AOL, AMZN Never Lose?
Wednesday, May 27, 1998
by Jeff Fischer (JeffF@fool.com)

ALEXANDRIA, VA (May 27, 1998) -- The market continued its volatile behavior on this, the 27th day of May, in the year 1998 -- a year that will sound sorely dated a mere five years from now. The Internet, meantime, probably won't be hitting its stride in earnest until about the years 2005 and 2006.

Studies show that it often takes technology about the same amount of time to reach 10% of the population as it then takes to reach 90%. In other words, once 10% saturation comes about, the speed of acceptance increases sharply. If ten years are required for a certain technology to reach the first 10% of households, in the following ten years it should be in 90% of homes.

On the message boards and in email, our most criticized stocks are among our most successful -- the Internet stocks. What people are essentially doing, though, is criticizing the Fool for having very successful investments that were taken with minimal risk. The way they paint it, you'd think we'd mortgaged the house and went on margin to buy inappropriately large stakes in these companies. In reality, our investment in America Online is a laughable $2,500. It's a sin that we don't have more in that stock. We have 5% of the portfolio's initial $50,000 in AOL. (It was initially a 10% stake before selling half of it last April -- a move that was a big mistake financially but had its purpose and lessons.)

Secondly, buying Amazon.com with $11,000 last September meant investing a whole 6.7% of the portfolio's value in the company. Not a big deal. It was bought without margin, knowing the risks, and for the long term. Investing in leading Internet stocks is as risky as investing in any start-up company, but the main questions to ask are:

1. Is the Internet going to grow or shrink?
2. Are leading Internet companies going to grow or shrink?
3. Can you afford to be wrong and lose on these investments?
4. How long is your investing time frame?

The answers to questions one and two are obvious; the answer to question four for the Fool is "indefinite." As long as our companies are progressing, we'll hold them. We'll hold through very rough times, too, as was done with AOL in 1996. The answer to number three for the Fool was, "Yes, we will do well even if these investments go to zero." It would be a setback, of course, but it would far from ruin the portfolio. At this point, though, I've got to share some news with the constant bears:

Barring the bizarre, the Fool Port will never lose its money on AOL. Ever.

Our $3.64 cost-basis is valued at about 4 times earnings estimates for the next year and grants the company a market value of only about $700 million. (Incidentally, that's about the same market price that we paid for Amazon last fall.) The "outrageous" price that the Fool paid for AOL in 1994 -- some 200 times earnings -- is still outrageous. But it's now an outrageously cheap price. Meantime, Amazon was bought at 14 times trailing sales, but our cost-basis of $38 per share values the company at around $900 million (before debt and cash on hand), which is now less than 3 times the revenue run-rate of $352 million. (The run-rate is the last quarter's revenues, in this case $88 million, multiplied by four.)

For the return on our Amazon investment to be flat once again, the stock needs to fall to a price that will probably equal about 1.5 times 1998 sales. Certainly that could happen, but it's not very likely to happen as long as the outlook for Internet companies remains positive. By 1999, our 1997 Amazon purchase price at 14 times sales will be valued at below 1 times sales. By 2002, let's hope that our purchase price will be at a ridiculously low level compared to both sales and earnings. Maybe, if Amazon is successful, we'll never have to worry about losing the money that we invested in it, either. At all. The company could reach a point where no one in their right mind would value it below the price that we paid, just as has happened with AOL for the Fool Port.

Internet bears look at the present prices and ask, "Why?" We're looking at the potential value down the road, and saying, "Interesting. Let's buy some. Let's not sell the kids to do so, but let's join the ride. The Internet is going to change how the world does business and communicates, and we want to participate and hopefully make great profits doing so." We never invested more than 10% of the portfolio in these companies, we've always been long term, and we've been constant in our belief and argument. So far, so good. And the Internet isn't even used by the majority of the world yet, and it won't be for years.

The bears next attack the Fool Port for succeeding, saying, "These few stocks have become such large parts of your portfolio!" Hey, that's the point. We want home runs like that. Buffett didn't let Coca-Cola become over 40% of his net worth, at times, without reason. You keep your winners and you let them run, even if that means that they "consume" your portfolio. You'd rather be consumed by a winner than a loser, no?

Speaking of losers, Innovex (Nasdaq: INVX) and 3Dfx (Nasdaq: TDFX) continued lower in this heartless market. These stocks trade, respectively, at about 7 and 8 times 1999 earnings estimates. You make the educated guess on whether or not there is value to be captured here down the road.

In the news, Iomega (NYSE: IOM) announced that its chief financial officer is leaving to join E*Trade Group (Nasdaq: EGRP) in a similar position. Does this gentleman believe that the online brokerage firm has a brighter future than Iomega? Or was he offered a much fatter pay package? Maybe some of both.

No great sage, I was recently most willing to sell our Iomega in the $7 to $8 range, but that's a personal call. I don't care for its industry and its low margins. I like Innovex in this industry only because it does have such great margins, and it dominates a niche that is less likely to change hands due to competition. Iomega looks inexpensive here, but over the long term I think that we can find better places to invest -- unless Zip really becomes the new standard. That possibility might quietly be becoming true with every Zip-enhanced PC that ships. So (back and forth), I'm not personally anxious to sell at this price (which would mean locking in a 450% gain on top of the 600% gain that we locked in last year), but I'm not thrilled to be an investor, either.

Today's highlighted message board post is on Iomega, while tonight's Drip Port column is on the advantages of DRP investing. In a declining market, these advantages become amplified.

See you on the message boards... Fool on!

--Jeff Fischer

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN +4 3/4 86.63 AOL + 1/16 82.69 T + 13/16 60.44 DD + 15/16 80.44 DJT --- 8.63 XON + 7/8 70.50 INVX -1 18.13 IP -1 9/16 48.13 IOM - 3/16 6.56 KLAC +1 5/8 36.63 LU +2 1/4 72.38 COMS + 3/8 27.38 TDFX - 13/16 18.50 SPY + 7/32 109.63
Day Month Year History FOOL +0.50% -4.66% 15.88% 288.90% S&P: -0.16% -1.76% 12.55% 138.27% NASDAQ: +0.17% -4.67% 13.42% 147.31% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 82.69 2173.86% 5/17/95 1960 Iomega Cor 1.28 6.56 412.53% 10/1/96 84 LucentTech 23.81 72.38 203.99% 9/9/97 290 Amazon.com 38.22 86.63 126.64% 8/12/96 130 AT&T 39.58 60.44 52.71% 2/20/98 215 DuPont 59.83 80.44 34.44% 1/8/98 115 S&P Depos. 95.91 109.63 14.30% 2/20/98 200 Exxon 64.09 70.50 10.00% 2/20/98 270 Int'l Pape 47.69 48.13 0.91% 4/30/97 -1170*Trump* 8.47 8.63 -1.84% 8/24/95 130 KLA-Tencor 44.71 36.63 -18.09% 1/8/98 425 3Dfx 25.67 18.50 -27.92% 6/26/97 325 Innovex 27.71 18.13 -34.59% 8/13/96 250 3Com Corp. 46.86 27.38 -41.59% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 58708.13 $56126.26 9/9/97 290 Amazon.com 11084.24 25121.25 $14037.01 5/17/95 1960 Iomega Cor 2509.60 12862.50 $10352.90 2/20/98 215 DuPont 12864.25 17294.06 $4429.81 10/1/96 84 LucentTech 1999.88 6079.50 $4079.62 8/12/96 130 AT&T 5145.11 7856.88 $2711.77 1/8/98 115 S&P Depos. 11029.25 12606.88 $1577.63 2/20/98 200 Exxon 12818.00 14100.00 $1282.00 2/20/98 270 Int'l Pape 12876.75 12993.75 $117.00 4/30/97 -1170*Trump* -9908.50 -10091.25 -$182.75 8/24/95 130 KLA-Tencor 5812.49 4761.25 -$1051.24 1/8/98 425 3Dfx 10908.63 7862.50 -$3046.13 6/26/97 325 Innovex 9005.62 5890.63 -$3115.00 8/13/96 250 3Com Corp. 11715.99 6843.75 -$4872.24 CASH $11558.06 TOTAL $194447.87

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