My Dumbest Investment?

by Al Levit

GLENDALE, CA (Sept. 10, 1998) -- The Motley Fool has a whole message board dedicated to the topic of "My Dumbest Investment," and we don't get much cause to refer to it here in the Cash-King portfolio. Unfortunately, I've found a decent reason to break that trend today. Even worse is that I've had some help from co-manager Phil Weiss along the way. There are some things we can all learn from my misfortune, and I believe it can benefit from more discussion, so I'm going to share the story with you now.

This is a tale of three companies. The first is Dell Computer (Nasdaq: DELL), which is an outstanding maker of personal computers. I've owned Dell since May of last year, and it's my single best-performing investment. The other company is Tellabs (Nasdaq: TLAB), which makes equipment used by telephone companies. I have owned a small amount of Tellabs for quite some time, although far less than the amount of Dell I purchased in May. Moreover, Tellabs hasn't performed nearly as well as Dell. However, this is not a criticism, Tellabs has been a strong performer in its own right over the years.

The third company is Ciena (Nasdaq: CIEN). Its story comes in down the road.

Both Tellabs and Dell were finalists in our contest in June to pick the eighth Cash-King stock. As many of you know, that contest was won by Cisco Systems (Nasdaq: CSCO). In the process of reviewing the finalists, I came to the following conclusions, which Phil shared:

* Cisco was the strongest pick of the five finalists,
* Dell wasn't really a Cash-King because the gross margins were too low (once again, this does not mean that Dell isn't a truly outstanding company. I strongly believe it is.)
* Tellabs had a lot of potential to be a Cash-King (we would call a company like this a Cash-Prince). The biggest hurdle in Tellabs' path was a flow ratio of 1.6 (we like to see the flow ratio of 1.25 or less).

The most promising aspect for Tellabs was its upcoming merger with Ciena. When the merger was announced, it was described by most, including the Fool's TMF Boring, as "a merger made in heaven." However, in the last month or so a few things have happened with Ciena that have resulted in the use of less flattering terms. More on that later.

At any rate, I had purchased Dell three times during 1997 and once again in May 1998. The last purchase was made at a much higher price than any of those in 1997, and I was actually down about 10% on those shares a month later when I learned of Tellabs' Cash-King potential. I also felt that I'd probably made a mistake in buying more Dell in May, because after the purchase 20% of my entire portfolio was in Dell stock. In my mind, this presented a perfect opportunity to sell the Dell shares I bought in May 1998 (15% of my entire holdings) and invest the proceeds in Tellabs, which more than doubled my holdings in Tellabs.

This was one of those things that seemed like a good idea at the time. By the way, I've mentioned that Phil Weiss and I conversed frequently about Tellabs, and in fact he and I bought shares at about the same time. On the other hand, selling Dell, which you will see is the dumber part of this dumbest investment, is strictly my own doing.

At the time that I did this exchange Dell was selling for about $40 1/2 (split-adjusted) and Tellabs was selling for about $64. Time marches on. A few weeks ago Dell put out a truly outstanding earnings release, even for Dell (which is really saying something). Not only did it show its traditional jaw-dropping execution numbers, such as a return on invested capital of 217%, but its earnings were 4 cents ahead of First Call consensus expectations, and it announced that it was now in the No. 2 position in the computer systems industry.

To top it off, in the midst of the Asian flu, Dell noted that in the Asia-Pacific region including Japan while "the computer systems industry declined 9 percent in unit shipments. [Dell] Revenue increased 34 percent." The stock dutifully went up 10% as a result. On the one hand, this was a painful reminder of why the Fools say, "Don't sell your winners." On the other hand, the 85% of my holdings that I didn't sell kept me from feeling too badly!

Of course, Tellabs had its own great earnings release at about the same time, when it beat expectations by nine cents a share. The stock didn't perform quite as well as Dell, but I wasn't complaining a bit. I still consider Tellabs to be a Cash-Prince, with the potential to enter into my "core" Cash-King portfolio someday. That means a lot, and I'm willing to sacrifice some performance for that. Basically, everything was hunky-dory until some Ciena problems came to light.

A few weeks ago, some sales to AT&T that Ciena had been counting on fell through. For various reasons, Lucent Technologies (NYSE: LU) got the business instead. As a result, the price of Ciena stock collapsed, and the price of Tellabs stock dropped fairly hard as well. At the present time, the situation looks like this:

* The merger of Tellabs and Ciena should still go through, but Tellabs is paying less.

* Even though Tellabs is paying less, 1999 EPS for the combined company will probably be a little less than originally projected.

* The Tellabs/Ciena combination certainly does not appear to be the sure thing now that it looked to be a couple of months ago. Lucent is certainly making a strong bid to capture the same market that Ciena is going after. On the other hand, it's far from clear to me that Tellabs/Ciena has lost this war. Cisco is also looking to be a strong player in this market.

I feel it's important strategically to be invested in the telecommunications market for years to come, since the Internet will be run on telecommunications lines. To a certain extent, investing in Cisco fills this need, and Cisco is my second biggest holding (next to Dell). I'm still hoping that Tellabs will be a core holding for years to come, but I have to allow for the fact that Lucent may well come out the winner in this battle. Thus, I've borrowed an idea from "gorilla game" theory, and I've bought Lucent stock equal to my Tellabs stock in an attempt to "buy the market" and own the winning gorilla when one emerges. Time will tell whether this strategy proves successful.

In the meantime, I ask for your thoughts on the Cash-King strategy folder. The facts are these:

* When I sold DELL, the price was $40.50,
* When I bought TLAB the price was $64.50,
* The corresponding prices now are DELL $54.75, TLAB $44.

Was this merely misfortune? After all, the loss of the AT&T contracts by Ciena seemed to take everyone by surprise. Should I have known better? After all, Fools let their winners run, right? What about my "gorilla-game" strategy? At what point do I give up on Tellabs altogether?

I look forward to hearing from you, and tomorrow we'll have thoughts from Phil.


Cash-King Strategy Folder
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09/10/98 Close

Stock  Change    Bid 
 AXP   -7 1/16  69.63 
 CHV   -  1/4   80.00 
 CSCO  -2 3/8   88.44 
 KO    -1 3/4   60.88 
 GPS   +  7/8   59.38 
 EK    -2 5/8   79.00 
 XON   +  15/16 69.69 
 GM    -1 15/16 55.63 
 INTC  -2 3/16  79.06 
 MSFT  -1 1/2   100.75 
 PFE   -3 13/16 94.38 
 SGP   -3 3/4   90.50 
 TROW  -1 1/4   26.75 
              Day      Month       Year       History 
 C-K         (2.60%)    2.54%      1.05%       1.05%  
 S&P 500     (2.58%)    2.37%     (2.56%)     (2.56%) 
 Nasdaq      (2.41%)    5.74%     (4.86%)     (4.86%) 
 Cash-King Stocks 
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    100.75    28.72% 
     5/1/98   37 Gap Inc.      51.09     59.38    16.22% 
     2/3/98   22 Pfizer        82.30     94.38    14.67% 
    6/23/98   23 Cisco Syst    86.35     88.44     2.42% 
    8/21/98   22 Schering P    95.99     90.50    -5.72% 
    2/13/98   22 Intel         84.67     79.06    -6.63% 
    2/27/98   27 Coca-Cola     69.11     60.88   -11.91% 
     2/6/98   56 T. Rowe Pr    33.67     26.75   -20.56% 
    5/26/98   18 AmExpress    104.07     69.63   -33.10% 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     79.00    25.10% 
    3/12/98   20 Exxon         64.34     69.69     8.32% 
    3/12/98   15 Chevron       83.34     80.00    -4.01% 
    3/12/98   17 General Mo    72.41     55.63   -23.18% 
 Cash-King Stocks 
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2418.00   $539.55 
     5/1/98   37 Gap Inc.    1890.33   2196.88   $306.55 
     2/3/98   22 Pfizer      1810.58   2076.25   $265.67 
    6/23/98   23 Cisco Syst  1985.95   2034.06    $48.11 
    8/21/98   22 Schering P   2111.7   1991.00  -$120.70 
    2/13/98   22 Intel       1862.83   1739.38  -$123.46 
    2/27/98   27 Coca-Cola   1865.89   1643.63  -$222.27 
     2/6/98   56 T. Rowe Pr  1885.70   1498.00  -$387.70 
    5/26/98   18 AmExpress   1873.20   1253.25  -$619.95 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1580.00   $317.05 
    3/12/98   20 Exxon       1286.70   1393.75   $107.05 
    3/12/98   15 Chevron     1250.14   1200.00   -$50.14 
    3/12/98   17 General Mo  1230.89    945.63  -$285.27 
                               CASH     $48.07 
                              TOTAL  $22017.88 
 *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