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August 9, 2000
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Rule Tweeners and the GG method
Rule Tweeners and the GG method
This is the third and final post in a series of articles comparing the GG method to the TMF methods of picking stocks. The GG vs TMF methods Trilogy.
Here are the first two:
Comparing GG and RM methods (long)
Comparing RB and GG investing methods
You may want to review these two posts before reading this one, since I build on some of the concepts presented before.
Rule Tweeners (RTs) are strange and rare beasts, indeed. They live somewhere in the realm between Rule Breakers (RBs) and Rule Makers (RMs). They show hybrid characteristics of both-type of companies, and as such offer superior returns. Rule Tweeners are leaders in their sector that have clawed their way out of their initial phase of existence into turbo-charged profit-making machines. I am talking about companies right smack in the middle of hypergrowth.
RTs live in the tornado, they are in the sweet spot of that S-curve with plenty of growth left in them.
Want some examples? OK, here are some:
YHOO the leading internet portal, sales growth last quarter of greater than 100% year over year, meets most of the RB criteria and has that light business model that makes RM enthusiasts drool. In the GG jungle YHOO is a prime example of a Godzilla succeeding very well.
Here's a recent RM article on YHOO:
JDSU is another case in point, it is riding the wave of fiber optics. As a King its tornado is very much far from over, and with its acquisition of SDLI it becomes ever more powerful in the space.
Rule Maker Port buys JDSU:
I believe JDSU fits most of the criteria for Rule Breaker and Rule Maker, a rare animal indeed.
1. Undisputed top dog in the fiber optics industry, market cap of around $90 billion.
2. RS>90 (great performer over the last year and the last 10 years)
3. Uniphase has great management and an outstanding marketing team, I've heard that JDS-Fitel was weak in this area. They merged last year, thus complementing each other perfectly.
4. With a PE of over 200 of course it is overvalued.
5. Great industry with long-term growth of over 50% a year (growing right now at over 100% year over year).
6. Clean balance sheet with lots of cash and no debt.
7. This behemoth is gobbling up small competitors just like CSCO.
8. While not a consumer brand, neither is Cisco. The demand for broadband and fiber optic products seems insatiable.
9. Lots of patents, business momentum and its competition in its sector is either very small or far behind (CSCO, LU, NT) in this area.
Now this post is not about Kings or Godzillas that meet both RB and RM criteria, it is about Gorillas, we want to find those young Gorillas that are still early in the tornado and have plenty of hypergrowth left in them. That's where the real money is to be made.
Let me propose some hybrid RB/RM/GG criteria that can help us find those young RT-Gorillas:
1. The top dog and first-mover in an important, emerging industry
Both RBs and RMs are top dogs, leaders in their sectors. Guess what, Gorillas also fit this bill.
2. Sustainable advantage gained through business momentum, patents,
visionary leadership, and/or inept competition...
Here's where many of the Gorilla characteristics fit in:
Proprietary open architecture
High barriers to entry
High switching costs
all of these GG characteristics assure long term profitability by milking their sustainable advantage.
3. Excellent past share appreciation, measured by a relative strength of
90 or higher...
Tornadoes engender sales growth of 100% year over year, this easily surpasses the RM mark of sales growth of at least 10%. The tornado indicates that the company has made it through the chasm. The market recognizes this and rewards its stock price very well, thus the RS of 90 or greater.
4. Good management and smart backing...
Execution is key, this is what drove a company to emerge as a Gorilla in the first place. Sharp management, that "gets it", is what allows the Gorilla to become one. Chambers at CSCO, Gates at Microsoft, Grove at Intel, Ellison at ORCL are all visionaries that knew how to drive their companies forward.
Strong value chain formation also plays a part in the smart backing. The value chain supports the Gorilla and accords it many benefits other companies don't enjoy.
5. The greater the consumer brand, the better...
Gorillas don't necessarily have a strong brand, but RMs do, and it certainly won't hurt. It is a sign of acceptance into Main Street.
6. A significant constituent of the financial media is recently on record
for calling it overvalued...
Gorillas are always considered overvalued, but that's what we are counting on in order to derive long term profits from these companies. The market is actually underestimating the Gorilla power.
Young Gorillas will usually fit into the Rule Tweener category. They are young dominant companies, in the middle of hypergrowth and with many good years of growth ahead. As Gorillas they can leverage their power to start showing great financial numbers, such as the ones present in the RM criteria, early in their dominance:
Gross margins of at least 50%
Net profit margins of 7% or greater
Cash no less than 1.5x total debt
Flow Ratio below 1.25
Cash King Margin of at Least 10%
Take Siebel Systems (SEBL), the CRM Gorilla, it meets most of the RM criteria and it is growing at RB pace:
Here's a RB Seminar analysis of SEBL:
I think ITWO, RMBS and QCOM as young Gorillas are in similar positions or will be in similar positions as their respective tornadoes form in full force.
Recently, Phileo offered this RB analysis of QCOM:
Rambus RB analysis on 3/4/00
Here are some RB analyses of ITWO from the March 2000 RB Seminar:
These Rule Tweener-Gorillas may offer some of the best investment opportunities out there. Their long-term fate is secure as long as no Discontinuous Innovations kill their Gorilla power and they are right within the sweet spot of the tornado, offering incredible growth. As such, it may pay to examine companies using all of these methods:
-RB to look for fast up and comers
-GG to examine long term fundamental strength in the technology sector
-RM to examine the financial strength of the company as it starts to spit out tons of cash.
It's all about picking the very best companies and having them compound to monster returns over the years.
Some sources and resources:
TMF GG FAQ:
SI GG FAQ
(version 1.24. Last updated 07/30/2000.):
The Gorilla Game: Picking Winners in High Technology written by Geoffrey A. Moore, Paul Johnson and Tom Kippola.
RM Portfolio FAQ:
Resources from the RB seminar (FAQ)
Summary of RB seminar lessons:
Rule Breakers, Rule Makers written by David and Tom Gardner
I hope this helps. As always feel free to point out any errors or omissions in my flimsy use of what passes for logic.
(Disclaimer: long JDSU, YHOO, RMBS and QCOM)
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