Blood in the Streets
by Tom Gardner
Alexandria, VA (Sept. 2, 1998) -- "Blood in the streets. Blood in the streets!"
In the heat of a market downturn, when investment accounts have been quartered, it can be difficult to keep our heads about us and stick to the business of valuing companies. After all, in heavy downdrafts, the rubber ducky gets thrown out with the baby and the bath water. The lines between excellence and mediocrity are smeared, like a thick red stroke of fingerpaint. Certain financial pundits are prone to yelling, "Sell, sell, sell!" and flipping lint in the air.
Together, we suffer through an indiscriminate discrimination against all equities -- which, to our Foolish sensibility, is only slightly less impractical than indiscriminate allegiance to all equities. Though we Fools must occasionally suffer the slings and arrows of outrageous ignorance about our investment approach, we must persist... press forward again and again, and never stop pressing forward. With this in mind, I'd like to put off our discussion of Microsoft's business for a day, and make room for a simple restatement of our Cash-King approach to the market. Here are a few of our beliefs:
a. We believe in holding onto common stocks like houses, since in the U.S. this century, stocks have been the best place to have your money over ten-year periods.
b. We believe that, over the long term, a stock price reflects the quality of its business more than the psychology of investors.
c. We believe in three simple classifications for public businesses: 1) Excellent, 2) Ordinary, 3) Pitiful.
d. Because we hold for long periods, we'd prefer to pay too much for an excellent business than to get a discount on an ordinary or pitiful company.
e. We understand and welcome that folks are going to disagree with some of our assumptions. We have, however, established an accounting standard here that no other financial organization matches: a public representation of all commission fees and tax costs, a commitment to announcing all trades in advance of making them, a public record of our performance every market day of the year, an historical record of all transactions, and a message board structure that invites (and is home to) opinions from around the world.
Imagine for a second what would happen if the same level of accountability and open dialogue was engaged in by brokerage firms, financial advisors and consultants, and mutual fund and money managers. Imagine if the mainstream media suggested that they should. After all, has a major media organization ever done a careful examination of Wall Street business practices? (Smiling) Huh. Hmm. Hmph.
In the spirit of public accountability, insufferable pride, and as a reflection of our love affair with not falling for substandard businesses, I'd like to refer you today back to the Cash-King column inked on August 27, 1998 (Nine West's Stumble).
My parents would advise that I let my actions speak for themselves. But after spending twenty minutes on the phone with a New York Times reporter during yesterday's media craze, a reporter who seemed convinced that the Internet is harmful to people looking for financial help, I cannot contain myself. (Author's repeat: Has a major media organization ever done a careful examination of Wall Street business practices? (Smiling) Huh. Hmm. Hmph.)
And so, let's look back at the Cash-King report on Nine West and consider what's happened since. On August 27th, we walked together through the shoe-sellers' financial statements -- noting that their income statement looked strong, with sales on the rise and margins holding steady. For those only following Nine West's earnings numbers, stacking them up against Wall Street estimates, the stock's fall from $52 to $19 was inexplicable. Together, we dug a little deeper.
Over on the balance sheet, we found accounts receivable on the rise, indicating that the company had to sign less favorable deals with its distributors ("Pay us a little later, that's okay."). More worrisome, inventory -- already at very high levels -- was also climbing. The company's Flow Ratio, our most important metric, had risen from 1.97 in 1996, to 3.03 to 1997, to 3.17 in fiscal 1998, to 4.30 in the first quarter of 1999 -- a very bad sign.
In fact, on August 28th, with Nine West carrying a Flow Ratio of 4.30 and a stock priced at $18 1/4 per share, the Cash-King column included the following:
A Flow Ratio of 4.30 positions the company on foot heading South on Route 95 North.
Now, less than a week later, Nine West today forecast lower than expected results for the remainder of fiscal 1999. On a flat day for the market, its stock closed down $5, to $11 per share.
The purpose of this revisit is not to suggest that, within a week, we expect our opinions to be confirmed in the public markets! Nor is it to imply that your Cash-King managers will always be right in our analysis. The purpose of it is to cite another example where our simple tool for measuring product and cash flow (The Flow Ratio) and our further explanation for evaluating businesses (11 Steps to Cash-King Investing) uncovered a company we would not want to own.
And is this stuff complex? No. Uncle Mycroft, one of our favorite contributors to the Web boards, is in the habit of reminding us that in finance what we can't teach to everyone isn't worth teaching. Simplicity is truth, and truth is beauty. If you have any questions about any aspects of the Cash-King approach to saving and investing, the allocation of the Cash-King portfolio, or the Cash-King's tools for business evaluation, please post them in our Cash-King Strategy folder.
I'll close by restating a few of our basic principles:
Yes, we favor common stocks for long-term investing. No, we don't buy indiscriminately. Yes, we plan to remain fully invested through good markets and bad. No, we wouldn't commit to holding businesses that showed a continual and dramatic decline in operations. Yes, we believe that evidence of underlying financial strength shows up on the balance sheet. And yes, we are Fools.
Tom Gardner, Fool
Stock Change Bid AXP +1 3/4 83.75 CHV -1 5/8 74.00 CSCO +1 5/8 91.63 KO -3 7/8 64.25 GPS -1 1/2 48.00 EK +2 11/16 82.63 XON -2 1/4 64.13 GM + 1/16 59.06 INTC -1 1/8 74.88 MSFT - 11/16 100.56 PFE +3 9/16 100.06 SGP +1 9/16 93.19 TROW + 13/16 30.81
Day Month Year History C-K 0.05% 3.67% 2.16% 2.16% S&P 500 (0.37%) 3.45% (1.54%) (1.54%) Nasdaq 1.13% 6.25% (4.41%) (4.41%) Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 100.56 28.48% 2/3/98 22 Pfizer 82.30 100.06 21.58% 6/23/98 23 Cisco Syst 86.35 91.63 6.11% 8/21/98 22 Schering P 95.99 93.19 -2.92% 5/1/98 37 Gap Inc. 51.09 48.00 -6.05% 2/27/98 27 Coca-Cola 69.11 64.25 -7.03% 2/6/98 56 T. Rowe Pr 33.67 30.81 -8.50% 2/13/98 22 Intel 84.67 74.88 -11.57% 5/26/98 18 AmExpress 104.07 83.75 -19.52% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 82.63 30.84% 3/12/98 20 Exxon 64.34 64.13 -0.33% 3/12/98 15 Chevron 83.34 74.00 -11.21% 3/12/98 17 General Mo 72.41 59.06 -18.43% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 2413.50 $535.05 2/3/98 22 Pfizer 1810.58 2201.38 $390.80 6/23/98 23 Cisco Syst 1985.95 2107.38 $121.43 8/21/98 22 Schering P 2111.7 2050.13 -$61.57 5/1/98 37 Gap Inc. 1890.33 1776.00 -$114.33 2/27/98 27 Coca-Cola 1865.89 1734.75 -$131.14 2/6/98 56 T. Rowe Pr 1885.70 1725.50 -$160.20 2/13/98 22 Intel 1862.83 1647.25 -$215.58 5/26/98 18 AmExpress 1873.20 1507.50 -$365.70 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1652.50 $389.55 3/12/98 20 Exxon 1286.70 1282.50 -$4.20 3/12/98 15 Chevron 1250.14 1110.00 -$140.14 3/12/98 17 General Mo 1230.89 1004.06 -$226.83 CASH $48.07 TOTAL $22260.51 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio for future investment. This will be reflected
in the numbers as soon as possible.
*The year for the S&P and Nasdaq will be as of 02/03/98