Fool Portfolio Report
Tuesday, February 3, 1998
by Jeff Fischer (

ALEXANDRIA, VA (Feb. 3, 1998) -- Today the Fool Port waltzed to her fifth market-beating day in a row, and she isn't even showing any signs of wear and tear -- nope, not this fair maiden. No fatigue here. The Fool gained 0.86% on general strength from many holdings, though without the help of previous suitors America Online and Amazon.

America Online (NYSE: AOL) has been on a tear following expectation-beating subscriber and online transaction growth, estimate-topping earnings in the last quarter, and the complete and utter consumption of CompuServe. Literally. Depending on how you value the company (on revenue, book value, subscriber-based valuation models, or on earnings per share), the stock is either reasonably priced or outrageously priced. Valuing AOL on its current book value is probably not the way to go, though -- or at least that appears to be what the market is telling us. It's valuing the stock on a subscriber-based model. We'll save this discussion for another night, though. I already promised to write about Amazon the last time that I wrote here, so let's do that.

The same week that (Nasdaq: AMZN) announced earnings in mid-January, three analysts initiated coverage of the stock, two with "buy" ratings and one with a "long-term attractive" rating. The stock price when the two "buy" ratings were announced was $60 and $61 (on January 21 and 22). The total number of analysts now drooling over Amazon is ten, with four rating it a "strong buy" and six rating it a "moderate buy." So, if analysts mean anything, it appears that we weren't complete idiots when we leapt at the chance to buy Amazon at $27 (having finally gotten it at $38). Will time prove us to be morons though?

Looking at the numbers, I feel as comfortable as a kid in his treehouse on a moderately windy but clear night. The treehouse is stable in the tree -- not rock solid, but with a worthy foundation and enough nails to hold it to the bark. At $61 per share, Amazon has a market cap of $1.45 billion, putting the stock at just under 10 times sales. In the record fourth quarter, Amazon sold $66 million worth of books at a cost of $53 million, giving the company gross margins of 19.4%. (For more on gross margins, please see tonight's Drip Port column on Intel.) This 19% is even with the company's gross margin in the third quarter, but below the gross margin of 22.3% achieved one year ago in the same quarter.

Bears have been clinging to this fact and asking why Amazon is selling more books but making less gross profit -- shouldn't economies of scale work positively for a company?

One simple reason, though, is that Amazon is now much more popular for everyday book buying and so is catering to over one million readers that are buying best selling books -- books that, of course, have very low margins. Last year when Amazon had fourth quarter revenue of only $8.4 million (compared to the $66 million this year) and when the company was much less known, it's likely that the thousands of customers were more frequently buying harder to find, higher margin books. Now that book buying online has become "popularized," people are buying more of the "easy to sell but hard to profit from" books -- the best sellers.

Running down the numbers on the earnings report, after gross profit we have operating expenses. In the last quarter marketing and sales expenses were $16 million, or 24% of sales, down from 34% of sales last year, and also down from quarter three's 28.8%. Ha! Trending down might = good. Trending up would = whatever. Too early to guess. Perhaps we want the company marketing itself even more. Or perhaps it's advertising just enough, in which case the lower cost as a percentage of sales is truly good.

We next have product development costs, which include a great deal of technology (servers fast enough to launch a space shuttle) and the Web design and functionality. Programming, in other words. This cost was $4.5 million last quarter, or 6.8% of sales. This compares to a cost that was 9.2% of sales in the third quarter and 10.6% of sales in the same quarter last year. Once again, this cost is trending down. In this case this is certainly a positive as long as we're happy with the shopping experience and speed at As soon as the company starts offering pictures of big floating heads or cows in hopes of getting our attention on the mainpage, and when the page starts to "time out" all the time, we might begin to worry.

The next expense is easy: administrative and general expenses. Of course we want this "fluff expense" trending down and then completely eliminated if possible. If Amazon can automate itself to the point of being the first public company with zero employees, it'll be excellent for shareholders. (Hey, that stupid joke aside, if anyone does know of a company that is a going concern and requires no employees, not ever, not even one, email me and let me know what it is. I'll share it here.)

So let's see here...

General and administrative expenses were $1.9 million last quarter, or 2.8% of sales. In the third quarter this expense was -- ah ha! -- $1.8 million, or 4.7% of sales. The absolute number hardly grew at all in the last quarter though sales grew 74% sequentially, while as a percentage of sales the number was sliced considerably. This is good. While Borders Group and Barnes & Noble would likely need to increase administrative expenses considerably in order to grow sales by $30 million at a traditional location, Amazon only needed to get more eyes to its website. It didn't need any fluffy overhead to do so.

As these expenses trend down as a percentage of sales and sales soar, perhaps it shouldn't be surprising to see so many analysts jump on Amazon stock with "buy" ratings following the earnings report.

Unfortunately for today I'm out of time, but I'll continue with this look at Amazon at my next opportunity. The Hall of Portfolios is not without great entertainment and education, though, for tonight and every night. Tonight the Cash-King Portfolio announces its third buy after making its first two transactions today, while in the Drip Portfolio today I began an in-depth look at Intel's (Nasdaq: INTC) performance in 1997. (Do you own Intel? Would you like to?) And finally, the Boring Portfolio takes a look at the earnings of Cisco Systems (Nasdaq: CSCO), which were announced after the market closed.

For now, see you on the Amazon and other message boards. Fool on!

--Jeff Fischer

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Stock Change Bid ---------------- AMZN -1 61.38 AOL - 3/8 99.75 T + 3/8 63.19 CHV + 5/16 75.94 DJT + 1/16 9.00 GM + 1/2 60.94 INVX + 3/4 24.00 IOM + 1/4 9.88 KLAC + 1/8 40.00 LU +2 15/16 92.31 MMM +1 1/2 88.38 RTN.A + 5/8 53.38 COMS + 3/16 34.00 TDFX +1 1/4 25.88 SPY + 9/16 100.69
Day Month Year History FOOL +0.86% 5.10% -1.00% 232.25% S&P: +0.47% 2.62% 3.67% 119.46% NASDAQ: +0.82% 2.90% 6.11% 131.38% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 99.75 1271.53% 5/17/95 1960 Iomega Cor 1.28 9.88 671.24% 10/1/96 42 LucentTech 47.62 92.31 93.87% 9/9/97 290 38.22 61.38 60.58% 8/12/96 130 AT&T 39.58 63.19 59.65% 8/11/95 125 Chevron 50.28 75.94 51.01% 8/12/96 110 Minn M&M 65.68 88.38 34.56% 8/12/96 280 Gen'l Moto 48.74 60.94 25.02% 1/8/98 115 S&P Depos. 95.91 100.69 4.99% 1/8/98 425 3Dfx 25.67 25.88 0.81% 12/19/97 17 Raytheon 53.21 53.38 0.31% 4/30/97 -1170 *Trump* 8.47 9.00 -6.27% 8/24/95 130 KLA-Tencor 44.71 40.00 -10.54% 6/26/97 325 Innovex 27.71 24.00 -13.39% 8/13/96 250 3Com Corp. 46.86 34.00 -27.45% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 35411.25 $32829.38 5/17/95 1960 Iomega Cor 2509.60 19355.00 $16845.40 9/9/97 290 11084.24 17798.75 $6714.51 8/12/96 280 Gen'l Moto 13647.92 17062.50 $3414.58 8/11/95 125 Chevron 6285.61 9492.19 $3206.58 8/12/96 130 AT&T 5145.11 8214.38 $3069.27 8/12/96 110 Minn M&M 7224.44 9721.25 $2496.81 10/1/96 42 LucentTech 1999.88 3877.13 $1877.25 1/8/98 115 S&P Depos. 11029.25 11579.06 $549.81 1/8/98 425 3Dfx 10908.63 10996.88 $88.25 12/19/97 17 Raytheon 904.57 907.38 $2.80 8/24/95 130 KLA-Tencor 5812.49 5200.00 -$612.49 4/30/97 -1170*Trump* -9908.50 -10530.00 -$621.50 6/26/97 325 Innovex 9005.62 7800.00 -$1205.62 8/13/96 250 3Com Corp. 11715.99 8500.00 -$3215.99 CASH $10740.46 TOTAL $166126.21