Fool Portfolio Report
Wednesday, September 10, 1997
by David Gardner (DavidG@fool.com)


ALEXANDRIA, VA (Sept. 10, 1997) -- The S&P 500 didn't fare too well in market trading Wednesday, getting whacked for a 1.56% hit. The Nasdaq, you ask? Better... down a less damaging 1.02%. The Fool Portfolio lost least of all today. Not a great distinction, when you gave away 0.68% of your money ($1125.19). That said, we teach our fellow Fools always to compare their portfolio returns to the market. Thus, a "less down day" can be as much or more a cause of celebration than a "more up day." The key is the long-term performance.

So let's pop open the Yoohoo chocolate soda and get crazy, hey?

Outperforming the S&P 500 by another percentage point today brought us still closer to reaching the 1997 performance of that revered market index... closest we've been since January, in fact.

Oooo-oooo that smell.... can you smell that smell?

Sniff, sniff. Yes, I think I can smell how close we are to the market right now. Sniff.

Given that in late March we were down 17 percentage points to the S&P 500, being down just 1.49% right now is quite a blessing. And I hope it strikes the casual or new investor as inspirational, because it shows how much your portfolio can come back if you show patience and stick with good stocks. What really counts of course is long-term performance, not last month or even this year. Year after year. It's hard for many financial commentators to remember that, it seems.

Ah, well... it's enough for us to just keep plugging away and trying to make the best decisions we can. Let the observers and commentators say what they will. We're as willing to talk about our mistakes as our successes, which can even sometimes be used against us! Who cares?! We celebrate our mistakes, and that's the case with so many of you. It's what makes the My Dumbest Investment folder is one of the best reads in The Motley Fool.

Indeed, it's probably worth mentioning right now that as a business, our entire focus is really just on serving YOU. I was on Alaska Public Radio last night, and gave out my e-mail address (DavidG@fool.com) on the show. The idea was that if any of the Anchorage listeners were having any problem navigating the Fool, or had questions about personal finance, "Just E-MAIL me!" I said. And the e-mails have been rolling in. Great! I or someone else at Fool HQ always dispatch a response within 24 hours. That's not just a standing offer; it's a permanent offer that goes for anyone who comes to Fooldom. We are here to serve.Questions? E-mail me.

Insofar as we do run such an open business, we're very open to criticisms which we receive all the time on our message boards. The latest round of criticisms regard our new purchase of AMAZON.COM (Nasdaq:AMZN). "How could you possibly buy a company with no earnings?" we read. "Borders [or whoever] will crush them!" Another one reads: "Who would ever buy books from an online store? You can't browse, and there's no cappucino."

Jeff and I have read these messages so frequently in the past 48 hours that we feel it's helpful to respond here (we've already done it on the boards).

First off, as we mentioned in our report, Amazon is not trying to make profits yet. If management had been dumb, it could've turned a profit last quarter by reducing its marketing and technology expenses. But that would've indeed been dumb. At this early stage, customer acquisition is far more important to long-term shareholders than turning a small profit with a smaller clientele. Just as America Online grew sales in huge amounts during the 1990's and only recently began turning a real profit -- and still was a great stock all the way along -- you can see a similar case for Amazon. Yes, profits mean a great deal to Fools. However, if you wait for profits in the dynamic world of Internet investing, you'll often get in on stocks like AOL and Amazon at much, much higher levels.

Second, the notion that the company will be vanquished by "the big boys" who come in and undercut all their prices seems extremely misguided. First of all, there's easily enough business here for everyone to succeed. I'm constantly bewildered by the zero-sum mentality that some investors take. I've written about this in the past. "Microsoft will bury AOL." Really? Wrong... BOTH Microsoft and AOL will benefit from the Internet. "Barnes & Noble will bury Amazon." Really? Wrong. BOTH Barnes & Noble and Amazon.com will benefit from the Internet. If you do view Amazon's bookstore competitors as being behemoths that cannot be competed with, do read this post by Jeff Fischer last night, in which he shows how difficult it is for Amazon's competitors to rework their cost structures:

Subject: BKS, BGP margins
Date: 10 Sep 1997 04:33:56 EDT
From: JeffFischer

In the latest quarters, Barnes & Noble had gross margins of 35% on $617 million in sales, and Borders has gross margins of 24% on $466 million in sales. These margins are in line with gross margins of the past. Amazon's goal of having gross margins above 20% (they're selling product at lower prices) are certainly attainable, and already have been reached in the past. Advertising revenue will be a small percentage of sales, certainly, but gross margins on ad sales for Yahoo! and others are above 90%. It costs very little to sell an ad banner.

Anyway, with strong gross margins at BKS and BGP, why doesn't the money make it to the bottom line in profits? Let's see...

Barnes & Noble had $219 million in gross profit last quarter, but the company spent all of it on sales and administrative expense (the employees for 1,000 locations), on rental expense (for some 1,000 locations), depreciation expense (again, for all those locations), pre-opening expenses (opening yet more locations), and interest expense (as a result of financing all those locations), ending up with another net loss for the quarter. If you eliminate even half of these expenses, you would have over $100 million in net profit, or over 15% net margins. Imagine that for a bookstore!

It's doubtful that Amazon could ever have net margins that high. Heck, we're not even saying that the company will have profits at all, though management stated that by the end of 1998 it could be possible. From the June San Francisco Chronicle:

>>>Amazon, which went public last month, had built deep discounting into its business plan. The company has told analysts that it doesn't expect to turn a profit until late 1998.<<<

That's neither here nor there. We'll see.

But it's obvious why traditional book retailers don't have decent profit margins, or often any. Eliminate many of those costs and book selling doesn't look like a horrible business to consider. As profits drive a business, I wouldn't be surprised to see a few "mega-store" closings in the decades ahead. Giant malls have been closed in the past because better sales locations came along. Businesses run to where the profits are like gazelle to water

in an African drought. If you can be profitable year-round on the Web (a big guess) rather than just one quarter of the year with 1,000 stores, which would you prefer? In which position would you rather be right now? Barnes & Noble with all those stores to tend to, or Amazon with the Internet to harvest?

The opinion on the board is pretty overwhelming -- in favor of the big guys. I find it interesting. Such marginally profitable, "heavy business" giants are so much more attractive than a new potentially very light business?

I can't guess who is right. Nobody knows. It'll be interesting...

And read this one about their balance sheets:

Subject: Re: BKS, BGP Cash
Date: 10 Sep 1997 04:49:54 EDT
From: JeffFischer

Barnes & Noble and Borders are going to crush Amazon using all of their cash.

From the most recent balance sheets, we have:

Cash Long-term debt Barnes & Noble $10 million $290 million Borders $ 4 million $286 million Amazon $56 million 0

But the lesson to take away is that they'll probably all win, and others besides. The notion that one company will put another out of business in a growing market is just weak analysis.

Finally, I'm surprised by anyone who, in the face of quarter-over-quarter sales growth of 50%-100%, would say that people just aren't going to buy books from an online store. The premise is either (a) that buying books is all about hanging out and browsing in a "physical space," which Amazon can't replicate, or (b) people won't give their credit cards over the Internet. As regards the first of those, I look to my own purchasing habits. I've now bought a number of books from Amazon, while at the same time also purchasing books in the big stores too. If I'd only bought stock at the IPO in other companies of which I was an "early adopter," I'd be an even happier man than I am today. I missed Schwab at its debut, AOL at its debut, and Intuit (maker of Quicken, which I've used for years) at its debut. I've come to learn from those examples that when I start liking and buying something, it might just make a fine investment. Same goes for you, dear reader, or anyone else... that's one of Peter Lynch's principles.

As regards credit-card purchases over the Internet, that is one of the great fallacies of our time… the notion that it isn't as safe to use credit cards to pay for Internet purchases as it is for any other purchase. In fact, this notion is shared by enough people that it makes me even more bullish about Amazon. As that fallacy gets shot down, it opens up the market even more for e-commerce products.

Sending your credit card number to a "stranger" vendor is really no different than giving it over the phone to a "stranger" vendor, or handing the thing to a waiter at a restaurant. In all cases, you are providing the number to someone you don't know. Insofar as the companies that offer electronic commerce spend lots of money to create "secure" commerce, it's certainly arguable that giving your credit card to something like Amazon.com is SAFER than reading it over the phone to a stranger, or handing it to someone in a restaurant.

Further, even supposing that your credit card number was in some way "stolen" by some Internet hacker, your actual liability is nil so long as you report the theft in anything like a timely manner. And then even if you didn't, your liability is limited to a $50 loss at most. It's Visa's problem, not yours. And no credit-card company has ever had any significant problem with Internet credit-card fraud. Ever. Now... can it happen? Sure. But keep in mind that if it does, it's your credit-card company's problem.

To close, let me publish the opinion of NMay1916, who wrote these feelings (pretty much my own) about Amazon in that folder on AOL: "I love Borders. I drive miles past a Barnes & Noble to get there. It's the CDs that make the difference for me. I buy books there, too. I love Amazon. Their price and shipping is the same as going to Borders, but convenience is often important. So I buy books at Amazon too.... Some people love Barnes & Noble. It's obvious from the posts. I love the Internet. It's wayyyy cool! That's why I'm long Amazon. They're the pure play!"

In addition to Amazon's gain of $3/4 today, also helping out the Fool Port was KLA-TENCOR (Nasdaq: KLAC). "What's the deal there, huh?" you're asking, scratching your belled cap as you spot a gain of $2 15/16 on a bad market day. Answer: The stock is joining the S&P 500. Stocks that do that generally get a nice one-day pop. Pop!

Fool on,

David Gardner

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TODAY'S NUMBERS
Stock Change Bid ---------------- AMZN + 3/4 39.50 AOL - 9/16 76.31 T +1 1/4 41.94 ATCT --- 5.00 CHV - 1/2 81.13 DJT --- 11.31 GM + 1/16 67.13 INVX + 1/8 32.63 IOM - 15/16 26.13 KLAC +2 15/16 72.69 LU -2 3/4 79.50 MMM -2 1/16 90.06 COMS -1 11/16 49.75
Day Month Year History FOOL -0.68% 5.03% 22.58% 227.16% S&P: -1.56% 2.17% 24.07% 100.49% NASDAQ: -1.02% 3.27% 26.97% 127.62% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 76.31 949.28% 5/17/95 980 Iomega Cor 2.52 26.13 936.71% 10/1/96 42 LucentTech 47.62 79.50 66.96% 8/24/95 130 KLA-Tencor 44.71 72.69 62.57% 8/11/95 125 Chevron 50.28 81.13 61.33% 8/12/96 110 Minn M&M 65.68 90.06 37.13% 8/12/96 280 Gen'l Moto 51.97 67.13 29.15% 6/26/97 325 Innovex 27.71 32.63 17.74% 8/13/96 250 3Com Corp. 46.86 49.75 6.17% 8/12/96 130 AT&T 39.58 41.94 5.96% 9/9/97 290 Amazon.com 38.22 39.50 3.34% 4/30/97 -1170 *Trump* 8.47 11.31 -33.58% 10/22/96 600 ATC Comm. 22.94 5.00 -78.20% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 27090.94 $24509.07 5/17/95 980 Iomega Cor 2594.53 25602.50 $23007.97 8/12/96 280 Gen'l Moto 14552.49 18795.00 $4242.51 8/11/95 125 Chevron 6285.61 10140.63 $3855.02 8/24/95 130 KLA-Tencor 5812.49 9449.38 $3636.89 8/12/96 110 Minn M&M 7224.44 9906.88 $2682.44 6/26/97 325 Innovex 9005.62 10603.13 $1597.51 10/1/96 42 LucentTech 1999.88 3339.00 $1339.12 8/13/96 250 3Com Corp. 11714.99 12437.50 $722.51 9/9/97 290 Amazon.com 11084.24 11455.00 $370.76 8/12/96 130 AT&T 5145.11 5451.88 $306.77 4/30/97 -1170*Trump* -9908.50 -13235.63 -$3327.13 10/22/96 600 ATC Comm. 13761.50 3000.00-$10761.50 CASH $29541.35 TOTAL $163577.54

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