by Al Levit
Glendale, CA (Oct. 13, 1998) -- We make a big point in the Cash-King portfolio about not worrying over stock prices when we buy shares of superior companies, especially when we're buying the stock of the company for the first time. We confess that we're much more concerned with the quality of the business than we are with the market's temporary valuation of its stock. We'd rather buy a great company for a little too much money than a house-of-cards on the cheap. That's all summed up in Step 7 when we say that for us Quality can be 100 times more important than Valuation when picking a Cash-King company.
That's our QuaVa Ratio -- quality equals one hundred times valuation.
Now, I believe in QuaVa as much as anyone, but I must admit that I've always been a little reticent about thinking that valuation could play as little as 1/100th of the role in deciding what to buy. But now that's changing a bit. In recent weeks, I've been exposed to a few things that have made me realize how dangerous it can be to overemphasize valuation in making a Cash-King purchase decision, and I'm going to use today's column to share them with you.
First of all, I recently ran across an article in the October issue of SmartMoney that peaked my interest. The article was about a reader who had been waiting to "get in" on several dream stocks, but had refrained because the prices were too high in relation to the current or projected earnings. However, the article went on to say, with the recent downturn in the market it was possible that these dream stocks would finally come into reach and the patient reader could finally, perhaps, buy without anxiety.
Just to make life easy, the article supplied not only the names of the "dream stocks," but the "target price" where the author felt that these stocks could actually be purchased. Interestingly enough, I happened to look through the ten dream stocks on the evening of October 1, after the Dow Jones had dropped 450 points over two successive days. The market was near its low point for the year then, although most of the "dream stocks" were well above their lows for the year. The article was written back in late August, and so here I share their price quoted in SmartMoney, their price on October 1st, and the target price set by the investor.
Here's the list:
8/31 10/1 Smart Money Company Price Price Target Price AOL (NYSE: AOL) 81.94 99.25 75.00 Cisco (Nasdaq: CSCO) 54.57 57.25 46.00 Coca-Cola (NYSE: KO) 65.13 56.50 40.00 DELL (Nasdaq: Dell) 50.00 61.56 33.00 GE (NYSE: GE) 80.00 75.25 50.00 Intel (Nasdaq: INTC) 71.19 83.41 65.00 Microsoft (Nasdaq: MSFT) 95.94 104.06 64.00 Pfizer (NYSE: PFE) 93.00 99.50 46.00 Wal-Mart (NYSE:WMT) 59.00 53.00 34.00 Walt Disney (NYSE: DIS) 27.44 24.875 22.00
A couple of things quickly jumped out at me:
- I have no quarrel with the term "dream stocks" to describe these ten companies.
- Disney may well hit its target price, but it is also one of the weaker businesses in the group today -- perhaps the weakest.
- There's a pretty good chance that none of the other companies' stocks will ever drop to the target price.
That's the big danger of worrying about valuation with high-quality growth companies. If you use traditional valuation metrics, like the P/E ratio, you may wind up never buying. That tool won't tell you anything about the quality of the earnings -- the levels of inventory, the load of uncollected bills, the amount of long-term debt -- and so, using the P/E, you may well buy what looks cheap, when what looks expensive is a great value.
To be fair, I need to mention the danger that comes from an immediate purchase. I feel particularly qualified to write about this, because it happened to me very recently. About eight weeks ago, I had some extra funds to add to my family's portfolio, and I noticed that Coca-Cola only made up about 3% of my total holdings. This didn't seem like enough to me, so I bought more Coke at the market price of $79.50. Today the stock has just battled its way back into the mid-$60s. I would clearly have been better off waiting a few weeks.
The question is -- could I have known that the drop was coming, how much work would it have taken for me to figure it out, and do I want to spend my days laboring in that way? For me, the answer has been no. As a long-term investor, I'm not going to fret over not getting the best price. If I can find businesses that I believe will excel over the next 10-20 years, I'll benefit so much from the less work, the lower commissions, and the delayed taxes that missing the best price won't mean much.
In short, a Cash-King investor always has a choice when it's time to purchase shares of a Cash-King company. Either --
1. Pay the market price now and take the chance that she can get a better price later.
2. Don't pay market now, and take the chance that she won't buy the stock at all.
When making this decision, I've found it useful to remember that the penalty for paying too much is normally far less than the penalty for not buying at all. The greatest companies have proved that this century. And it doesn't take but a few great investments to make for a market-walloping portfolio.
That's all for today, until tomorrow...
Al Levit (CashKingAl)
Stock Change Bid AXP -1 1/4 78.50 CHV -1 1/2 83.56 CSCO -1 11/16 50.69 KO +1 3/16 64.00 GPS + 3/8 53.38 EK -11 3/16 72.38 XON +1 3/16 73.00 GM - 7/8 51.06 INTC -1 7/8 83.56 MSFT -3 5/16 96.44 PFE -5 88.00 SGP +1 11/16 97.38 TROW -1 1/4 24.50
Day Month Year History C-K -2.43% -6.39% -1.12% -1.12% S&P: -0.28% -2.18% -1.11% -1.11% NASDAQ: -2.37% -10.89% -9.42% -9.42% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 96.44 23.21% 2/3/98 22 Pfizer 82.30 88.00 6.93% 5/1/98 37 Gap Inc. 51.09 53.38 4.47% 8/21/98 22 Schering-P 95.99 97.38 1.45% 2/13/98 22 Intel 84.67 83.56 -1.31% 2/27/98 27 Coca-Cola 69.11 64.00 -7.39% 6/23/98 34.5 Cisco Syst 57.56 50.69 -11.95% 5/26/98 18 AmExpress 104.07 78.50 -24.57% 2/6/98 56 T. Rowe Pr 33.67 24.50 -27.24% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 72.38 14.61% 3/12/98 20 Exxon 64.34 73.00 13.47% 3/12/98 15 Chevron 83.34 83.56 0.26% 3/12/98 17 General Mo 72.41 51.06 -29.48% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 2314.50 $436.05 2/3/98 22 Pfizer 1810.58 1936.00 $125.42 5/1/98 37 Gap Inc. 1890.33 1974.88 $84.55 8/21/98 22 Schering-P 2111.7 2142.25 $30.55 2/13/98 22 Intel 1862.83 1838.38 -$24.45 2/27/98 27 Coca-Cola 1865.89 1728.00 -$137.89 6/23/98 34.5 Cisco Syst 1985.95 1748.72 -$237.23 5/26/98 18 AmExpress 1873.20 1413.00 -$460.20 2/6/98 56 T. Rowe Pr 1885.70 1372.00 -$513.70 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1447.50 $184.55 3/12/98 20 Exxon 1286.70 1460.00 $173.30 3/12/98 15 Chevron 1250.14 1253.44 $3.30 3/12/98 17 General Mo 1230.89 868.06 -$362.83 CASH $48.07 TOTAL $21544.79 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.
*The year for the S&P and Nasdaq is as of 02/03/98