
         NASDAQ:  +0.76%  -3.95%   8.57%   8.57% 
 Cash-King Stocks 
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   22 Pfizer        82.30    106.38    29.25% 
    2/27/98   27 Coca-Cola     69.11     78.94    14.22% 
     2/3/98   24 Microsoft     78.27     86.25    10.20% 
     5/1/98   37 Gap Inc.      51.09     53.44     4.59% 
     2/6/98   56 T. Rowe Pr    33.67     34.38     2.08% 
    5/26/98   18 American E   104.07    103.38    -0.66% 
    2/13/98   22 Intel         84.67     73.44   -13.27% 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     70.69    11.94% 
    3/12/98   20 Exxon         64.34     70.94    10.26% 
    3/12/98   17 General Mo    72.41     73.19     1.08% 
    3/12/98   15 Chevron       83.34     80.25    -3.71% 
 Cash-King Stocks 
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   22 Pfizer      1810.58   2340.25   $529.67 
    2/27/98   27 Coca-Cola   1865.89   2131.31   $265.42 
     2/3/98   24 Microsoft   1878.45   2070.00   $191.55 
     5/1/98   37 Gap Inc.    1890.33   1977.19    $86.86 
     2/6/98   56 T. Rowe Pr  1885.70   1925.00    $39.30 
    5/26/98   18 American E  1873.20   1860.75   -$12.45 
    2/13/98   22 Intel       1862.83   1615.63  -$247.21 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1413.75   $150.80 
    3/12/98   20 Exxon       1286.70   1418.75   $132.05 
    3/12/98   17 General Mo  1230.89   1244.19    $13.30 
    3/12/98   15 Chevron     1250.14   1203.75   -$46.39 
                               CASH   $2037.63 
                              TOTAL  $21238.19 
 *The year for the S&P and Nasdaq will be as of 02/03/98