Fool Portfolio Report
Tuesday, May 20, 1997
by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA., (May 20, 1997) -- Stocks moved sharply higher as Greenspan & Co. decided to hold interest rates steady. Citing an economy that seemed in control -- rational, strong but contained, steady -- the decision to waive a rate increase made sense and didn't surprise many. Since the last Fed increase in March, the economy has appeared well in order, and at times even tame. Inflation seems to be at bay -- gone fishing, even. Steady growth without inflation is the goal, and is apparently being achieved. It's been a great few years.

A recent article in The Wall Street Journal hypothesized that inflation and overall boom-and-bust economic cycles could be a thing of the past. That's hard to believe, but one finds the desire to believe compelling. The author stated that businesses have never been so efficient, and "just-in-time" inventory and product fulfillment maintains a pace of steady growth (or decline?), rather than large swings of surplus to deficiency. In that sense, the author has a good point, which has been made before -- but, and I believe the author admitted, there are many other factors to consider in nailing down an economy.

In 1994 many were claiming that the semiconductor industry was no longer cyclical. The opposite proved true within a year. The economy as a whole is certainly still cyclical, too, but the author contended that it "corrects" by sectors -- rather than as a whole -- because each industry is an efficient micro-economy of its own.

This argument has been shared in the past, too; but perhaps the efficient solutions within each industry -- regarding surplus or deficiencies -- for the first time comprises an overall system that is tight piece-by-piece, and so as a whole it can move forward naturally, as it should, progressively, while individually booms and busts occur on smaller scales.

We've presented a similar argument here about stock sectors in general. The stock market has corrected dramatically by industry, rather than as whole, over recent years. Does that have anything to do with the spreading of knowledgeable investors?

The control of inflation through efficient business is the strongest argument going forward. A lack of goods with increased demand produces inflation. Businesses meeting demands consistently, on time, reduces that risk. America has made itself into a lean, efficient business leader. Then again, Japan had, too, at one point. Different story, though.

Anyway... let's quit the boring talk. Who cares in the long run?

The Fool Portfolio kept ahead of a hot market, gaining 1.72% against the S&P's 1.01%, and nipping the bud of the Nasdaq's 1.69% gain. With too much money in cash, it's good to see the Fool win anyway. We're working on new buys!

General Motors and Lucent had the usual slew of press releases, but none were significant to us. Other than that, there was little news on Fool stocks. 3COM (Nasdaq: COMS) gained another $1, adding to its recent 50% recovery. The selling there was over-done, we could easily argue.

KLA TENCOR (Nasdaq: KLAC), ever-volatile, gained $3 1/2, TRUMP HOTELS (NYSE: DJT), our one short, fell $1/4 in today's strong market, and ATC COMMUNICATIONS (Nasdaq: ATCT), which we paid a slight premium for, held steady at $4.

No news, so let's look at something interesting:

At the beginning of May, while working on a Dow Dividend primer to be offered in FoolMart, I was looking at the relative valuations of the thirty Dow stocks, not considering dividends, intrinsic value, business, historical performance -- anything. Just valuations. If anything really caught my eye, so be it.

The results were revealing. The recent average market cap of the thirty stocks was about $50 billion, and the average price-to-sales ratio was 1.70. Below is the list, and then the "highest" valued stocks, and the lowest.

Firm Market Cap Price-to-Sales ratio (billions) AT&T $57 0.7 Allied Sig 20 1.4 Alcoa 12 0.9 Amer Exp 28 1.7 Boeing 35 1.6 Cat 15 0.9 Chevron 45 1.0 Coca Cola 160 8.5 Disney 49 2.6 Dupont 59 1.3 East-Kodak 25 1.6 Exxon 140 1.0 GE 185 2.3 GM 47 0.3 Goodyear 8 0.6 Hewlett-Pack 54 1.4 IBM 71 0.9 Intl Paper 12 0.6 Johnson&John. 81 3.7 McDonald's 37 3.4 Merck 110 5.2 3M 36 2.5 JP Morgan 19 1.2 Philip Mo 95 1.4 P&G 85 2.4 Sears 19 0.5 Travelers 31 1.4 United Carb 6 0.9 United Tech 18 0.8 Walmart 64 0.6 -------- $1,500 billion Avg. Market Cap: $50 billion Avg. Price-to-Sales ratio: 1.70

Highest market caps: 1. GE $185 billion 2. Coke $160 billion 3. Exxon $133 billion Highest price-to-sales: 1. Coke 8.5 2. Merck 5.2 3. J&J 3.7 4. McDonald's 3.4 Lowest market caps: 1. Union Carb $6 billion 2. Goodyear $8 billion 3. Alcoa $12 billion 4. Int'l Paper $12 billion Lowest price-to-sales: 1. GM 0.3 2. Sears 0.5 3. Goodyear 0.6 4. Walmart 0.6 5. Int'l Paper 0.6

A few points of interest, though initially none too shocking: Two of lowest-valued stocks are among the current Foolish Four picks: GM and International Paper. Goodyear was recently on the Foolish Four list, too, but it dropped off.

GE is the largest-capped company of all -- no surprise -- and Coca Cola is second. Coke, with $18.5 billion in 1996 sales, is capped at $160 billion; while Exxon, with about seven times more sales than Coke, or $130 billion last year, is capped at $20 billion less than Coke.

The value of such a comparison is very questionable, though, for many reasons.

No other stock on the Dow has achieved an average compound annual return of 30% over the past fifteen years (including dividends). Only Coca Cola. The company also has the best brand name in the world, one of the best distribution networks, is probably recession-proof, has a leading return-on-equity (due to the low costs of producing more soft-drinks) -- and the list goes on, from competitive advantages to expanding margins. You're probably tired of hearing about it.

Exxon is another story -- cyclical, oil prices are not in its control, sporadic earnings and sales, 5.4% net margins, etc.

But what about the comparison of Coke to Johnson&Johnson, or McDonald's? Does Coke merit a price-to-sales ratio of 8.5, while the next highest, after Merck at 5.2,  is Johnson&Johnson at 3.7, then McDonald's at 3.4? (Obvious note to make: the highest price-to-sales Dow stocks are consumer brand names, supporting, "Buy what you know.")

J&J and McDonald's have net profit margins of about 15%, while Coke is at 20%. Both companies have sales-growth that mirrors that of Coke -- in its steady, percentage-wise, but sometimes backwards (down a quarter here and there) progress. But in return on equity, Coke is far and away the winner. Coke's recent ROE stood at 56%, J&J at 27%, and McDonald's at 19%. In fact, Coke offers the highest return-on-equity of any Dow stock.

But is Coke worth 8.5 times sales, compared to an average of 1.7 for the Dow 30? How certain is Coke's future compared to that of an Exxon, IBM, or J&J? Has the country fallen too hard for the stock?

Perhaps the country has gotten ahead of itself -- but the country isn't exactly stupid.

Considering Coke's strong margins, historic returns, and return on equity, and expecting it to grow earnings 18% for the next few years, it currently would trade at around 28 times trailing earnings within about thirty months -- which doesn't sound too outrageous. It could trade at a lower multiple because the company is consistently buying back large amounts of stock, too.

Either way, it's not cheap, but if investors are buying for the next five to ten years... well, perhaps waiting for a cheaper price is costly in itself, if the past few years are any indication. It's hard to imagine seeing Coke's stock (now $68) at levels it touched even at the end of 1996 ($46 per share) -- as it would then trade at 23 times estimates less than two years out, while growing earnings at about 18% per year and increasing margins, and buying back stock.

So how long is your time-frame?

After Friday's recap, Fool Jean-David sent email stating: "It does not seem as though Warren Buffett buys low and sells high. He seems to buy low compared to what the stock is worth much later, but it does not always seem low at the time. He does not sell at all (well, hardly ever). Yet some people consider him the greatest investor ever."

--- Jeff Fischer, May 20th, 1997

The Daily Trouble -- The well-known PETsMART is cut in half: a merited slaughter, or now a good value?
The Daily Double -- Pollo Tropical: Learn why this chicken stock doubled. Fair value?
Tuesday's Evening News: Former hot stock C-Cube is crushed.
The Fribble -- a fun, thoughtful two minutes -- today on the Dow approach, rule of 72.

Stock Change Bid -------------------- AOL +1 1/2 50.00 T + 3/4 34.13 ATCT --- 4.00 CHV - 1/4 70.38 DJT - 1/4 9.63 GM +1 1/2 57.38 IOM + 1/8 17.50 KLAC +3 1/2 50.50 LU +1 3/4 63.38 MMM + 3/8 91.75 COMS +1 38.88
Day Month Year History FOOL +1.72% 4.30% -0.03% 166.79% S&P: +1.01% 5.03% 13.62% 83.61% NASDAQ: +1.69% 8.18% 5.64% 89.38% Rec'd # Security In At Now Change 5/17/95 980 Iomega Cor 2.52 17.50 594.44% 8/5/94 355 AmOnline 7.27 50.00 587.76% 8/11/95 125 Chevron 50.28 70.38 39.95% 8/12/96 110 Minn M&M 65.68 91.75 39.70% 10/1/96 42 LucentTech 47.62 63.38 33.10% 8/24/95 130 KLA Tencor 44.71 50.50 12.95% 8/12/96 280 Gen'l Moto 51.97 57.38 10.39% 4/30/97 -1170 *Trump* 8.47 9.63 -13.65% 8/12/96 130 AT&T 39.58 34.13 -13.78% 8/13/96 250 3Com Corp. 46.86 38.88 -17.04% 10/22/96 600 ATC Comm. 22.94 4.00 -82.56% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 17750.00 $15168.13 5/17/95 980 Iomega Cor 2594.53 17150.00 $14555.47 8/12/96 110 Minn M&M 7224.44 10092.50 $2868.06 8/11/95 125 Chevron 6285.61 8796.88 $2511.27 8/12/96 280 Gen'l Moto 14552.49 16065.00 $1512.51 8/24/95 130 KLA Tencor 5812.49 6565.00 $752.51 10/1/96 42 LucentTech 1999.88 2661.75 $661.87 8/12/96 130 AT&T 5145.11 4436.25 -$708.86 4/30/97 -1170*Trump* -9908.50 -11261.25 -$1352.75 8/13/96 250 3Com Corp. 11714.99 9718.75 -$1996.24 10/22/96 600 ATC Comm. 13761.50 2400.00-$11361.50 CASH $49020.02 TOTAL $133394.90