Fool Portfolio Report
Thursday, August 29, 1996


by David Gardner (MotleyFool)

SAN FRANCISCO, Ca., August 29, 1996 -- Bad day for the market as the S&P 500 dropped 1.12%. Bad day for Fools as our portfolio drooped 1.56% on a $7/8 dip by America Online and a $1/2 retrace by Iomega Corporation.

The only Fool stock to rise today was our fair dermatological products developer, Medicis Pharmaceuticals, which bucked the trend by climbing a mere $1/4. Medicis has been fighting back the summer doldrums every step of the way.

Doing its darnedest to make us a buck today was 3Com, which was up $3/4 to $49 earlier in the day but fell back a full point from there to close at $48. 3Com has been on a mini-rampage over the past week. After cascading as low as $42 1/2, the stock has rebounded 13% amidst in just over a week. At this rate, 3Com will be trading above $27,626.14 We don't expect earnings and the company's stock to grow at a weekly rate of 13%.

But let's not concentrate our motley flow of brain chemicals only on what's going right in The Fool Portfolio. After all, we lost money today, lost to the market today, and have been kicked around in a dead summer market. Let's not pretend otherwise!

Of course, it does bear repeating that at historical returns of 133.7% and 1996 returns of 25.16%, we're licking the Wise. To some, that seems the work of genius. They want a tip over dinner. They wonder what secret formulas roll ongoing through the grey matter of a Fool.

The truth is, as you know, that if you manage your own money, that if you avoid the bad business models and interest conflicts that Wall Street can't, beating the market is as easy as A-B-C and 1-2-3. Veteran Fools will agree that teaching 10-year-olds how to beat the S&P 500 ten years at a time might take all of a week or two.

How do we find the Microsofts, Intels, Gillettes, Coca-Colas, Nikes, Gaps, Ciscos, Johnson & Johnsons, et al.? It doesn't take much---just a few simple lessons about sales and earnings growth, about underlying financial strength, about debt and cashflow, about marketing and brand names---simple ten-box checklist. And the customary few words in favor of buying, holding, avoiding commissions costs and yearly tax bites. Simple.

Sadly, this doesn't mean every investment we make's going to be a winner. You name the premiere American investor, she's had her losers. But I received a great email yesterday, which reminded me that losers can be nearly as educational as winners. It was a simple electronic letter via our Web site from a guy named Marv in New Jersey, which read: "Hey Tom, any idea what went wrong with KLA Instruments?"

Sometimes we get so caught up trying to reason with Wall Street traders that despise The Motley Fool and this free flow of information, learning, and market-whomping investment ideas across the nation and globe that we lose sight of the vast majority of our readers who are simply looking for logic, clarity, wit, and profits in excess of the paltry returns generated by most mutual funds and trading desks.

The residue of Wall Street's broad willingness to put the short-term interests of The Firm or The Fund ahead of The Client sits in Fooldom. Five years, though, and it's gone. Digital interactivity is the ultimate tool of consumer advocacy. The stock market of the early 21st century will bear very little resemblance to what we see today.

Back to Marv's question about KLA. The beauty of it is the plain evidence of his desire to learn from our mistake. What went wrong with KLA Instruments and how we might eliminate the same mistake in years and decades forward and in the financial jottings that we pass on to our children and theirs?

You just have to love it.

Today, I'm going to toss out some ideas about KLA Instruments which since our purchase one year ago has declined 55%, drawing $3200 out of our account. In the next week, I'm going to reason through some other Foolish miscues---from Sonic Solutions to our short of Paychex. Shedding some light on our losers ought help us avoid making the same mistake thrice.

In the case of KLA, I think we purchased a company that looked like a growth outfit but that wasn't and isn't in a state of pure growth. All the financials point to furious, unfettered prosperity---strong cashflows, good earnings numbers, rapid sales growth, underlying financial sturdiness.

It looks like pure growth, talks like it, walks like it, has the scent of it. . . so how come it ain't?

Because semiconductors---and by extension semiconductor equipment manufacturers---are a reliant and unbranded business. They have no exposure. The last-link or end customer---Marv, Tom, Suzanne, and Joe---who buy the computers, televisions, microwaves, automobiles, they have no familiarity and no psychological investment in any one chip company.

There's an exception to every rule, and that exception is Intel, which is extremely well-marketed, which recognized the value of consumer awareness. But 99% of the chip makers are unknown to the average Fool in the street.

Every great business, I think, has to engage the battle for a national and global consciousness. Whether it's Doritos, Nike Air shoes, Chevrons that serve McDonald's burgers, Goodyear tires, et cetera, the challenge is to move down the chain from suppliers, distributors, and corporate partners into the few-pound grapefruits of the consumer.

To protect profit margins, businesses need to be able to call on price hikes. And to hike prices you need customer loyalty. And to gain customer loyalty, you need to give an identity to your brand. Intel showed you their minute chip inside the personal computer at halftime of Lakers-Celtics games. Unbelievable. And, absolutely brilliant.

Certainly there are non-consumer businesses that thrive. But that's where the economic cycles wreak havoc, and where you have to do a better job of timing your entries as an investor. Branded growth is purer, less subject to rising and falling interest rates, since it protects pricing.

Most semiconductor companies aren't close enough to the end consumer. So while the stocks of KLA Instruments and Applied Materials have walloped the market over the past five years, these are cyclical-growth companies. They don't enough control their own destiny.

They are two steps below finished electronic products. One level below are the semiconductor chips. And another level below that sit the semi-equipment makers. They're nearly out of view entirely. They can get bitten in negotiations with chip companies---with talks reduced almost entirely to pricing. And of course they can get burnt in negotiations between chip companies and the product makers, in which they don't participate.


Without marketing ability, without product or service differentiation, I don't think they're pure growth businesses. Thus, the PEG and YPEG are ineffectual. Business and equity performance relies on too many external forces, from the industry to the macro-economic environment.

Compare KLA Instruments and Applied Materials to Nike or Gap or Microsoft, each of which reach all the way down to consumers, dropping their corporate name and logo in every brain. That allows them to control end prices; it allows them to control suppliers; it allows them to control distributors. . .

We mistook pure, end-consumer growth for cyclical growth, hidden as it was from da eyes of our citizenry. As sound as the companies are, their performance is too reliant on external forces. An additional external force is Wall Street's attention. Wall Street is intellectually as consumer-driven as the consumer! The company that can't market its brand name and story in Manhattan or San Francisco office buildings is probably not a pure-growth enterprise.

The lesson with KLAC and AMAT is that they're cyclical growth companies. They can't be PEGged. When they start advertising during the Olympics, things might change. Until then, as with other cyclicals, The Fool ought be concentrating on buying in during the darkest hours and selling when all is a-glitter. We bought with the sun shining most brightly on chips and their equipment makers.

Please follow-up in our KLA Instruments folder with ideas and analyses. Fool on!

Tom Gardner

OTHER FOOLISH STUFF: FOOLBALL and George Runkle's latest Fribble. Need we say more?

Today's Numbers

Day Month Year History FOOL -1.56% 1.90% 25.16% 133.70% S&P 500 -1.12% 2.73% 6.73% 43.41% NASDAQ -0.70% 5.97% 8.83% 58.99% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 14.75 485.56% 8/5/94 680 AmOnline 7.27 30.50 319.37% 1/29/96 375 Medicis Ph 18.57 40.00 115.36% 8/11/95 125 Chevron 50.28 59.38 18.08% 8/12/96 110 Minn M&M 65.68 67.38 2.59% 8/13/96 250 3Com Corp. 46.86 48.00 2.43% 8/12/96 130 AT&T 54.96 52.50 -4.48% 8/12/96 280 Gen'l Moto 51.97 49.38 -5.00% 8/24/95 130 KLA Instrm 44.71 20.00 -55.27% Rec'd # Security Cost Value Change 5/17/95 2010 Iomega Cor 5063.13 29647.50 $24584.37 8/5/94 680 AmOnline 4945.56 20740.00 $15794.44 1/29/96 375 Medicis Ph 6964.99 15000.00 $8035.01 8/11/95 125 Chevron 6285.61 7421.88 $1136.27 8/13/96 250 3Com Corp. 11714.99 12000.00 $285.01 8/12/96 110 Minn M&M 7224.44 7411.25 $186.81 8/12/96 130 AT&T 7144.99 6825.00 -$319.99 8/11/95 280 Gen'l Moto 14552.49 13825.00 -$727.49 8/24/95 130 KLA Instrm 5812.49 2600.00 -$3212.49 CASH $1379.61 TOTAL $116850.24