What Happened to Cash-King?

Rule-Making Yahoo!: Part 2

By Al Levit (alanl@ix.netcom.com)

Glendale, CA (Jan. 14, 1999) -- Yesterday I wrote that I had picked Yahoo! Inc. (Nasdaq: YHOO) as my first "pure" Internet investment for my son Alex's college fund. Although Alex doesn't really understand it yet (he's only seven years old), he's already a Rule-Making investor, so Yahoo! is something of a change for his portfolio. Most people would think of Yahoo! as a Rule Breaker, not a Rule Maker, and perhaps that's where the company belongs. For today, however, I want to take a look a Yahoo! as a Rule Maker, and specifically as an investment for a Rule-Making investor who hasn't spread out to Internet investing yet.

I think that I share a common belief that the economy is rapidly changing to incorporate the Internet, and that this change will take many years, if not decades, to complete. However, at the same time, it seems as though a large segment of investors wanted to get in on this Internet boom already, and the prices of many stocks, perhaps including Yahoo!, have been bid to extraordinary levels by historical standards. We often mention that quality is 100 times more important than valuation when it comes to Rule-Making investing. I suppose that an argument could be made that the prices of some of the Internet stocks are approaching that 100 times threshold.

Thus, a question can arise as to whether it is too late to invest in the Internet. When I think of this question, I think of the investors who decided in 1990, and again in 1992, and again in 1996, and again in 1998, that it was too late to invest in Microsoft (Nasdaq: MSFT). As regular readers of these columns are aware, those investors wish that they had jumped in to Microsoft at any of those dates, in spite of what seemed to be a very expensive price each of those times.

Now, when I look at Yahoo! in terms of our Rule Making criteria from Step 6 I find that it is VERY close to being a Rule Maker, and it even performs at Microsoft's high level on most of the financial criteria. Specifically:

  1. Repeat Purchase Business -- I use Yahoo! several times a day (although I rarely "buy" by clicking through to an ad). The same is true for Microsoft (I use it all the time, but I rarely make a purchase).

  2. Global Consumer Brand -- I don't know about global, but Yahoo! is certainly a national brand. Yahoo! has maintained its market-share in the five years it's been around, in spite of the tremendous growth of the Internet. In Yahoo's 4th quarter earnings release it calls itself a global Internet media company, and if it is not well known on a global basis now, it will be before long!

  3. Strong historical performance -- Yahoo! began in 1995. Its performance has been phenomenal since then.

  4. Super-size -- In terms of market-cap, Yahoo!'s $30+ billion is more than enough. However, we usually like to see at least $1 billion a year in revenues, and Yahoo! is still a little short here. 1998 revenues were $200 million, but the way revenues are growing (from 70 million in 1997) the company should be there within a year or two.

  5. Direction is More Important than Location -- This is one of Yahoo's greatest assets. It is the number one portal on the Internet from work, and second to American Online (NYSE: AOL) from home. It continues to maintain its market share in an industry that doubles in size every 100 days.

  6. Margins -- We like to see our Rule Makers with gross margins of at least 50%, and net margins of at least 7%. We've long been impressed with Microsoft in this area (gross margins over 90% and net margins over 30%), but would you believe that Yahoo is at the same level? (OK, its gross margin was only 89.7% in the 4th quarter of 1998, but its net margin was 32.8%.) This kind of performance is truly outstanding in an industry where the vast majority of the companies are still losing money.

  7. Debt -- Microsoft doesn't have any. Neither does Yahoo!

  8. Flow ratio -- Microsoft beats everybody here, with a flow ratio of 0.26. Yahoo's ratio is 0.58, which is still very good.

Thus, I could make a case that Yahoo! is a Rule Maker right now. On the other hand, the youth of the company combined with the current lack of revenues make me wonder whether Yahoo! is quite ready. It might be better to think of Yahoo! as being "a Rule Maker in training," and the kind of company that might appeal to a Rule-Making investor looking for a more aggressive investment.

On that note, I'd like to add a few more thoughts:

  • The main aspects that drew me to Yahoo! in the first place were that it was an Internet investment that was actually making money, had high margins, and was a clear leader in the field. ("Top-dog and first mover," as the Rule Breakers would say.)

  • Another company that fulfills two of these three criteria would be American Online, which has been a 75-bagger for the Rule Breaker portfolio. I'll cover why I went with Yahoo! over AOL tomorrow.

  • With the big run-up in Internet stocks of late, many people are waiting for the prices to come back down. So far, those who have put their money where their mouth is by shorting the Internet stocks, almost any Internet stock, have been badly burned. Even so, many think, as it is frequently put, that the bubble is about to burst. If so, I believe that it is especially important for us "newcomers" to be:
    1. Invested in Top-dogs with real earnings like Yahoo! or AOL; and
    2. In it for the long-term like my son, Alex, is with his college fund.

I'll be back tomorrow to talk about Yahoo! vs. America Online. Until then, Fool on,


01/14/99 Close

Stock  Change    Bid
AXP   -2 11/16 96.00
CHV   -1 7/16  79.88
CSCO  +  1/2   96.38
KO    -1 9/16  63.69
GPS   -  11/16 58.25
EK    -8 3/16  70.50
XON   -  3/4   69.75
GM    -  11/16 81.00
INTC  -5 1/4   133.75
MSFT  -2 1/16  141.75
PFE   -3 3/16  113.50
SGP   +  1/16  51.13
TROW  -1 5/8   33.38
                   Day   Month    Year  History
        R-MAKER  -2.23%  -0.09%  -0.09%  30.02%
        S&P:     -1.80%  -1.39%  -1.39%  20.50%
        NASDAQ:  -1.73%   3.84%   3.84%  36.64%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    141.75    81.11%
    5/1/98 55.5 Gap Inc.      34.06     58.25    71.02%
   6/23/98   34 Cisco Syst    58.41     96.38    65.00%
   2/13/98   22 Intel         84.67    133.75    57.96%
    2/3/98   22 Pfizer        82.30    113.50    37.91%
   8/21/98   44 Schering-P    47.99     51.13     6.53%
    2/6/98   56 T. Rowe Pr    33.67     33.38    -0.89%
   5/26/98   18 AmExpress    104.07     96.00    -7.75%
   2/27/98   27 Coca-Cola     69.11     63.69    -7.84%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     81.00    11.87%
   3/12/98   20 Eastman Ko    63.15     70.50    11.64%
   3/12/98   20 Exxon         64.34     69.75     8.42%
   3/12/98   15 Chevron       83.34     79.88    -4.16%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3402.00  $1523.55
    5/1/98 55.5 Gap Inc.    1890.33   3232.88  $1342.55
   6/23/98   34 Cisco Syst  1985.95   3276.75  $1290.80
   2/13/98   22 Intel       1862.83   2942.50  $1079.67
    2/3/98   22 Pfizer      1810.58   2497.00   $686.42
   8/21/98   44 Schering-P   2111.7   2249.50   $137.80
    2/6/98   56 T. Rowe Pr  1885.70   1869.00   -$16.70
   5/26/98   18 AmExpress   1873.20   1728.00  -$145.20
   2/27/98   27 Coca-Cola   1865.89   1719.56  -$146.33

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Eastman Ko  1262.95   1410.00   $147.05
   3/12/98   17 General Mo  1230.89   1377.00   $146.11
   3/12/98   20 Exxon       1286.70   1395.00   $108.30
   3/12/98   15 Chevron     1250.14   1198.13   -$52.02

                              CASH    $120.62
                             TOTAL  $28417.93

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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