<THE RULE BREAKER PORTFOLIO>
Why We Own What We Own
eBay, AOL, @Home, Amazon
by Jeff Fischer (TMFJeff)
ALEXANDRIA, VA (May 25, 1999) -- Prices on the stock market changed again during the last 6 1/2 hours as a result of buying and selling, although most businesses didn't change one whit.
By now, stock market volatility is not surprising nor troubling to you. If you're a new Fool and you're not accustomed to volatility, here you have it. Here it is. Despite popular sentiment, volatility isn't a risk unless you use margin or you are a short-term investor. For long-term investors buying stock with their own funds -- not a novel concept, but a very smart one -- volatility is simply a sideshow during the long drive to a final destination.
Extreme market volatility can present opportunity, however, and can make you rethink your holdings, too. Let's do that.
Why we own eBay: The company is the leading online auction house, hosting over 2 million consumer-to-consumer and business-to-consumer auctions daily. eBay (Nasdaq: EBAY) has been profitable since year one, and its online industry is expected to grow 65% annually for the next five years. That's exciting.
More exciting is the next ten years. Based on estimated long-term growth rates, eBay could earn around $3.11 per share in 2004, and over $15 per share in 2010 assuming a natural slowdown in earnings growth after 2004. Before share dilution, the stock is at 10.9 times the ten-year ahead guess. Yes, we're thinking 10 years ahead.
As preposterous as it might seem to consider more than three years ahead and make earnings estimates, it hopefully makes the point that, long term, the valuations now granted leading New Economy companies can make sense given long-term potentials.
Why we own AOL: The number one online service in the world has 17 million members (over 19 million members total) at its fingertips. Whether or not America Online (NYSE: AOL) will need to lower its access fees or pay high-speed Internet providers part of its subscription fees, the company will always have the strength of its nearly 20 million members. It can leverage them through advertising, commerce, saleable applications, and special content charges, among other means. The strength is in the audience. During the gold rush of the online world, the key is to build a large community. Many long-term revenue possibilities follow.
AOL is already profitable, of course. It is expected to earn $0.57 per share next year and grow 52% annually the next five years. We'll knock that number down some (assuming closer to 43% growth) in order to arrive at a fiscal 2005 estimate of $3.43 per share, putting the stock at 33 times the forward estimate. As with eBay, it's another large guess. It could easily go either way. Given the growth of the Internet and AOL's strengths, a betting Fool (if there is such a thing) would bet to the upside.
Again, the point is that current valuations of New Economy leaders are not outlandish when one looks ahead five years and estimates potential -- that is, when the potential includes eventual success, which is a variable.
Why we own @Home: The leading high-speed cable access company in the country, with Excite under its belt to deliver content, is poised for its healthiest five years of growth starting.... NOW.
With the potential to grow from 300,000 subscribers to 1 million this year, and then to 5 million in the next four to five years, @Home (Nasdaq: ATHM) has the potential to grow more quickly than any other Internet Service Provider in the business. The year 2000 should be @Home's first fully-profitable year.
@Home is estimated to earn $0.45 per share in fiscal 2000 and grow over 90% for the next five years -- a giant growth estimate! We'll ratchet it down. Assume 90% growth in 2001, 80% in 2002, 70% in 2003, 60% in 2004, and 50% the following year (these five years will supposedly represent the boom for high-speed access), and you get year 2005 estimates of $6.27 per share before share dilution or Excite are added to the numbers. We have a stock at 18 times a wild but hopefully not idiotic $6 per share earnings estimate, while the underlying company should grow at a rate more than twice that P/E ratio -- more like three times or more.
Why we own Amazon: The real estate of the leading e-commerce site on the Internet will be worth its weight in gold one day. Sure, you laugh -- a site on the Web doesn't weigh anything.
The sentiment has apparently turned against Amazon (Nasdaq: AMZN), and we like that. The company and its stock have had an amazing two years, but of course this isn't the first time that doubts have lingered. Doubters have always overshadowed the company. Management has never said that it would be profitable anytime soon, but now the Wise are saying investors are tired of waiting for profits, so the stock is declining. Maybe. More likely, though, Amazon's stock is experiencing typical volatility for a new issue (this puppy is only two-years-old, after all -- still an infant on the market), and the Wise are using a lack of profitability as an excuse for the falling stock.
We don't mind falling stocks, however, because we don't plan to sell anytime soon. We mind falling businesses and we don't see any falling businesses in this portfolio. We see only rising businesses, and Amazon's is one of the more promising. Eight million users could turn into 20 million in five years; five primary product offerings could turn into ten offerings; millions in losses could become hundreds of millions in losses.
I joke. Eventually, management at Amazon will reel in its immense marketing and business development expenses and work to run a tight online ship that serves millions of customers daily at what could become one of the lowest operating costs per retail customer of any retailing business in operation. They're not idiots over there in Seattle. They're spending now. Expect losses. Bezos wants to gobble up as much of the online markets as he can. The pricing of many products online will probably follow a traditional curve that eventually leads to a few leaders pricing items slightly above cost and clearing a consistent profit. Nobody wants to put others out of business by destroying oneself, too.
Or, prices might fall to "at cost" levels and money will be made through other means -- advertising, referrals, transactions, etc. If anyone can do it, Amazon with its leading customer base can. The leading online retailer is now valued at $18 billion. Considering that the online commerce industry is expected to be worth a few trillion bucks in five years, if Amazon can profitably grab just a tiny fraction of that business, the stock should -- in 2005, 2010 -- prove a good investment today. That's providing that Amazon's business is executed successfully into profitability. Many businesses aren't.
Why we're short the Donald: The situation at Trump Hotels (NYSE: DJT) is not better than it was over two years ago when we shorted it, so we remain short the company and its stock. Even when it sat in the $3 range, we remained short. We did so for a few reasons. One, the business stinks. Two, the outlook isn't promising: more competition is due in Atlantic City during the next three years, and already casinos are proliferating around the country and taking a bite out of Trump. Three, we like having a short in the portfolio and Trump fits the bill. Four, we like being short a debt-heavy gambling house.
This company tries to make money by placing numerous traps against its potential customers -- its potential patrons -- and then luring them to its lair. It's good to see Trump get a taste of its own medicine, quarter after quarter, in the form of regular losses. Good businesses serve the community. Bad businesses try to take advantage of the community.
Don't expect us to cover Trump anytime soon. The company is still paying over 11% interest on well over one billion in long-term debt that helps insure quarterly losses. Unless Trump refinances, we probably won't cover the position. We'll wait for more competition, further devaluation of Trump property, and more life-sucking interest payments. Plus, we'll keep hoping that Trump takes on more leverage. We're hoping that Trump does invest in South American hotels. Sure. Why not? That's like having $100,000 due on your credit card and buying a new car with your Visa anyway, adding eventual misery on top of misery. The more that Trump can do that, the better our short position looks.
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Day Month Year History Annualized R-BREAKER -3.62% -21.21% 27.93% 1184.02% 70.16% S&P: -1.70% -3.80% 4.81% 193.75% 25.16% NASDAQ: -2.97% -6.37% 8.58% 230.60% 28.27% Rec'd # Security In At Now Change 8/5/94 2200 AmOnline 0.91 115.50 12608.37% 9/9/97 1320 Amazon.com 6.58 111.56 1595.67% 5/17/95 1960 Iomega Cor 1.28 4.69 266.09% 12/4/98 450 @Home Corp 56.08 112.81 101.16% 2/26/99 300 eBay 100.53 163.94 63.08% 12/16/98 580 Amgen 42.88 60.38 40.82% 4/30/97 -1170*Trump* 8.47 5.50 35.06% 2/23/99 300 Caterpilla 46.96 58.75 25.10% 2/23/99 290 Goodyear T 48.72 59.75 22.65% 7/2/98 470 Starbucks 27.95 33.81 20.96% 2/20/98 260 DuPont 58.84 67.88 15.35% 2/23/99 180 Chevron 79.17 91.19 15.18% 1/8/98 425 3Dfx 25.67 19.06 -25.73% Rec'd # Security In At Value Change 8/5/94 2200 AmOnline 1999.47 254100.00 $252100.53 9/9/97 1320 Amazon.com 8684.60 147262.50 $138577.90 12/4/98 450 @Home Corp 25236.13 50765.63 $25529.50 2/26/99 300 eBay 30158.00 49181.25 $19023.25 12/16/98 580 Amgen 24867.50 35017.50 $10150.00 5/17/95 1960 Iomega Cor 2509.60 9187.50 $6677.90 2/23/99 300 Caterpilla 14089.25 17625.00 $3535.75 4/30/97 -1170*Trump* -9908.50 -6435.00 $3473.50 2/23/99 290 Goodyear T 14127.38 17327.50 $3200.13 7/2/98 470 Starbucks 13138.63 15891.88 $2753.25 2/20/98 260 DuPont 15299.43 17647.50 $2348.07 2/23/99 180 Chevron 14250.50 16413.75 $2163.25 1/8/98 425 3Dfx 10908.63 8101.56 -$2807.06 CASH $9924.87 TOTAL $642011.43Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends in the yearly, historic and annualized returns). For a history of all transactions, please click here.
</THE RULE BREAKER PORTFOLIO>