What Happened to Cash-King?

Yahoo! vs. AOL

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

Glendale, CA (Jan. 15, 1999) -- As I mentioned Wednesday, two days before last Christmas I used a small portion of my son's college fund to invest in an "Internet stock." I had been studying these three companies for the better part of a year, all Top Dogs and First Movers in their respective areas of business:

  • Amazon.com (Nasdaq: AMZN) - the mass retailer (or is it e-tailer?).

  • America Online (NYSE: AOL) - far and away the number one on-line service.

  • Yahoo! (Nasdaq: YHOO) -- the number one "portal" to the Web for people at work.

Today's column is about how I chose between them.

Of the three, Amazon.com had performed the best over the past year, and yet I quickly rejected it. This is not because I have anything against the company; indeed, I believe that all three of these companies are truly great. However, I had two main reasons for passing up on Amazon.com in spite of the fact that it has made a ton of money for other people (and more than either AOL or Yahoo! last year):

  1. It hasn't made any money yet. This isn't a death knell, but it does make the company much harder for me (and I believe the market) to value. Given a choice, I'd rather go with one of the other two companies where I have a better handle on how much future profits are likely to be.

  2. Margins for Amazon.com are much lower than for AOL, or Yahoo!. Many businesses can thrive with low margins, if asset turnover is high enough, and Amazon.com could very well be one of them. Personally, however, I like to see low margins turn into profits before I invest (which takes me back to point 1.)

On the other hand, I found the choice between AOL and Yahoo! very tough. In the end, I believe that if two people fight about these companies, and each invests in her favorite, then the loser will cry all the way to the bank. At the time, however, I didn't feel I had enough money to invest in both companies so I had to pick one. This is why I selected Yahoo!:

  • Yahoo! is based on an open standard, the Internet, whereas AOL is proprietary. In general, open standard architectures provide more room for growth than do proprietary standards. I always think about the difference between the PC and Apple in this area, although I understand that this analogy is not completely fair.

  • AOL has ease of use.

  • Yahoo! has better access (for example, I can't use AOL at work).

Currently, I'm concerned about the merger between AOL and Netscape. It could work out very well, and in fact it may well solve the open standard problem described above. At the same time, I'm concerned about a culture clash between AOL and Netscape.

In this area, I'm reacting, and possibly over-reacting, to a mistake I almost made in the spring when I had to decide between buying 3Com (Nasdaq: COMS) and Cisco (Nasdaq: CSCO). I was all set to buy 3COM, but a Motley Fool evening news series warned of possible problems with the merger with US Robotics. I wound up buying bought Cisco (Nasdaq: CSCO) at a split-adjusted price of about 22. It hasn't worked out too badly.

Right now, I prefer to wait for AOL to successfully assimilate Netscape before buying its stock.

Yahoo's high margins are very appealing. Moreover, the striking similarities between Yahoo's financials and those of Microsoft (Nasdaq: MSFT) make me drool. I understand that Yahoo! currently has nothing like the monopoly power over the Internet that Microsoft has over operating systems, but the very thought that it could be leaning that way sends chills down my spine. Yahoo! has more than $500 million in cash and equivalents (in addition to its extremely valuable stock) to purchase smaller companies and consolidate its hold as the number one portal at work.

On the other hand, make no mistake about it, there is a lot of risk involved with an investment in Yahoo! The Fool's new book calls Yahoo! a "Tweener," meaning that there are alternatives to Yahoo! on the market, like Lycos (Nasdaq: LCOS). These alternatives may not be as good as Yahoo! (or then again, they may), but in any event they will get the job done. Some Tweeners go on to become Rule Makers, but many others descend into a "death rattle."

As I mentioned above, Yahoo! has a ways to go to truly build the legal monopoly power of most Rule Makers. AOL on the hand, is already a Rule Maker with true monopoly power in the online service area. Yahoo! is clearly the riskier of the two companies right now, I favor it because I believe it has more potential in the long run. I think it can be a better Rule Maker than AOL, IF it becomes a Rule Maker at all.

However, at this point, I think it important to mention something I wrote on Wednesday, namely that "the best mistakes to learn from are other peoples'. In this case, perhaps in the next few weeks or months you will be able to learn from mine."

Yahoo! might drop by 50% or much more in the future if it begins to look like it won't be a leading portal on the Internet. Maybe Yahoo! will lose market share to AOL/Netscape, and Alex will lose some money. Fortunately, he already has some protection since Yahoo! has run up quite a bit in the last few weeks. However, stocks tend to fall harder and faster than they rise, and I don't expect Yahoo! to be an exception if the fundamentals aren't there. On the other hand, the prospect that Yahoo! can perform over the next 13 years like Microsoft has over the last thirteen makes taking some chances prudent.

Last but not least, in case anyone was wondering, in the event that Yahoo! just doesn't pan out, then Alex should still be OK. You see, I've already used the other 96.5% of his college fund to buy Microsoft, and Cisco, and Pfizer (NYSE: PFE), and Schering-Plough (NYSE: SGP), and the Foolish Four (RP), and... well, you get the picture.

That's it for now. Rob will be with you on Monday, and I'll be back in three weeks.

Until then, Fool on,


01/15/99 Close

Stock  Change    Bid
AXP   +8 3/8   104.38
CHV   +  3/16  80.06
CSCO  +5 5/16  101.69
KO    +1 3/16  64.88
GPS   -  13/16 57.44
EK    -1 1/2   69.00
XON   +1 5/16  71.06
GM    +2 5/16  83.31
INTC  +1 5/8   135.38
MSFT  +8       149.75
PFE   +2 1/8   115.63
SGP   +1 5/8   52.75
TROW  +1       34.38
                   Day   Month    Year  History
        R-MAKER  +2.67%   2.58%   2.58%  33.49%
        S&P:     +2.56%   1.14%   1.14%  23.58%
        NASDAQ:  +3.14%   7.09%   7.09%  40.92%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    149.75    91.33%
   6/23/98   34 Cisco Syst    58.41    101.69    74.09%
    5/1/98 55.5 Gap Inc.      34.06     57.44    68.64%
   2/13/98   22 Intel         84.67    135.38    59.88%
    2/3/98   22 Pfizer        82.30    115.63    40.49%
   8/21/98   44 Schering-P    47.99     52.75     9.91%
    2/6/98   56 T. Rowe Pr    33.67     34.38     2.08%
   5/26/98   18 AmExpress    104.07    104.38     0.30%
   2/27/98   27 Coca-Cola     69.11     64.88    -6.12%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     83.31    15.06%
   3/12/98   20 Exxon         64.34     71.06    10.46%
   3/12/98   20 Eastman Ko    63.15     69.00     9.27%
   3/12/98   15 Chevron       83.34     80.06    -3.94%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3594.00  $1715.55
   6/23/98   34 Cisco Syst  1985.95   3457.38  $1471.43
    5/1/98 55.5 Gap Inc.    1890.33   3187.78  $1297.45
   2/13/98   22 Intel       1862.83   2978.25  $1115.42
    2/3/98   22 Pfizer      1810.58   2543.75   $733.17
   8/21/98   44 Schering-P   2111.7   2321.00   $209.30
    2/6/98   56 T. Rowe Pr  1885.70   1925.00    $39.30
   5/26/98   18 AmExpress   1873.20   1878.75     $5.55
   2/27/98   27 Coca-Cola   1865.89   1751.63  -$114.27

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1416.31   $185.42
   3/12/98   20 Exxon       1286.70   1421.25   $134.55
   3/12/98   20 Eastman Ko  1262.95   1380.00   $117.05
   3/12/98   15 Chevron     1250.14   1200.94   -$49.20

                              CASH    $120.62
                             TOTAL  $29176.65

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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