<THE RULE MAKER PORTFOLIO>

Cisco's Q2 Earnings...
...Rule Maker Style

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

NEW ORLEANS, LA (Feb. 9, 1999) -- As promised, today we're going to take a look at the most recent quarterly report of Cisco Systems (Nasdaq: CSCO) -- in the manner that a Rule Making investor would on a routine, quarterly basis after she had already added the company to her portfolio. Tom and Phil have done this exercise with most of the other RMs in our portfolio already, and Cisco is one of the last to report, since its fiscal year closes near the end of July.

Before I get started, you may have noticed from yesterday's and today's dateline that I'm writing this report in New Orleans. This is my first visit. I'm here for a business meeting, but my wife has joined me and we have turned this into a vacation as well. Now that I'm here, I've discovered that New Orleans has some of the finest restaurants in the country. I would encourage any Fool who has the chance to stop by and enjoy the wonderful New Orleans cooking at any opportunity possible.

In addition, and quite by accident, I seem to have found myself in the middle of the New Orleans experience that they call Carnival, which ends in Mardi Gras. I have certainly never seen anything that approaches it. I understand that many people come to New Orleans every year to take part in this activity. For many others, once is plenty. In either case, I do believe that Carnival is something that Fools should try to take part in at least once. After that, you're on your own. In addition, if you are married, or otherwise involved, I strongly recommend that both partners experience Carnival together.

So ends the travelogue; it's time to return to Cisco. First, let me note that Dale Wettlaufer put together a nice summary of the Cisco earnings release himself last week and he'll be cranking out a conference call synopsis soon. Even though Dale and Alex Schay look at things at little differently over in the Boring Portfolio (for example, they are very concerned with a company's return on invested capital), I think you'll notice that Cisco measures up quite well on their standards.

Of course, we want to look at how Cisco is doing on our standards. These standards are laid out in chapters 11 - 14 of Rule Breakers, Rule Makers (a.k.a. the RuleBook). The idea is to get Rule Maker "points" -- the more points the better, with a perfect score being 60 (Microsoft is the current champion with 59!).

Chapter 11 measures a company on Brand. It includes a number of subjective criteria that determines whether a company is familiar, open, optimistic, legitimate, inevitable, solitary, and humorous. Each of these is worth 1 point apiece. Once a company achieves these goals, it's unlikely that it will lose them. Cisco already earned points in all categories except familiarity, so we'll keep its Brand score at 6 and continue.

Chapter 12 is all about Financial Location. The tests for financial location are the familiar metrics laid out in Steps 6 and 7 and they are worth up to 2 points a piece. Cisco ranks as follows:

  1. Repeat purchase product -- Cisco's switches and routers are normally repurchased between one month and one year, giving the company 1 point.
  2. Gross Margins -- Cisco's 2nd quarter gross margin of 65.2% is good enough for the maximum 2 points.
  3. Net Margins -- The 2nd quarter net margin of 21.4% is also good enough for 2 points (only 10% is needed for 2 points).
  4. Sales Growth -- Sales grew 40% between 2nd quarter 1999 and 2nd quarter 1998. This is well above the 10% required for 2 points.
  5. Cash-to-Debt Ratio -- Zero. Zilch. Nada (I love the way that sounds when it refers to debt) -- 2 points.
  6. Foolish Flow Ratio -- (dollars in millions) Current Assets: $4,808,000; Cash and equivalents: $1,421,000; Short-term investments: $886,000; Remaining Current Assets: $2,501,000; Current Liabilities: $2,234,000.

    Foolish Flow Ratio: $2,501,000 / $2,234,000 = 1.12.

    A Foolish Flow Ratio between 1.0 and 1.25 is good for 1 point.

  7. Familiarity and Interest: Any company in the Rule Maker Portfolio gets 2 points
The total score as of the 2nd quarter 1999 for the Financial Location tests is 12. Cumulative score: 18

At this point, we are halfway through the complete set of metrics that is used to rank Rule Makers in the RuleBook. Cisco is looking very good at this halfway point, with a cumulative score of 18 out of a possible 21. However, the final two classes of metrics, Financial Direction and Monopoly Status carry more weight. I will cover those two classes tomorrow. Until then, Fool on.

Al

02/09/99 Close

Stock  Change    Bid
AXP   -1 1/8   95.94
CHV   -2       79.75
CSCO  -6       95.94
KO    +  1/2   61.94
GPS   -2 15/16 61.31
EK    -1 7/16  65.94
XON   -  1/2   72.19
GM    -1 1/4   84.69
INTC  -6 11/16 125.31
MSFT  -5 3/16  160.06
PFE   -6 3/8   125.13
SGP   -  5/16  52.88
TROW  -1 1/4   32.13
                   Day   Month    Year  History
        R-MAKER  -2.99%  -5.74%   2.20%  29.32%
        S&P:     -2.22%  -4.96%  -0.75%  22.87%
        NASDAQ:  -3.91%  -7.79%   5.39%  39.80%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    160.06   104.50%
    5/1/98   55 Gap Inc.      34.37     61.31    78.39%
   6/23/98   34 Cisco Syst    58.41     95.94    64.25%
    2/3/98   22 Pfizer        82.30    125.13    52.04%
   2/13/98   22 Intel         84.67    125.31    47.99%
   8/21/98   44 Schering-P    47.99     52.88    10.17%
    2/6/98   56 T. Rowe Pr    33.67     32.13    -4.60%
   5/26/98   18 AmExpress    104.07     95.94    -7.81%
   2/27/98   27 Coca-Cola     69.11     61.94   -10.37%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     84.69    16.96%
   3/12/98   20 Exxon         64.34     72.19    12.21%
   3/12/98   20 Eastman Ko    63.15     65.94     4.42%
   3/12/98   15 Chevron       83.34     79.75    -4.31%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3841.50  $1963.05
    5/1/98   55 Gap Inc.    1890.33   3372.19  $1481.86
   6/23/98   34 Cisco Syst  1985.95   3261.88  $1275.93
    2/3/98   22 Pfizer      1810.58   2752.75   $942.17
   2/13/98   22 Intel       1862.83   2756.88   $894.05
   8/21/98   44 Schering-P   2111.7   2326.50   $214.80
    2/6/98   56 T. Rowe Pr  1885.70   1799.00   -$86.70
   5/26/98   18 AmExpress   1873.20   1726.88  -$146.33
   2/27/98   27 Coca-Cola   1865.89   1672.31  -$193.58

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1439.69   $208.80
   3/12/98   20 Exxon       1286.70   1443.75   $157.05
   3/12/98   20 Eastman Ko  1262.95   1318.75    $55.80
   3/12/98   15 Chevron     1250.14   1196.25   -$53.89

                              CASH   $2205.98
                             TOTAL  $31114.29

Added $ 2,000 on August 4, 1998 to the portfolio; this will show in the numbers at a later date.

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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