Le Foolish Four
...in Le Fool Port, plus AOL's value
by Jeff Fischer

ALEXANDRIA, VA (July 13, 1998) -- A World Cup victory, the Three Tenors, and tomorrow is Bastille Day -- yes, France is definitely the place to be. But if you can't be there, you're in the next best place: Le Fool Port! (Raise both arms in the air and shout those words, like this: LE FOOL PORT! Now use a very deep voice. Try again. LE FOOL PORT!)

Thanks. Le Fool Port is the official sponsor of the French soccer team (they've always been our favorite group of athletes -- honest).

That might not be true, but today the market did ring true for the Fool, with America Online kicking to a new all-time high, Amazon turning about-face and running upfield, and 3Dfx (Nasdaq: TDFX) surging 20% ahead of an earnings announcement this week. The still relatively depressed stock of our 3D company closed at $20 -- that's 10 times the '98 earnings estimate of $1.87 per share. Quarterly earnings of $0.48 per share is expected this week.

These three all-stars lifted the Fool 4% while Nasdaq gained over 1% and the S&P was flat. There was little news to account for the resurgence in these stocks. Let's take a closer look at one of them.

America Online (NYSE: AOL) announced another deal with a relatively obscure finance company called IN-TOO-IT, and it was also reported that the AOL.com website will offer personal home page publishing services, a la competitors GeoCities and Tripod. By the end of the month, reportedly, AOL.com will provide some homepage building tools for individuals. So, yes, you can build your own Web page and compete with Amazon.com. Or, heck, build a page and become an Amazon associate, selling their books for a cut of revenues. Thousands are doing it, why not you?

Generally, analysts have a 12-month price target for America Online of $150 per share and a 24-month price target of $180. These targets are based on regular valuation multiples placed on AOL's projected subscriber base, advertising and commerce revenue, and existing cash and investments. Subscribers are valued at $1,300 to $1,400 apiece, or only 75% of the value granted cable TV subscribers (because it's easier to switch online services than cable companies, arguably, so online members aren't as certain to be loyal).

Many estimates call for AOL to have about 20 million members by the end of fiscal year 2000, and nearly $1 billion in advertising and commerce revenue. High-margin advertising sales are commonly granted a 20 times valuation multiple, giving the stock a $70 value on this projected revenue stream alone. With a quantifiable $180 price target for the year 2000 based on three moderately predictable (though not at all certain) revenue streams (those being subscribers, advertising and commerce), one shouldn't be incredibly shocked to see AOL climb above $118 today, despite the current fair value (based again on those three revenue streams) of about $112. The market almost always values businesses on expectations more than on past results. You probably won't see us pull the trigger on AOL unless something better in its market begins to displace it.

And now for something completely different -- a brainless, methodical investment approach.

The Foolish Four

In our continuing summary of Fool Port holdings, today we address the Foolish Four. Valued at $55,300, our Fool Four investment -- which for all practical purposes represents a single but diversified lump investment -- is the third-largest position in the portfolio. By cost-basis, the Foolish Four is by far the largest investment made here, at $48,000. The Fool's cost-basis on America Online, for comparison, is only $2,500. Our current Foolish Four holdings are AT&T, DuPont, Exxon, and International Paper -- oh, and bless its red heart, Lucent is lumped in there, too, having been spun-off from AT&T.

As shared in The Motley Fool Investment Guide, the Foolish Four is ideally 20% to 25% of one's diversified portfolio whenever you reconfigure the Foolish Four holdings, which is every eighteen months. (Though with current tax legislation awaiting President Clinton's signature, this holding period could change back to 12 months.) Currently the Fool Four represent 21.8% of the port -- as Curly of The Three Stooges would say, "Poifect."

A Foolish portfolio is usually based on this methodical approach and then builds up from there, like the Sears Tower (wide and sturdy at the bottom, but getting higher, thinner, and perhaps more risky at the top -- with small-caps piled on, etc.). We think an individual's portfolio best totals eight to fourteen stocks. It should be a long-term portfolio in order to maximize performance and minimize effort and mistakes. Consider the Odean research on traders whenever you think that they can outperform. Even during the turbulent times of 1987 to 1993, frequent traders underperformed.

Le Fool Port puts a great deal of weight in the Foolish Four because the approach has worked so well in the past -- and worked for specific reasons. The methodology behind it even carries over into international markets. As detailed on our Fool U.K. site, Fools in Britain use the Beating the Footsie approach as the Fool Four equivalent. In the U.S., buying the leading Dow companies when their stock prices are low and dividend yields are high has led to a 22% annualized return from 1971 to 1996. In the U.K., the Beating the Footsie Five has returned 19.5% annually.

Although this approach doesn't favor any particular environment, it is defensive and it seems to perform slightly better in a weak market -- which makes sense. When stocks are declining, money doesn't seek out the potentially high and falling stocks (say, the generously valued Coca-Colas of the 1973 decline). Instead, money goes to the already depressed stocks that have high and defensive yields. This partially explains why the Foolish Four often outperforms in down markets. Even so, the approach isn't deadwood in good markets. The gilded four gained 37% in 1995, 30% in 1996, and 28% in 1997. The approach should be used in the long-term only, though. Some years it will decline, of course, but over time it has won. It took from 1971 to 1996 for the approach to turn $10,000 into over $2 million.

For the first time, this year the Fool began to use an 18-month holding period rather than 12 months, for tax reasons. The 18-month long-term tax rate, at 20%, is much better than owning stock only 12 months and paying the regular 28% tax rate. The longer holding period also lowers commission costs (though already minimal) over the years. However, if tax legislation that has passed both the House and Senate is signed into law by the President, then the necessary 18-month holding period will be eliminated and the 20% long-term rate will apply to investments held for over 12 months.

Rather than explaining the approach in detail here (essentially, you buy the four lowest-priced and highest-yielding Dow stocks on one day, and then you reconfiguring and buy the new set eighteen months later, rolling the money over), please visit our complete Dow Approach and Foolish Four area. There are several variations to the method now, but the Fool Port uses the simple Foolish Four approach. There are also message boards there for you to post questions. And if you take 30 minutes to read the 13 Steps to Investing Foolishly (if you haven't), you can confirm that you're a full-fledged Fool, and you'll also know better why we base our portfolio on this bedrock foundation. The steps are fun to read, too.

Tomorrow -- back to individual stocks, beginning with Innovex.

Fool on!

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07/13/98 Close

Stock Change Bid ---------------- AMZN + 8 107.50 AOL +6 3/8 118.88 T - 1/4 56.75 DJT + 1/16 7.81 DD + 3/8 68.50 XON -1 1/4 70.50 INVX - 1/4 14.38 IP - 1/4 42.88 IOM - 1/16 5.81 KLAC - 1/4 26.75 LU +3 1/16 89.44 SBUX + 7/16 57.50 COMS - 1/8 28.81 TDFX +2 11/16 19.69
Day Month Year History Annualized FOOL +4.13% 5.82% 51.02% 406.81% 51.02% S&P: +0.08% 2.77% 20.07% 154.19% 26.74% NASDAQ: +1.16% 3.74% 25.17% 172.92% 29.05% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 118.88 3169.00% 9/9/97 580 Amazon.com 19.11 107.50 462.51% 5/17/95 1960 Iomega Cor 1.28 5.81 353.96% 10/1/96 84 LucentTech 23.81 89.44 275.66% 8/12/96 130 AT&T 39.58 56.75 43.39% 2/20/98 215 DuPont 59.83 68.50 14.48% 2/20/98 200 Exxon 64.09 70.50 10.00% 4/30/97 -1170*Trump* 8.47 7.81 7.75% 7/2/98 235 Starbucks 55.91 57.50 2.85% 2/20/98 270 Int'l Pape 47.69 42.88 -10.10% 1/8/98 425 3Dfx 25.67 19.69 -23.30% 8/13/96 250 3Com Corp. 46.86 28.81 -38.52% 8/24/95 130 KLA-Tencor 44.71 26.75 -40.17% 6/26/97 325 Innovex 27.71 14.38 -48.12% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 84401.25 $81819.38 9/9/97 580 Amazon.com 11084.24 62350.00 $51265.76 5/17/95 1960 Iomega Cor 2509.60 11392.50 $8882.90 10/1/96 84 LucentTech 1999.88 7512.75 $5512.87 8/12/96 130 AT&T 5145.11 7377.50 $2232.39 2/20/98 215 DuPont 12864.25 14727.50 $1863.25 2/20/98 200 Exxon 12818.00 14100.00 $1282.00 4/30/97 -1170*Trump* -9908.50 -9140.63 $767.88 7/2/98 235 Starbucks 13138.63 13512.50 $373.88 2/20/98 270 Int'l Pape 12876.75 11576.25 -$1300.50 8/24/95 130 KLA-Tencor 5812.49 3477.50 -$2334.99 1/8/98 425 3Dfx 10908.63 8367.19 -$2541.44 6/26/97 325 Innovex 9005.62 4671.88 -$4333.75 8/13/96 250 3Com Corp. 11715.99 7203.13 -$4512.87 CASH $11876.47 TOTAL $253405.78

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