Last week, I announced the Rule Maker's intention to sell Cisco (Nasdaq: CSCO). It may be a sign of the sway, considering the company's untouchable performance in the '90s, but the amount of correspondence I received over this single transaction was astounding.
A number of people "got it"; they understood that I sold Cisco, in part, because I believe any rebound in the company's profitability wouldn't accrue to me as an outside shareholder, but rather to company insiders. Others recognized that my sale of Cisco was, in no small part, a protest against what I consider to be shareholder-hostile positions on stock option accounting by lobbyist organization AeA, in which Cisco holds an influential position.
Some respectfully took issue with my position, many times and eloquently so, I might add. To these people, and you know who you are, I salute your choices and intellectual rigor. Certainly, I don't think everyone should sell Cisco, or any other company, based on my reasons. The AeA may get the message if enough people walk away from its member companies' stock (need the list again? Here it is: Group 1, Group 2, Group 3), but people should sell for the right reasons, just like those who buy.
Let me reiterate an opinion I share with Fed Chairman Alan Greenspan and Berkshire Hathaway (NYSE: BRK.A) Chairman Warren Buffett: Massive stock option grants have played a major role in the breakdown of accounting practices, as executives sought to use whatever means necessary, including those detrimental to the long-term position of their companies, to meet earnings and keep stock prices inflated.
Stock option grants were at historical highs in the late '90s. Bad capital allocations and accounting trickery were at historical highs in the late '90s. This isn't a coincidence. So, I sold Cisco, and I'll continue to sell the stocks of companies that belong to the AeA, the chief proponent of keeping stock option effects off the income statement.
One more thing. Several companies do account for employee stock options: AMB Property Corp. (NYSE: AMB), Bank One (NYSE: ONE), Boeing (NYSE: BA), Coca-Cola (NYSE: KO), Level 3 Communications (Nasdaq: LVLT), The Washington Post Co. (NYSE: WPO), and Winn-Dixie (NYSE: WIN).
If you know of others, or if your company has made the decision to do so, let me know. I'm going to keep a running tally.
A strange subset of people claimed the Rule Maker's selling of Cisco indicates the market has hit rock bottom, and that my decision was somehow a sign of "capitulation." Frankly, I doubt there's a cheesy nightclub in America with blinder bottom groping than in the U.S. market these days. Sadly, there are, in all likelihood, many more shakeouts to come. Those worshiping the god of Capitulation will be very disappointed.
My action isn't likely to turn the economy around. My action isn't likely to mark the last vestige of abuse of shareholders by an executive. And being that the market is both an economic and psychological beast, my action is in no way a harbinger for the blowout of the unwashed masses.
Lest this protest means nothing to you, I suggest you read last week's column more closely. We're buying! Our sale of Cisco is the aberration. We're not abandoning the stock market -- we're abandoning companies we don't believe in. Look for signs somewhere else, because there are some astounding bargains right now.
People are generally averse to loss and chance. While there are plenty of undervalued companies left out there, people aren't going to buy them. Well, we've got cash, and we're not afraid to use it.
We're buying two companies today, a new holding and an existing one. We've talked about both recently. Let's take the existing holding first. In Matt Richey's retrospective on the Rule Maker's decision to buy Johnson & Johnson (NYSE: JNJ) last month, he said that while he didn't think the company was overvalued, it wasn't much of a bargain above $42. Well, a quick 30% drop later, and J&J is below that price. We only hold precious few shares in J&J, since the stock price ran away from us after our first nibble in the equity in late 2000. I'm a little concerned about the allegations of wrongdoing at the company's Puerto Rican facility, but the drug in question represents only 4% of J&J's total revenues, so the massive drop would only be justified if the company faces significant litigation. Frankly, the accusations don't seem to hold much water. I can't be sure, but at current prices, I'm willing to assume that risk.
We will be buying approximately $1,000 of J&J in the next five business days.
Earlier this year, we ran a two-part study of the Rule Maker criteria using warehouse retailer Costco (Nasdaq: COST) as our test company. I chose Costco for many reasons -- suffice it to say that Costco's the quintessential Rule Maker. The company has revolutionized shopping with its big-box warehouses and bulk selections at rock-bottom prices. As we discussed before, Costco's biggest downside is its lack of free cash flow. The company is still expanding and will spend more than $1.1 billion in 2002 on new location openings. Tom Gardner made Costco one of his selections in the Motley Fool Stock Advisor at $36. We didn't think it would get there, much less 20% below that price. These are exciting times!
Costco nearly derailed this purchase when it last week announced intentions to open specialty furniture stores using the same big-box model. It's a yellow flag when companies venture off from core concepts, particularly those concepts that work extremely well. In as many cases as branching out leads to success, it's been part of the company's downfall or, even worse, a sign that things are worse than they appear. For every McDonald's (NYSE: MCD) with its Chipotle sidekick (mmm!), there's a Tyco (NYSE: TYC), which added more and more acquisitions to mask big financial problems at its core.
But two things lead me to believe this branch-out holds potential. First, Costco already has significant furniture offerings at its superstores, so it's quite familiar with the market. Second, the furniture business is uniquely suited to the big-box approach. Berkshire Hathaway subsidiaries Nebraska Furniture Mart, R.C. Willey's, and Jordan's Furniture have grown to dominate their home markets by virtue of their cost structures and unparalleled customer service. Berkshire Vice Chairman Charlie Munger is on the board of directors at Costco. Of course, he shouldn't give away Berkshire subsidiaries' store secrets (if he even knows them -- Berkshire is a pretty hands-off corporate parent), but it's safe to assume that Costco made its expansion plans with significant input from Mr. Munger.
Costco's price has dropped nearly 25% since we analyzed it earlier this year. At the time, I thought the company was at a fair value. Frankly, I was a little ticked that I didn't revisit it as an investment opportunity in late 2001, when it was as low as 30. Well, it's nearly there now, and I'm not going to let the same chance slip by again.
In the next five business days, we will be buying approximately $1,500 worth of Costco shares. I'm comfortable with the potential that Costco's shares may get cheaper as the stock market continues to purge. I'm pretty sure this won't be accompanied by a loss in value, and I pin the company's value at a price higher than the current price.
And here's the thing. We're not done buying by a long shot. I have full confidence that the U.S. economy is going to rebound -- that perhaps it's rebounding now. When the rest of the world is rushing to put their money under their mattresses (or in gold, same difference), I'm looking for bargains in some of the world's best companies.
The bad times may continue for a while. But this market, too, shall pass -- and, eventually, the speculative excess of the late '90s will burn off. Maybe we need to get a few more WorldComs out of our system, one or two more debt-addled poster children for bad corporate management -- wrecked monuments to the excess of an era of free money. But survivors exist today, and we're buying them.
Bill Mann, TMFOtter on the Fool Discussion Boards
[If you'd like to receive Rule Maker columns in your inbox, sign up for our free email newsletters.]
Bill Mann likes to balance anger and outrage with optimism and encouragement. He has beneficial interest in Cisco. Please see his profile for a full list of companies in which he holds an interest. The Motley Fool is investors writing for investors.