Tuesday, June 16, 1998
Our Next Stock
by Al Levit
Glendale, CA (June 16, 1998) -- Before launching into tonight's column, Fools, please remember to vote in the Cash-King Stock Poll. The last day to vote is Thursday, and the competition is heated between the five stocks: Cisco, Dell, General Electric, Schering Plough and Tellabs. Your votes will determine the next stock we add to the Cash-King portfolio. Click here to cast your vote: Motley Fool and C-K Online Poll.
Ok, on to the report...
Regular readers of our column know that occasionally we Cash-Kingers take time to read a book -- and on occasion, we even write up a review of it. Today we'll do just that, covering a financial book that has a great deal to say about our brand of investing here in the Cash-King portfolio.
In fact, I plan to dedicate most of the rest of this week's columns to covering the ideas found therein. And, if you enjoy these articles, Louis Corrigan (TMF Seymor) also gave the book a quick review in his Fool on the Hill column of April 22.
The book in question is The Gorilla Game by Geoffrey A. Moore, Paul Johnson and Tom Kippola. It analyzes high-technology companies that have dominated their markets, enabling them to set the standards in the marketplace. And what's the end result of that?
Dominating an expanding technology market can make for a very high margin business with little or no debt and increasing global opportunity. You can imagine what happens to their stock prices! The authors call these companies "Gorillas" -- referring to the 800-pound gorilla domination of an industry. We call them Cash-Kings, using slightly different criteria but drawing many of the same conclusions.
The authors' basic thesis is that one way to aggregate wealth is to find a gorilla early and to just hold on tight. As the front jacket spells out, "[T]he possibilities are staggering. $10,000 invested in Cisco Systems in 1990 would be worth over $1 million today."
The book's aim is to dig out a system for discovering Cisco (Nasdaq: CSCO) and other gorillas early on. The suggestion is then that an investor should hold them through their gorilla lifetime and sell them just as they're ready to fall from the vine, overripe and soft (a quality the book aims to identify as well). Tom Kippola, one of the three authors, began using the system in 1990 (although he didn't get around to buying Cisco until 1994).
The results from this "early beta test" of the Gorilla Game were to take "less than $100,000 and turn it into the better part of $1 million in seven years." That return sounds very impressive, and it is. We can't, however, verify the claims without seeing a log of the investments. And the phrase "the better part of $1 million" is unclear to me.
Additionally, while I find the gorilla principles compelling, I didn't find the overall philosophy of investment consistent with the Cash-King philosophy. The method outlined by the book involves a lot of work, more work than is required with the Cash-King style of investing. The authors claim that efforts should encompass "a minimum of two, perhaps three hours a week on average for a serious amateur" -- with considerably more time consumed by a semi-pro, professional, or "high-tech insider."
By definition, we're amateur investors. We're just Fools. And high-tech is only one part of a Cash-King portfolio. My confession tonight is that I don't want to spend a full three hours a week on just a portion of my portfolio. There's too much going on for me to set aside that much time.
In addition, my read suggests that three hours a week may be optimistically low. This looks like a good deal of work to me. Of course, for those interested, the potential reward may very well be worth it. I'm told that Mike Buckley hosts a great folder for Gorilla hunters on AOL and there's also a Gorilla folder on the Fool's website. For those of you with the time and inclination, I wish you good hunting as you play the gorilla game. I only ask that you remember me fondly at Christmas if you're successful at it.
That said, let me make it very clear that I found the underlying philosophy compelling enough to read the book. For those of us on Cash-Kindom, there is plenty of value that The Gorilla Game has to offer. I'll try to present the high points for Cash-King investors over the next few days, but that shouldn't be taken as an excuse to skip reading the book. In fact, if you order through Amazon or one of the other online booksellers, your copy should arrive just about the time that you have finished reading this introductory series.
We'll start today by examining why some companies become gorillas, and others do not.
According to the authors, high-tech products are built around architectures, which are the way the parts of a system work together. High-tech markets in particular have a need to standardize around these architectures. Sometimes these architectures are proprietary, meaning they are under the control of a single company. Other times the architectures are public and all companies are free to use them. Any company with control of a proprietary architecture has the beginnings of gorilla power. However, most companies with proprietary (not open) architectures will not achieve true gorilla status.
When are architectures open or closed?
When architectures are closed, their secrets are closely guarded. With closed architectures, there are normally few, if any, companies that are licensed to develop products using that proprietary architecture. Nintendo, Polaroid, and Apple are good examples of companies with closed architectures.
Open architectures, on the other hand, are published, and any vendor that chooses to can easily get authority to build products to the architecture's specifications. Open architectures are usually more difficult to support, but they are potentially much more valuable. Some examples of successful companies, all of them gorillas, with open architectures are Intel, Cisco, and Microsoft. The authors of the book describer C-K stock Microsoft as "the biggest and baddest gorilla in the jungle."
The other key component to gorilla power is high switching costs. Ideally, once the work has been done to adopt the gorilla's architecture, the market should find it unthinkable to move to something else. This completes the formula for true gorilla power, which is open proprietary architecture with high switching costs.
These gorilla advantages feed on each other. For example:
* With open architectures there is a far greater potential for products that can be tied to the gorilla's proprietary standard.
* The gorilla has the option to keep the high-margin work for itself, and to pass the lower-margin work on to other companies.
* As other companies that use the gorilla's product increase their sales, the gorilla increases its sales as well.
That's enough on gorillas for today. I'll be back tomorrow for our regular Q&A. Then on Thursday we'll come back to The Gorilla Game, and on Thursday and Friday we'll examine how the high-tech market produces gorillas and why the authors say:
* that gorillas tend to be undervalued for long periods of time;
* that some great high-tech industries, like PC manufacturing can't produce gorillas;
* what happens when gorillas finally die, and
* when you should look to sell a gorilla.
Until then -- vote in the C-K poll before Thursday, and drop by the Cash-King companies folder linked below. Some great work flows through there.
Stock Change Bid ---------------- AXP + 1/16 101.38 CHV +1 13/16 81.25 KO - 5/16 79.00 GPS -1 1/8 58.00 EK - 3/4 67.19 XON +1 1/16 69.56 GM + 1/2 68.88 INTC +2 13/16 69.75 MSFT +3 15/16 89.88 PFE +1 11/16 109.69 TROW + 3/8 33.75
Day Month Year History C-K +0.99% 0.51% 6.30% 6.30% S&P: +0.98% -0.30% 8.62% 8.62% NASDAQ: +2.18% -1.45% 6.06% 6.06% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 22 Pfizer 82.30 109.69 33.28% 2/3/98 24 Microsoft 78.27 89.88 14.83% 2/27/98 27 Coca-Cola 69.11 79.00 14.32% 5/1/98 37 Gap Inc. 51.09 58.00 13.53% 2/6/98 56 T. Rowe Pr 33.67 33.75 0.23% 5/26/98 18 American E 104.07 101.38 -2.59% 2/13/98 22 Intel 84.67 69.75 -17.63% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 69.56 8.13% 3/12/98 20 Eastman Ko 63.15 67.19 6.40% 3/12/98 15 Chevron 83.34 81.25 -2.51% 3/12/98 17 General Mo 72.41 68.88 -4.88% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 22 Pfizer 1810.58 2413.13 $602.55 2/3/98 24 Microsoft 1878.45 2157.00 $278.55 2/27/98 27 Coca-Cola 1865.89 2133.00 $267.11 5/1/98 37 Gap Inc. 1890.33 2146.00 $255.67 2/6/98 56 T. Rowe Pr 1885.70 1890.00 $4.30 5/26/98 18 American E 1873.20 1824.75 -$48.45 2/13/98 22 Intel 1862.83 1534.50 -$328.33 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 1286.70 1391.25 $104.55 3/12/98 20 Eastman Ko 1262.95 1343.75 $80.80 3/12/98 15 Chevron 1250.14 1218.75 -$31.39 3/12/98 17 General Mo 1230.89 1170.88 -$60.02 CASH $2037.63 TOTAL $21260.63 *The year for the S&P and Nasdaq will be as of 02/03/98