Look at the 11 companies in the Rule Maker Portfolio and you'll see that we're weighted heavily towards big companies. Scratch that, enormous companies.
This makes sense. By definition, Rule Makers are dominant companies that generate lots of cash in attractive industries. These attributes make it possible for the companies to grow quickly. Here's a look at our companies' trailing 12-month sales and market cap in billions:
Sales Market Cap P/E Amer. Express $23.3 $66 24.7 Cisco 21.5 301.4 103.1 Intel 33.7 216.6 21.3 JDS Uniphase 2 58 n/a Coca-Cola 20.5 141.7 75 Microsoft 23.8 296 31.8 Nokia 26 192 57.0 Pfizer 29 259.5 69.1 Schering-Plough 9.7 77.7 33.3 T. Rowe Price 1.2 5.1 19.4 Yahoo! 1.1 19.2 344.4 Mean $18.93 $148.4 77.9A few trivial facts caught my eye. First, Pfizer (NYSE: PFE) has the second-highest sales in the group, $29 billion, while Microsoft (Nasdaq: MSFT) isn't even in the top three. Schering-Plough (NYSE: SGP), our other pharmaceutical holding, has just $10 billion in sales. Second, T. Rowe Price (Nasdaq: TROW) is the only company in the portfolio with a market capitalization under $10 billion. In fact, it's half that, at $5 billion. Third, the mean (average) market value of companies in our portfolio is $148.4 billion, compared to $23.4 billion for the S&P 500; and the mean P/E of our portfolio is 78 compared to 24.6 for the S&P. Fourth, our portfolio has six technology companies, two pharmaceuticals, two finance companies, and one consumer brand.
I don't take this list or the above comparison with the S&P 500 too seriously. We don't spend a lot of time looking at trailing P/Es (we focus on free cash flow). And, we didn't set out to balance the portfolio with mid-cap and large-cap, or so-called new economy and old economy companies. We just looked for companies with the best economic characteristics we could find. I think we found a pretty good group.
Still, the list whispers that we've packed the portfolio with very large, very well known, very expensive stocks, and I think we could find other fishing grounds using the Rule Maker criteria. Last week we wrote about Charles Schwab (NYSE: SCH) (Is Charles Schwab Worthy?) and Applied Materials (Nasdaq: AMAT) (Applied Materials' Great Expectations) as potential Rule Makers, two dominant firms that generate lots of cash. Great companies, to be sure, but they don't stand out as particularly distinctive from what we already have. On the Rule Maker Master List, for example, readers can pore over a list of more than 50 companies ranked by the Rule Maker criteria. It's worth a look. Thumbing through these companies got me thinking in broader terms.
Let me set forth three companies worth a closer look with lower market values and sales than most of our Rule Makers. I've made an effort here to look for established companies that operate in industries with predictable revenue streams. For that reason, I left out otherwise attractive companies such as worldwide online trading leader eBay (Nasdaq: EBAY), a consumer franchise with a powerful advantage: a customer base that's locked in. As appealing as this firm is -- appealing enough to be included in the Rule Breaker Portfolio -- I wouldn't consider it appropriate for the Rule Maker Portfolio until sales topped $1 billion and I had a better handle on the company's long-term growth prospects. (Of note, eBay reported strong earnings and impressive operating metrics late last week which the Fool covered in-depth.)
Each of these contenders has powerful Rule Maker characteristics, though none except Intuit (Nasdaq: INTU) has the whole package. You might completely disagree with these suggestions, but each of these companies has plenty of room to grow and possesses a competitive advantage that should keep its earnings marching steadily upward.
- Timberland (NYSE: TBL). What I like about this company is its established brand name and track record of success in perhaps the most attractive and versatile segment of the footwear industry: brown shoes. The company has grown sales almost 19% through the first nine months of 2000, has no long-term debt, sports profit margins in the 10% range, and generates good cash on an annual basis. Over the last 10 years, it has grown at a 46.5% annual rate (mainly because of a powerful run-up over the last two years), and it's just crossing the $1 billion sales barrier. It has a market value around $2.7 billion. It's expensive thanks to its recent performance, but I consider it a company to keep an eye on.
- Estee Lauder (NYSE: EL). The country's premier cosmetics, skin care, and fragrance company, Estee Lauder's stock has grown at a 20.8% annual rate since 1995. Brand name products with strong customer recognition include Clinique, Origins, and Aveda. Gross margins topping 60% give the company the resources to develop sales clerks into an elite group. Sales grew 10% to $4.4 billion last year, though high operating costs have kept its net margins below 10%. Its market value is just under $10 billion.
- Intuit. King of the personal finance software world, Intuit has net margins of nearly 30%, 12 times more cash than debt, sales that grew 30% last year, and 27.7% annual returns over the last seven years. It just topped $1 billion in sales in its latest fiscal year and has a $7.5 billion market value. In addition to its light business model, Intuit's dominance in the personal finance arena has given it a foothold to expand its business onto the Web with online tax filing and small business management software.
This exercise convinced me more than ever that pure Rule Makers are an elite bunch, a coterie of companies that operate in their own universe. Finding profitable and smaller Rule Makers off the beaten path isn't an easy chore, and the stock screens I ran produced very few companies we haven't already recognized as Rule Maker candidates that meet our criteria.
So, is that all there is in our universe, a group of maybe 30 or 40 large, true Rule Maker stocks? Strictly speaking, yes. That means the Rule Maker strategy is really more of a waiting game than a hunt for unknown gems. Identify a basket of Rule Makers and wait for an opportunity to purchase them at a price you determine is attractive.
Nevertheless, the heart of the Rule Maker philosophy, in my opinion, is to find highly profitable companies with strong competitive advantages at reasonable prices. There are companies that fit this mold that don't perfectly fit our criteria, and it's worth casting a large-enough net so that you pull up some different candidates for consideration from time to time.
Have a great day.