<THE RULE MAKER PORTFOLIO>
What Happened to Cash-King?

Learning By Experience
How Cannondale Got a Flat

By Phil Weiss (pweiss@homemail.com)

Towaco, NJ (Jan. 8, 1999) -- Normally when I write about companies in this space, I write about companies that are potential candidates for inclusion in this portfolio. Not tonight.

In my opinion one of the most important aspects in investing is the ability to learn from our past actions. When we make a buy or sell decision, the market doesn't stop trading the stock, so that gives us the ability to see how our decisions worked out. As a general rule, on the rare occasions that I sell a stock, I don't follow it too much after that. Tonight though I'm going to revisit a small cap stock that I bought in July 1997 and sold in February 1998.

After following the stock for a couple of months, I purchased shares of Cannondale (Nasdaq: BIKE), which manufacturers bicycles and bicycle accessories. I purchased this company based upon valuation reasons rather than the "quality" reasons that we normally focus on in this portfolio. The valuation work I did on the stock made the stock appear to be grossly undervalued. At the time of my purchase, I did have some concerns about the "quality" of the balance sheet (particularly receivables and the related turnover), so I called the company and obtained a level of comfort. I also learned from some other research that the company managed these items much better than the competition that I studied.

I bought the stock and followed it much more closely than the kind of stocks that we typically hold in this portfolio. I really didn't mind this since one of my favorite hobbies is biking, and I had been considering the company's products while shopping for a new bike that spring and summer. After holding the stock for between six and seven months in a non-taxable portfolio I decided to sell it. Here is a link to a message I posted on Cannondale's Message Board when I sold the stock.

Although the turnover of both accounts receivable and inventory was better when I sold the stock than it was when I purchased it, I was disappointed because it hadn't improved as much as I had expected. Additionally, receivables were turning over more slowly on a comparable quarter basis. And, the company's cash balance was still painfully low.

A few weeks after I sold it, the company's stock took a hit after this announcement. A look at the stock's chart since then paints a pretty ugly picture. It's now trading at a price that's about 60% lower than it was when I sold it.

From my perspective, this means that I made a good decision in deciding to sell this stock. But, the purpose of writing this wasn't to pat myself on the back. It was really to look at what's happened to the company's financial statements since I sold it and what problems the poor quality of its balance sheet have caused.

The company still is having trouble turning over both its receivables and its inventory. In addition, its cash balance is still extremely low. So, what has this led to? To start with, long-term debt is now nearly 70% higher than it was at the time that I sold my stock. In my view, this is because Cannondale is finding that its lack of cash on hand is making it more and more difficult to fund its day-to-day operations.

Both gross and net margins have fallen since the time that I sold as well. This could be because the company is finding its business environment increasingly competitive. It could also be because the company is trying to increase its revenues by lowering prices. Either of these could easily be related to its attempts to meet its cash and/or debt servicing needs. If Cannondale's balance sheet had been stronger to start with, it most likely wouldn't have had to keep borrowing money or lowering its margins wouldn't have been so damaging. It also wouldn't have paid as much in interest expense. These are some of the reasons that we like to see our Rule Makers have high margins and a strong balance sheet.

What this helps reinforce for me is the importance of looking at the financial statements of a company when you want to add it to your portfolio. This applies no matter how you classify the stock (i.e., Rule Maker, Rule Breaker, small cap, large cap, mid-cap, whatever). It also shows why you have to be willing to follow a company more closely when it isn't a Rule Maker. By keeping up with the company's performance, and having a relatively short fuse on deviations from its expected performance, I was able to avoid taking a bath on this stock.

This example also reminds me that just because a stock looks like it's a good value doesn't mean a thing unless it's got good financial statements as well.

That wraps things up for me this week. I'll be back three weeks from Monday. In the meantime, I'll see you on our message boards, linked at the top right of this page.

Have a Foolish weekend,

Phil Weiss

01/08/99 Close

Stock  Change    Bid
AXP   +3 1/4   108.06
CHV   +  1/16  83.94
CSCO  +3 1/16  106.69
KO    -1 7/16  68.00
GPS   -1 15/16 61.19
EK    -  5/16  72.31
XON   -  7/16  74.31
GM    +2 7/16  80.00
INTC  +  7/16  129.69
MSFT  -  5/8   149.88
PFE   -2 1/4   122.25
SGP   -1 13/16 55.00
TROW  -  15/16 36.44
                   Day   Month    Year  History
        R-MAKER  -0.47%   5.74%   5.74%  37.61%
        S&P:     +0.43%   3.74%   3.74%  26.76%
        NASDAQ:  +0.79%   6.92%   6.92%  40.69%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    149.88    91.49%
   6/23/98   34 Cisco Syst    58.41    106.69    82.65%
    5/1/98 55.5 Gap Inc.      34.06     61.19    79.65%
   2/13/98   22 Intel         84.67    129.69    53.16%
    2/3/98   22 Pfizer        82.30    122.25    48.54%
   8/21/98   44 Schering-P    47.99     55.00    14.60%
    2/6/98   56 T. Rowe Pr    33.67     36.44     8.21%
   5/26/98   18 AmExpress    104.07    108.06     3.84%
   2/27/98   27 Coca-Cola     69.11     68.00    -1.60%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     74.31    15.51%
   3/12/98   20 Eastman Ko    63.15     72.31    14.51%
   3/12/98   17 General Mo    72.41     80.00    10.49%
   3/12/98   15 Chevron       83.34     83.94     0.71%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3597.00  $1718.55
   6/23/98   34 Cisco Syst  1985.95   3627.38  $1641.43
    5/1/98 55.5 Gap Inc.    1890.33   3395.91  $1505.58
   2/13/98   22 Intel       1862.83   2853.13   $990.30
    2/3/98   22 Pfizer      1810.58   2689.50   $878.92
   8/21/98   44 Schering-P   2111.7   2420.00   $308.30
    2/6/98   56 T. Rowe Pr  1885.70   2040.50   $154.80
   5/26/98   18 AmExpress   1873.20   1945.13    $71.93
   2/27/98   27 Coca-Cola   1865.89   1836.00   -$29.89

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon       1286.70   1486.25   $199.55
   3/12/98   20 Eastman Ko  1262.95   1446.25   $183.30
   3/12/98   17 General Mo  1230.89   1360.00   $129.11
   3/12/98   15 Chevron     1250.14   1259.06     $8.92

                              CASH    $120.62
                             TOTAL  $30076.71

  
Note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.


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