Fool Portfolio Report
Tuesday, December 10, 1996
by Tom Gardner
(TomGardner)
ALEXANDRIA, VA., December 10, 1996 -- A lot of people decided to sell Fool Portfolio stocks, and by market close, our holdings were looking a bit like bruised grapes under colossal feet. Our savings account gave away 2.29% today versus the more bearable 0.30% drop for the market. What wrought this fall? Scan the numbers. Our three largest holdings -- Iomega, America Online, and 3Com -- all closed markedly lower.
AOL took the fiercest beating, falling 6.5%, or $2 1/2, to $36. Two of the Company's competitors/cooperators launched meaningful announcements. Netscape (NASDAQ:NSCP) continued its busy pilgrimage, inking distribution partnerships with the five Baby Bells. And Microsoft announced the upgrade and re-launch of its MSN Web network.
At $36 a ticket, America Online is now trading exactly where it did on the first of this year. Given that the S&P 500 has risen 22% during that time, we're disappointed. Given that AOL has grown its capitalization from $420 million in 1993 to $3.6 billion three years later, many earlier-entry and longer-term shareholders are naturally not frustrated by the slowdown.
Take a look at the business growth from '93 to '96, and imagine what hustle and bustle must've been going on at America Online HQ over the past 36 months:
1993 1996 Sales $40 mil. $1.1 bil. Earnings $4 mil. $30 mil. Margins 10.0% 2.7% Employees 236 5,830But none can afford to much care about where this company has been. The great challenge of the investor is to determine where the outfit is headed, whether its value will increase more rapidly than that of the S&P 500 over the next five years, and how to accurately measure and set expectations at each quarterly stop.
I continue to maintain that it would be a considerable error on AOL's part were they to attempt to vertically integrate the Digital World. In non-financial lingo, if they seek to own the network, control the software platform, develop all the system tools, design every site, and brand-and-own all of the content, they will be making a damaging business oversimplification.
The new medium is too open; its builders, programmers, designers and creators are too ambitious; its users too demanding. Vertical integration in this environment will lead to the creation of unnecessary competition and to a continued reduction in profit margins going forward. This is a basic, common-sense principle in an emerging, rapidly-evolving marketplace.
What controls, withers. What supports, prospers.
The common sense of it is supremely evident when we look at the development and performance of another Fool Portfolio stock, 3Com Corporation (NASDAQ:COMS).
The Company does not own a search engine; they are not trying to provide a ratings system for the Internet; they aren't developing content in fifteen different categories; they don't manage a network; they aren't programming a new interface. Instead, they concentrate on their tightly-integrated variety of networking products and the support of those who use it.
Take a look at their performance over the past three years:
1993 1996 Sales $617 mil. $2.3 bil. Earnings $39 mil. $178 mil. Margins 6.3% 7.6% Employees 1,971 5,190Interestingly, their top-line growth and their growth in employees is considerably more moderate than that of America Online. However, their profits have grown far more rapidly and defensibly. Profit margins have improved and the stock has been a monster each of the last four years.
From 1993 to today, 3Com's capitalization has grown from $1 billion to $13.7 billion. Over the past twelve months, COMS has added $6.8 billion of value to its shareholders, while America Online has not added a dollar. Although a short-term phenomenon, I think the comparison illustrates the value of staying on target, of committing to customer satisfaction, of buckling down on a growing but core market, and of again rigidly staying on target.
Gleeful clients, ambitious partners, enthused employees, profit-seeking shareholders and a focused management team have served 3Com well. My own belief is that America Online ought aggressively try to duplicate that model. There is plenty of room for growth on the Internet. There is far too much room for vertical integration, though.
Drawing boundaries, abiding them, and aiming for maximal profitability within that horizontal is what made winners during the PC revolution (eg. Intel-to-Dell-to-Microsoft). I don't think the principles of business have altered significantly enough in the last decade to warrant much change from that modeling.
Elsewhere in The Fool Portfolio, Iomega gave back $7/8, rounding out the day's demise. We look forward to coverage of Iomega's holiday product presentation in our stock folder on AOL. This next month is absolutely crucial for Iomega, as no other four-week period will offer the Company as much exposure, as much sales potential, and as much a demand for customer service as these. Should be a doozy.
I'd like to close tonight without even discussing our one winner, 3M -- up $1 on the day, and up 28.5% for us since our purchase of 't last August. No, I'd like to finish instead by racing into a non-sequitur, sans segue, and discussing Chairman Greenspan's recent comments for just a moment.
Some have bemoaned his speech, asking aloud whether his responsibilities extend to market forecaster. Others have wondered aloud whether his insinuation mightn't be right. Anyone with a significant portion of their portfolio weighted in short positions is probably ecstatic, and craving more chatter. Not that it matters, but I guess that I'm essentially neutral.
I believe the point that he should've made, however, has less to do with investing in stocks than investing in fatal vehicles. For example, our state lottery systems introduce bear markets every day to those who can least afford it. For each dollar invested, the state pays back fifty cents to the people. That's a 50% average loss on each ticket. That's an uninterrupted, unchallenged, unhealthy bear market.
Perhaps it would've been inappropriate for Mr. Greenspan to remark on this last Thursday night to the American Enterprise Institute. But it would've reminded us that while stocks hold some short- and intermediate-term risks, they don't BEAR down on us with 50% losses each ticket, each day.
Better for more Americans to push their savings into stocks and affect a bit of market volatility over the next decade than to allow savings accounts to deteriorate in the name of the blessed state.
Stay Foolish out there!
Tom Gardner
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