Coke, The Plough, Mr. Softy
by Tom Gardner (TomG@fool.com)
ALEXANDRIA, VA (Oct. 27, 1998) -- A number of our companies have reported quarterly earnings in the month of October, and I'd like to walk through three of those reports with you today.
The three I've chosen do an admirable job of representing the core of our investment approach here. We like to find the rare business that offers very light, small products (soft-ware, soft-drinks, soft-medicine) that are habitually purchased in markets around the world. We're looking for the fuel in the engine, not the engine. The juice in the bottle, not the bottle. The information in the machine, not the machine.
And what we find among the very best of these companies are high gross margins, high net margins, a heavy load of cash, and a business model that doesn't demand substantial upfront investment (i.e. little or no stock dilution or long-term debt). We end up with companies like Coca-Cola, Schering-Plough, and Microsoft.
Let's take a look at their recent three-month reports. We'll start with The Coca-Cola Co. (NYSE: KO).
Coca-Cola 3rd Quarter 1998 1997 Sales $4.7 bil. $5.0 bil. Gross Margins 69.5% 66.5% Earnings $1.0 bil. $888 mil. Net Margins 21.3% 17.8%
The pluses for Coca-Cola in its third quarter are that earnings rose more than 12%, while gross and net margins climbed as well. Essentially, the company was earning more for its efforts than ever before -- a simple but crucial business principle. Now, the negative for Coke is that its sales line continues to stagnate. Big Red has been forced to drop its prices as it establishes a presence in emerging markets. Your C-K managers are counting on Coke's ability to "regain" pricing power as distant markets take to the bubbly.
Next up, Schering-Plough (NYSE: SGP).
Schering-Plough 3rd Quarter 1998 1997 Sales $2.0 bil. $1.7 bil. Gross Margins 80.2% 80.9% Earnings $432 mil. $353 mil. Net Margins 21.8% 20.7%
The pluses for Schering-Plough are that sales grew more than 17%, earnings grew at an even faster clip of 22%, and net margins inched higher. We're talking higher sales coupled with more earnings per dollar of sales; we're looking at an accelerating car that just hit the turbo-speed button. The negative for The Plough comes via the mild erosion of gross margins, a slight loss in pricing as competing products to Claritin nibble at the edges. But as I've noted in past columns, a margin loss of less than one percent doesn't raise our eyebrows.
On to Microsoft (Nasdaq: MSFT).
Microsoft 1st Quarter1998 1997 Sales $4.0 bil. $3.1 bil. Gross Margins 92.2% 91.9% Earnings $1.5 bil. $952 mil. Net Margins 38.4% 30.4%
The pluses for Microsoft are almost too many to list. Microsoft's first-quarter report represents, to my eye, the strongest financial statement in the history of our stock market. Sales climbed 29%, earnings were up 58% and margins improved across the board. The company's gross and net margins of 92.2% and 38.4% are unequaled by any blue-chip company today. The only reason for the stock not to trade at all-time highs today is related directly to concerns about the Justice Department's ongoing antitrust action. For those interested in my layFool's opinion on what will come of it, take a look at this October 1st article: Microsoft & Standard Oil.
And so, the three Cash-King companies above announced fine numbers. I list them here in the order of their performance for the quarter.
3rd place: Coke's earnings showed the expected signs of greatness, but its pricing power must improve in international markets over the next decade.
2nd place: Schering-Plough posted excellent numbers, without blemish but for the slight weakening in its gross margins.
1st place: And Microsoft again strutted like a champion, topping the greatest collection of financial statements ever released... it's fourth-quarter 1998 report.
But, Fools, don't be misled. All we've laid our eyes on here are the income statements of three gigantic corporations. What if these performances have been bolstered by an increase in borrowings, or loosened policies on collections, or via incentive packages that don't recognize product management (i.e. rising inventories). Without looking at the balance sheet, how can we know these things? The Breakfast Fool this morning threw out a colorful quotation from Burton Malkiel, author of Random Walk Down Wall Street. Malkiel wrote, "A firm's income statement may be likened to a bikini -- what it reveals is interesting but what it conceals is vital."
This is one of the reasons that The Fool pushes so hard on the openness of quarterly conference calls as well as full and simultaneous disclosure from public companies. Since many companies don't release their balance sheets alongside their income statements, it can take up to four weeks to get the information. And if a given company has engaged analysts and institutional investors in a private conference call and pre-announced certain balance-sheet items, guess which way the playing field is tilted.
Thankfully, the world is beginning to recognize that this is a basic violation of securities laws... and one that we're pleased to hear SEC Chairman Arthur Levitt writing and speaking about with greater frequency. This is an article I highly commend: Arthur Levitt Addresses the NYU Center for Law and Business. Once the information is released freely and simultaneously to the entire investing community, we will truly be investors in public markets.
In the meantime, thank heavens we've found companies great enough to manage their balance sheets even more aggressively than their income statements.
Tomorrow, I'll write about Amazon.com and why many have missed its 500% gain over the past year. On Thursday, I'll analyze the worldwide brand, Playboy, and talk about why it hasn't proven to be a Cash-King. And on Friday, I'll be reviewing one of the Gap's lead competitors, Abercrombie & Fitch.
Stock Change Bid AXP -1 3/16 86.94 CHV -1 3/8 79.13 CSCO - 5/8 60.75 KO -1 15/16 67.94 GPS -2 1/8 54.38 EK +1 1/2 74.63 XON -1 5/8 69.56 GM +1 3/16 61.94 INTC -1 5/8 87.31 MSFT -1 5/8 105.44 PFE + 13/16 106.31 SGP + 1/16 100.25 TROW - 1/4 31.94
Day Month Year History C-K -1.04% 1.94% 7.68% 7.68% S&P: -0.65% 4.75% 5.90% 5.90% NASDAQ: -0.43% 1.40% 3.08% 3.08% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 105.44 34.71% 2/3/98 22 Pfizer 82.30 106.31 29.18% 5/1/98 37 Gap Inc. 51.09 54.38 6.43% 6/23/98 34.5 Cisco Syst 57.56 60.75 5.54% 8/21/98 22 Schering-P 95.99 100.25 4.44% 2/13/98 22 Intel 84.67 87.31 3.12% 2/27/98 27 Coca-Cola 69.11 67.94 -1.69% 2/6/98 56 T. Rowe Pr 33.67 31.94 -5.15% 5/26/98 18 AmExpress 104.07 86.94 -16.46% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 74.63 18.18% 3/12/98 20 Exxon 64.34 69.56 8.13% 3/12/98 15 Chevron 83.34 79.13 -5.06% 3/12/98 17 General Mo 72.41 61.94 -14.46% Cash-King Stocks Rec'd # Security In At Value Change 2/3/98 24 Microsoft 1878.45 2530.50 $652.05 2/3/98 22 Pfizer 1810.58 2338.88 $528.30 5/1/98 37 Gap Inc. 1890.33 2011.88 $121.55 6/23/98 34.5 Cisco Syst 1985.95 2095.88 $109.93 8/21/98 22 Schering-P 2111.7 2205.50 $93.80 2/13/98 22 Intel 1862.83 1920.88 $58.05 2/27/98 27 Coca-Cola 1865.89 1834.31 -$31.58 2/6/98 56 T. Rowe Pr 1885.70 1788.50 -$97.20 5/26/98 18 AmExpress 1873.20 1564.88 -$308.33 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1492.50 $229.55 3/12/98 20 Exxon 1286.70 1391.25 $104.55 3/12/98 15 Chevron 1250.14 1186.88 -$63.27 3/12/98 17 General Mo 1230.89 1052.94 -$177.95 CASH $48.07 TOTAL $23462.82 *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
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