Many of us have a tendency to want to follow something, invest in something, believe in something, or root for something well after it has done well. Witness: Swarms of investors buy the latest, hottest mutual funds just in time to see them cool down, more people owned stock in early 2000, at the peak, than any other time in history, and winning sports teams soon find they have more fans than ever imagined. (I can't wait for the Cubs to make the World Series. No, really, I can't. I don't have that many decades left.)With that in mind, it's time to review how our holdings did in the year 2002 -- the year of corporate scandal, "Waiting for Terrorists," "Iraq in the Crosshairs" (that classy cable news!), and Year 3 of "Market Meltdown" (trademarked probably by CNBC). We had a few strong investments in '02, so the question now is, "As they attracted more investors last year, will the stocks remain strong this year? And what really matters -- will they be strong for many years to come? And will Louis Rukeyser use less makeup than a cadaver?" First, as if you needed the cheery reminder, the major indexes tanked again last year. The S&P 500 lost 23%, the Nasdaq, plunging more than a plunger, is down another 31%, and the Dow lost a comparatively benign 17%, which was its worst annual loss since bell-bottoms. I mean, the first time. Our portfolio was a non-event. Really. It was. It stuck with the market averages like cotton sticks on candy that is sticky after being licked, or when a sucker's put on the floor and picks up a bunch of hair. Let's take a look.
Company 2002 return
(or reduction) LendingTree (Nasdaq: TREE) +118% *Sirius Satellite (Nasdaq: SIRI) -95% Amazon.com (Nasdaq: AMZN) +75% Starbucks (Nasdaq: SBUX) +7% eBay (Nasdaq: EBAY) +1% Amgen (Nasdaq: AMGN) -14%
S&P 500 -23% Overall RB return -23% *Guitar Center (Nasdaq: GTRC) +21% AOL Time Warner (NYSE: AOL) -59% Millennium (Nasdaq: MLNM) -68%
Six of our investments topped the S&P 500, and three lost to it. The toppers outweighed the floppers. LendingTree had a tremendous run, having started the year around five bucks a share. We didn't buy it until $13, so we didn't see that return. Sirius Satellite had a disastrous year, where only the shorts made money. We were on the right side of that one. The next eye-popper is Amazon, up 75%. Wasn't 2002 the worst holiday shopping season for, what is the media saying, 1,800 years? Whatever, it was a bad year for retail. All of it. Sears (NYSE: S) blew up. Home Depot (NYSE: HD) blew up. Merry-Go-Round blew up. (Well, they went bankrupt in the early '90s, but roll with me here.) Yet, Amazon soared. Amazon -- our winged chariot, our roaring provider of life, our online Eden -- yeah, it rose.
The stock sits mightily at $21 per share, giving the company a market value of $8 billion. Twice, sometime in 2001, I wrote that at around $14 per share I'd wait to buy the stock -- that it looked pricey, that there was time to wait until it was closer to profitability, because it probably wouldn't do much. And for a long time it didn't. Except, well, then it vaulted 50%.
Why? Why?! Because David Gardner picked it at $14 in Motley Fool Stock Advisor a few months back? Because now it's close to seeing profits? Because lower prices helped sales? Anyway, what's more important now is will the stock hold this Park Place price, or will it drift back down? Is there upside for investors chasing last year's good thing, or is it too late? And does Pete Rose cut his own hair? (I sometimes do. And it shows.)
Let's look at some financials. Amazon will have about $3.9 billion in 2002 sales. It had free cash flow of $120 million the last 12 months. This will pop in quarter four alongside an expected pro forma operating profit. The company recently had $327 million in cash and equivalents and $2.2 billion in long-term debt, giving it an enterprise value of $9.9 billion.
Its net loss was $151 million the first nine months of 2002, much better than the $572 million lost the same period of 2001. Finally, compromised as it is, a pro forma profit is expected this year and in 2003. The company trades at 81 times trailing free cash flow, and 87 times the average estimate of $0.24 per share for 2003 earnings. Right now, sales are expected to grow about 10% in '03, but I'm betting Amazon will raise guidance into the teens after a strong 2002.
So, Amazon in a nutshell: Business shaping up, cash position certain, free cash flow set to climb, a safer buy than when things were much less certain 18 months ago, but also less likely to beat the market here at forward multiples above 80 and long-term growth rates well below that. Business risk is much lower now, but valuation risk is considerable. That said, Amazon will likely see its free cash flow soar the next few years.
So, a good buy here? Or too pricey? I don't know. We can't know. For one thing, the market doesn't always care about valuation (did you notice that?). At least not in the intermediate term. So, I don't know. Nobody knows. I could pretend to know and then charge you for the answer, if you want. (Or, in The Motley Fool Select, we give you enough analysis and information to make your own decisions.)
Let's move to some other deep observations about our stocks and 2002. Look at the list up there again. (Or don't. Suit yourself.) What's interesting to me is that Starbucks and eBay, two stocks many people think perpetually overvalued, both rose as the market tanked. Either the things deserve their premiums or they're (for a few years now) living on borrowed time.
I side with the "They deserve it" camp -- until they do something wrong, that is. Like Amazon, valuation makes them risky. One misstep and... But no misstep, and the train keeps going. (eBay is at 62 times '03 earnings estimates, while growing around 50%. Starbucks, 26 times estimates while growing 20%.) Amgen also held up well to the indexes, despite many seeing it as richly valued. At 28 times '03 earnings estimates, and growing 25%, I think Amgen is positioned to at least retain its value, in the intermediate term, and rise later.
Guitar Center, our newest position, was sold short after it rose last year, so we were sitting on even money there -- until it jumped 21% today. The company stated strong year-end sales. After its numbers are released, we'll have more to say. Tom Jacobs (TMF Tom9) is expecting more erosion of fundamentals while management keeps everyone focused on sales.
Finally, Millennium Pharmaceuticals, our absolute worst investment in 2002, is the only one we bought more of last year. At least you can't say we only chase the hot ones. Hopefully our contrarian purchase will pay off. If not, we'll blame Tom Jacobs.
Have a great... yeah, yeah... everyone. Smile. Goodbye. Wave. Trip off stage.
Rule Breaker Portfolio Returns as of 1/07/03 Market Close:
RB S&P S&P 500 Port 500 DA* Nasdaq Week 6.53% 5.64% -- 6.11% Month 5.97% 5.59% -- 6.43%
Year 5.97% 5.59% -- 6.43%
using IRR** since 8/4/94*** 21.53% 8.74% 10.49% 8.40%
10/20/98*** 1.24% -3.25% -2.87% -4.65%
*Dividends added. Or, danger ahead. Whatever.
**Compound Annual Growth Rate using Internal Rate of Return. This performance measure is more meaningful than total return because we began adding cash occasionally in July 2001. In a total return calculation, or ((Current Value - All Cash Deposited)/All Cash Deposited), cash added would show up as returns. And that wouldn't be cricket!
***What's this? The Rule Breaker Portfolio's precursor, the Fool Portfolio, was born Aug. 4, 1994. In a 10/20/98 column, David Gardner announced the name change of the Fool Portfolio to the Rule Breaker Portfolio. Here we provide returns as if the RB Port started on either date. Remember, don't mimic any online portfolio. Most individual investors should restrict any positions as risky as these to under 20% of their portfolio -- and could have a long and happy investing life with 0%.