Fool Portfolio Report
Thursday, January 15, 1998
by Jeff Fischer (JeffF@fool.com)

ALEXANDRIA, VA (Jan. 15, 1998) -- In a volatile day of what may be another volatile year, stocks ended lower across the board. The Fool Port, though sometimes immune to hurt, just as often skins its knees while climbing a proverbially paved Wall Street leading to... years from now. Today only one knee was skinned, though. Today the portfolio surpassed the S&P for the year, but lost to the Nasdaq and remains slightly below it for 1998 (please see today's numbers).

Aside from reports on Asia, fears of inflation that have now turned into worries of deflation, and concerns that earnings are slowing at least temporarily in some key industries, there are several Wise economic numbers that churn out of Wall Street and the government on a daily basis. Rather than study those numbers, though, it's best to simply keep up with your specific companies, as only some economic numbers will actually change their near-term business, while many of the so called "hot market stories" (most of them, in fact) mean absolutely nothing to your companies -- especially in the long term.

Hence, you don't need to buy a business newspaper every day. You should read your companies' quarterly reports and latest news when you can and -- and, well, that's nearly about it, over the years. The other end of your investing life should be about enjoyment -- about actually enjoying what you're doing, sharing, and learning about investing with other Fools on the message boards and taking the time to reflect that -- hey! -- much of this isn't for you, ultimately, but perhaps for the young Fools asleep in bed right now, or for those not even yet inducted into the Hall of Life.

Or maybe you just want to buy a beach house fifteen years from now. Whatever.

There is plenty to keep abreast of with our Fool stocks. Monday we listed the coming earnings announcements from our non-Fool Four holdings, and today we'll cover some of the latest in the ongoing sagas and concerns surrounding our more quickly growing businesses. (Interesting how concerns and drama almost always surround the smaller but more quickly growing industries -- and how the worries of the Wise always seem to circulate with the thickest density around what prove to be some of the most successful stocks of the decade.)

(I spent a few hours last night going through the entire S&P Stock Guide, confirming that AOL and Iomega are two of the very best performing stocks over the past five years, bar none, both compounding over 90% annually. Another one of the few giant successes of that caliber: Innovex. More on that later.)

Before getting to stories of recent turmoil, it's notable that America Online (NYSE: AOL) touched its record high today. With its earnings announcement in February, the company will likely announce record revenue from electronic commerce, as December was well above expectations in terms of retail sales. The number from the Bloomberg machine states that America Online had 114 companies selling products on AOL in December, and those vendors sold $150 million worth of merchandise in that month alone. Of course, AOL has different contracts with each vendor that determines what it receives from these sales. America Online announces earnings on February 6, and $0.17 per share is expected.

Amazon.com (Nasdaq: AMZN) is another online leader whose stock has enjoyed recent success (up nearly $10 this week), probably in anticipation of what will be a record quarter announced on January 20. For the prior three quarters of 1997, Amazon had combined revenue of $81.8 million. Going forward, the company is expected to lose $0.44 per share this quarter, or $10.4 million (22% more than last quarter), meaning that the revenue estimate (not accounting for a change in gross margins) stands at around $46 million for the quarter that just ended.

That would give Amazon $128 million in total revenue for 1997, putting the sixty dollar stock at 11 times sales and 7.7 times the revenue run rate (the run rate is the fourth quarter revenue multiplied by four). For an Internet stock (and I love to say this because I'm going to get flamed left and right for it), it doesn't appear expensive.

Hey, of course I'm not comparing Amazon to General Motors, which trades at 0.2 times sales. I'm comparing it to Internet companies -- such as Yahoo!, OnSale, Excite, Lycos, CNet. Yes, the stock is extremely risky -- I can see the bear argument, I'm not wearing rose colored glasses -- but we feel that the potential is excellent, hopefully above and beyond the risk. So far Amazon has proven to be most risky for the shorts. The stock has gained 55% for the Fool since September 9. I wouldn't consider buying it, though, unless you have a long-term outlook and can absorb the risk.

A stock making a mini-comeback of late is 3Com (Nasdaq: COMS). As written of in today's Lunchtime News, yesterday the networker stated that its inventory woes would be over by February, surprising some investors (and me). What this means is that 3Com has nearly reduced its inventory channel to desired levels and is working towards a balance whereby there hopefully won't be excessive inventory in the future. This doesn't mean that revenues will benefit immediately, but it does mean that the company is clearing its bowling alley, so the speak, and that it will likely soon be bowling again without having to worry about all of the old pins that were stuck in the lane these past months.

3Com has gained about 14% this week on the news, in a move that almost inevitably will be mimicked by Innovex (Nasdaq: INVX) at some point in the future -- the moment that any good news at all is released from a disk drive company. Alongside Innovex's 80% annualized stock growth over the past five years, it's interesting to note that Innovex has the best margins of any company in the Fool Port, by far, and one of the best five-year histories of earnings per share growth (only Iomega may equal it). Yet it trades at the lowest multiple to earnings of any Fool stock.

Yes, I know -- it's a disk drive-related stock. What do I expect?

When the sentiment is different, however, Innovex can trade at over 20 times earnings (rather than 9 right now)(not that I'm implying that it should). I find it interesting, though, how Wall Street is so often willing to lump stocks together, by industry, regardless of the niche and margins (and advantages) that certain companies hold over other companies in their same industry. Innovex doesn't have 3% margins like a disk drive maker that competes on a price basis. It has 24% profit margins, better than Coca-Cola's; and its return on equity is better than 90% of all companies. Return on equity is, "For every dollar invested into the assets of the business, how much money is generated?" In Innovex's case, it's over 50%. Compare that to Seagate (NYSE: SEG) at 8% return on equity with 3% profit margins (compared to Innovex's 24%).

The funny thing is, if from the beginning Innovex had described itself as a company that "allows for the reading of software from the software disk," or something -- anything related to software, rather than disk drives -- maybe it would be given a different valuation. A foolish thought? Yeah, it is. I don't actually believe that it would happen. But with stocks, sometimes image is everything. That's not right, of course, and it usually creates short-term inefficiencies.

Finally, 3Dfx (Nasdaq: TDFX) has had two stories written about it in the past two days that are reminiscent in tone of stories that were written about Iomega three years ago. (I'm standing on a small ledge saying that, I know -- I dislike mentioning any stock in the same sentence with Iomega, because the less enlightened press then seem inclined to simply lump the two together, as we've seen already with 3Dfx.)

Anyway, as Iomega worked to build a new storage standard, nearly every popular media story about the company foretold how it would get absolutely crushed by "the bigger guy." By the Compaq, the TDK, the IBM, the BigFoot. Whatever. Anything bigger than it. Now we're already hearing the same thing about 3Dfx. Today an Investor's Business Daily story warned of Intel's entering of the 3D chipset market (though with a chip that targets a different audience!). Granted, the IBD story, I think, tried to be fair while also attempting to insert dramatic flare into the coming competition -- and you can't really blame the journalist for that, as long as facts are presented accurately.

But as we've seen in the past, when one company has the better product, has a substantial lead on the market, is getting its name known throughout the industry, and is having games (in 3Dfx's case) made based on its technology (or computers being made with Zip drives, in Iomega's case), it takes more than just being "big" to displace the little guy, who is often running circles around the giant and pleasing the customer in the process.

Of course, this isn't always the case. Oftentimes the big guy does come in and crush the little guy. That's why these stories are so compelling (and so easy for journalists to write -- it's such an easy stance to take!). This is why we're going to see more of these stories about 3Dfx in the future. The risks certainly exist, as we wrote in our buy report. Meantime, 3Dfx is growing so quickly that managing its growth, according to the CEO, is one of the largest challenges that it currently faces -- alongside with turning out products at least one generation ahead of the competition. That's the more compelling story, but not the easiest one for journalists to explain.

Foolishly,

Jeff Fischer

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN +1 59.38 AOL +2 1/16 92.81 T - 13/16 64.88 CHV + 9/16 76.06 DJT + 3/16 7.75 GM - 1/8 58.50 INVX -1 21.75 IOM - 3/8 12.13 KLAC +1 15/16 38.44 LU -3 1/4 75.25 MMM -1 9/16 82.50 RTN.A +1 1/8 49.50 COMS + 13/16 33.44 TDFX - 7/8 25.00 SPY - 49/64 94.98
Day Month Year History FOOL -0.38% -1.68% -1.68% 229.95% S&P: -0.75% -2.03% -2.03% 107.40% NASDAQ: -0.11% -1.48% -1.48% 114.82% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 92.81 1176.15% 5/17/95 1960 Iomega Cor 1.28 12.13 846.96% 8/12/96 130 AT&T 39.58 64.88 63.92% 10/1/96 42 LucentTech 47.62 75.25 58.03% 9/9/97 290 Amazon.com 38.22 59.38 55.34% 8/11/95 125 Chevron 50.28 76.06 51.26% 8/12/96 110 Minn M&M 65.68 82.50 25.62% 8/12/96 280 Gen'l Moto 48.74 58.50 20.02% 4/30/97 -1170 *Trump* 8.47 7.75 8.49% 1/8/98 115 S&P Depos. 95.91 94.98 -0.96% 1/8/98 425 3Dfx 25.67 25.00 -2.60% 12/19/97 17 Raytheon 53.21 49.50 -6.97% 8/24/95 130 KLA-Tencor 44.71 38.44 -14.03% 6/26/97 325 Innovex 27.71 21.75 -21.51% 8/13/96 250 3Com Corp. 46.86 33.44 -28.65% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 32948.44 $30366.57 5/17/95 1960 Iomega Cor 2509.60 23765.00 $21255.40 9/9/97 290 Amazon.com 11084.24 17218.75 $6134.51 8/12/96 130 AT&T 5145.11 8433.75 $3288.64 8/11/95 125 Chevron 6285.61 9507.81 $3222.20 8/12/96 280 Gen'l Moto 13647.92 16380.00 $2732.08 8/12/96 110 Minn M&M 7224.44 9075.00 $1850.56 10/1/96 42 LucentTech 1999.88 3160.50 $1160.62 4/30/97 -1170*Trump* -9908.50 -9067.50 $841.00 12/19/97 17 Raytheon 904.57 841.50 -$63.07 1/8/98 115 S&P Depos. 11029.25 10923.20 -$106.05 1/8/98 425 3Dfx 10908.63 10625.00 -$283.63 8/24/95 130 KLA-Tencor 5812.49 4996.88 -$815.62 6/26/97 325 Innovex 9005.62 7068.75 -$1936.87 8/13/96 250 3Com Corp. 11715.99 8359.38 -$3356.62 CASH $10740.46 TOTAL $164976.91