Dell vs. the Cash-Kings
by Al Levit

Glendale, CA (Oct. 16, 1998) -- Yesterday, I expanded upon a couple of Rob Landley's earlier great columns about Merchant-Kings. These are companies that make their money distributing products, whereas Cash-Kings make their money by producing them. One of the interesting things that came out of yesterday's discussion was that not all Merchant-Kings have been great investments. In fact, I thought of several Merchant-Kings, and only about 50% of them showed the same historical outperformance as the Cash-Kings we know and love. Fortunately, we have some strong clues about which companies are in this 50%:

  • Warehouse retail stores selling hardware -- Home Depot (NYSE: HD) and Lowe's Co. (NYSE: LOW),
  • PC makers, selling top quality high-margin PCs and specializing in the direct sales model -- Dell Computer (Nasdaq: DELL), and
  • A discount retail outlet named Wal-Mart (NYSE: WMT)

The one question I didn't cover yesterday was whether these high-performing Merchant-Kings belong in a Cash-King portfolio. In one sense, this is an easy question, because we have never maintained that a portfolio should be exclusively devoted to Cash-King stocks (or even Fool Four and Cash-King stocks, since the Fool Four should come first).

Thus, we note in Step 3 that an investor with the time, interest, and stomach (i.e., risk tolerance) might want to progress from a portfolio with Fool Four stocks and Cash-King stocks to a portfolio with Fool Four, Cash-King, and Small Cap stocks. A different path for such an investor might be to expand to Fool Four, Cash-King and Merchant-King stocks. Moreover, there is nothing wrong, per se, with investing in all four types of stocks (Fool Four, Cash-King, Merchant-King, and Small Cap). Still, it may be difficult to keep the total number of stocks in the portfolio down to a manageable number if you try to spread out the styles that broadly.

A more interesting question, however, is whether Merchant-Kings can be SUBSTITUTED for Cash-Kings in a portfolio. In my mind, this is only possible if I can expect everything out of a Merchant-King that I would expect out of a Cash-King. To answer this question then, I'll review what I expect from a Cash-King company:

  • Significant market outperformance
  • Top-flight management
  • Great prospects going forward

To a certain extent, an investor expects the above from any company she purchases. The difference for the Cash-King investor is that she expects all of the above to last at least 10 years!

Now, it's time for the acid test. I'll apply this test to the Merchant-King that I know best, Dell Computer. I have consistently written that Dell is not a Cash-King because of its low margins, and I haven't changed my mind on this. At the same time, I must admit that Dell's virtue grows on me quarter by quarter.

There are many reasons for this, but one reason of particular significance is that I sort my holdings by market value, just like the Cash-King portfolio, and Dell always insists on finding its way to the top of the list! I should also point out that I have invested more in several other Cash-King stocks than I have in Dell -- including such great performers as Microsoft (Nasdaq: MSFT) and Cisco (Nasdaq: CSCO) -- but Dell still tops the list, and by quite a bit! Something must be awfully great about this particular Merchant-King.

Clearly, I would have been better off today if I had bought Dell exclusively instead of spreading my investments between Microsoft, Cisco, and Dell (not that I'm complaining). But how about going forward? For my next investment dollars, is the better place Dell or one of the Cash-Kings?

I look at it this way. I believe that Dell is continuing to grow like a weed for two reasons:

  • There are still more places to expand its business (most of them overseas), and
  • There is still more domestic market share to take from its many PC competitors

As long as this continues, there is every indication that Dell's outstanding performance will also stay on track. How long this can continue is naturally the big question. At this point, it appears that the answer is very probably in years, though whether it will last a full decade is anybody's guess.

What will happen when Dell moves out of its current hypergrowth stage? My guesses are:

  • The company will continue as strong as ever,
  • The stock price will sink like a stone (I call this "the hit"), as investors quickly adjust the prices they will pay to the new growth expectations, and
  • The stock price, once adjusted, will rise again at roughly the rate that earnings are expected to grow (reflecting growth in profits from both earnings on increased sales through existing channels and new channels that can be opened up each year).

If the above scenario is right, then after the hit, Dell may not perform as well as the Cash-Kings. Now, I need to be clear here that the hit I'm referring to will be strictly related to Dell. I realize that over the last couple of weeks, Dell's stock price has dropped significantly along with the rest of the Nasdaq, but that shouldn't be a concern for a long-term investor. The real concern is that at some point Dell's stock price may stop performing when the rest of the market is doing just fine.

But then again, the key word in that last sentence is MAY. After all, Dell has performed better than the Cash-Kings for quite a while. Moreover, Dell has continually surprised to the upside, and it may do so again by holding its own against the best of the Cash-Kings even after moving out of hypergrowth.

Whether or not it makes sense to invest in Dell as a substitute for a Cash-King depends on when (or, really, if) you think the hit will come, and what you think Dell's performance will be like after it. If you think the hit will come late enough (or not at all), and/or Dell will perform almost as well after the hit as before, then your outlook for the stock's 10-year performance should be on par with the Cash-Kings. More importantly, you'll be able to treat this Merchant-King like any of your other Cash-Kings.

On the other hand, you don't need to treat Dell as a Cash-King. This gives you a couple more options:

  • You may want to try to sell Dell before the hit (I don't recommend this, it's a lot like timing the market!), or
  • You may want to sell right after the hit because you feel performance will not be on par with the Cash-Kings after that.

Finally, the same logic can be applied to the other Merchant-Kings. Let us know how you feel about them in the Cash-King companies folder. In particular, have any of the other high-performing Merchant-Kings already taken their hits? If so, then are they already performing on par with the Cash-Kings after the hit?

Let us know, and Fool on.


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Cash-King Companies Folder

10/16/98 Close

Stock  Change    Bid 
 AXP   +  3/8   88.88 
 CHV   +1 3/16  86.94 
 CSCO  -1 9/16  55.38 
 KO    +1 9/16  69.06 
 GPS   +  9/16  61.06 
 EK      ---    74.56 
 XON   +  5/16  75.94 
 GM    +2 15/16 59.00 
 INTC  -  13/16 83.75 
 MSFT  -  3/8  105.06 
 PFE   +1       98.50 
 SGP   -1 1/2   97.88 
 TROW  +1 5/16  32.00 
                  Day     Month   Year    History 
         C-K      +0.54%   2.00%   7.74%   7.74% 
         S&P:     +0.85%   3.88%   5.01%   5.01% 
         NASDAQ:  +0.62%  -4.30%  -2.72%  -2.72% 
 Cash-King Stocks 
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    105.06    34.23% 
     2/3/98   22 Pfizer        82.30     98.50    19.69% 
     5/1/98   37 Gap Inc.      51.09     61.06    19.52% 
    8/21/98   22 Schering-P    95.99     97.88     1.97% 
    2/27/98   27 Coca-Cola     69.11     69.06    -0.06% 
    2/13/98   22 Intel         84.67     83.75    -1.09% 
    6/23/98 34.5 Cisco Syst    57.56     55.38    -3.80% 
     2/6/98   56 T. Rowe Pr    33.67     32.00    -4.97% 
    5/26/98   18 AmExpress    104.07     88.88   -14.60% 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     74.56    18.08% 
    3/12/98   20 Exxon         64.34     75.94    18.03% 
    3/12/98   15 Chevron       83.34     86.94     4.31% 
    3/12/98   17 General Mo    72.41     59.00   -18.51% 
 Cash-King Stocks 
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2521.50   $643.05 
     5/1/98   37 Gap Inc.    1890.33   2259.31   $368.98 
     2/3/98   22 Pfizer      1810.58   2167.00   $356.42 
    8/21/98   22 Schering-P   2111.7   2153.25    $41.55 
    2/27/98   27 Coca-Cola   1865.89   1864.69    -$1.20 
    2/13/98   22 Intel       1862.83   1842.50   -$20.33 
    6/23/98 34.5 Cisco Syst  1985.95   1910.44   -$75.51 
     2/6/98   56 T. Rowe Pr  1885.70   1792.00   -$93.70 
    5/26/98   18 AmExpress   1873.20   1599.75  -$273.45 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Exxon       1286.70   1518.75   $232.05 
    3/12/98   20 Eastman Ko  1262.95   1491.25   $228.30 
    3/12/98   15 Chevron     1250.14   1304.06    $53.92 
    3/12/98   17 General Mo  1230.89   1003.00  -$227.89 
                               CASH     $48.07 
                              TOTAL  $23475.57 
 *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