When I began investing, I was starting from a knowledge base of zero.
One of the first books I read was The Motley Fool's Rule Breakers, Rule Makers. In it, Motley Fool co-founder Tom Gardner laid out specific criteria for crowning a company a Rule Maker: a mature, consumer-facing business that's king of its market space, and an investment that can confidently and profitably be held onto for years, with only quarterly check-ins.
His step-by-step process for analyzing a business was an easily understandable way for a beginner like me to quickly get up to speed, but its back-to-basics approach will benefit even advanced investors. Today we're going to run the famous "name your price" travel site Priceline.com (NASDAQ:PCLN) through Tom's merciless gauntlet, and see exactly what makes it a classic Rule Maker.
1. The mass-market, repeat purchase of low-priced goods
Yes, this is the company made famous by spokesperson William Shatner's overacted and reliably funny television commercials, but it's the company's unique and reliably money-saving travel service that keeps users coming back for more. As previously mentioned, Priceline.com let's consumers name the price they're willing to pay for a flight, hotel room, car, cruise, or vacation, and the system finds a match and books it.
Since its founding in 1997 -- ancient in Internet years -- it's become immensely popular. Most people love to travel, and do it as often as they can, funds allowing. And the travel industry itself is a relentlessly reliable, mass-market business. Sure, the business has its ebbs and flows, but it's the kind of business that's here for the long haul.
Low priced? That depends on what it is you're looking for. A car rental or short flight can be cheap enough, while a cruise or vacation package might cost you. In the end, Priceline.com may not be as mass market/repeat purchase/low price as, say, Coca-Cola (NYSE:KO)-- quite possibly the ultimate company in this regard -- but it earns solid marks on this first Rule-Maker benchmark, nonetheless.
2. Gross margin
Gross margin indicates manufacturing efficiencies, brand power, and pricing power. The ideal gross margin for a Rule Maker is 60%.
- At 76%, Priceline easily blows past our Rule-Maker benchmark.
- Expedia (NASDAQ:EXPE) does even better, with a gross margin trailing twelve months of 78%.
- Orbitz Worldwide (NYSE:OWW) does best of all, with a gross margin TTM of 82%.
3. Net-profit margin
Net-profit margin dictates how many pennies a company gets to keep from every dollar of sales. Tom Gardner likes to see net-profit margins of 10% for his Rule Makers.
- Priceline's net-profit margin TTM is a staggering 26.8%.
- Expedia's is a solid, if unexceptional, 9% TTM.
- Orbitz is, unfortunately for its investors, operating the red right now, with a net-profit margin TTM of -4.4%.
4. Sales growth
Year-over-year sales, or revenue, growth counts, even for big companies, where it will naturally slow with age, because it's an indicator of business momentum. Top-tier Rule Makers grow their sales by 10% every year.
- Priceline grew its year-over-year quarterly sales by a more-than-Rule-Making 17.4%.
- Expedia just slightly edged out Priceline here, with YOY quarterly sales growth of 17.5%.
- As you may have already guessed, Orbitz isn't setting the sector on fire with this Rule-Maker metric either, with YOY quarterly sales contracting by 2.3%.
5. Cash-to-debt ratio
Rule Makers should be cash heavy and debt light, ideally having at least 1.5 times more cash than debt:
- $4.7 billion in cash, and $1.5 billion in debt, gives Priceline the enviable C/D of 3.13, well in excess of our Rule-Maker benchmark.
- $2.4 billion in cash, and $1.3 billion in debt, gives Expedia the also enviable C/D of 1.85.
- $152 million in cash, and $440 million in debt, gives Orbitz the unenviable C/D of 0.35.
Money is extraordinarily cheap right now. As such, too many companies are in debt up to their corner offices. Kudos to two of our companies for keeping their balance sheets in top Rule-Making trim.
6. The Foolish Flow Ratio
The Foolish Flow Ratio measures how well a company manages its inventory and cash. A company should be keeping its inventory and accounts receivables low, and its accounts payables high: strong indicators of market-space dominance.
To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments, then divide by current liabilities. The acceptable upper limit for F/F is 1.25, but the lower the number, the better:
- Priceline does exceptionally well on this metric, with an F/F of 0.47.
- Expedia cuts Priceline's F/F by more than half, coming in with an F/F of 0.22.
- Orbitz ties Expedia here, with a phenomenal F/F of 0.22, as well. Well done to all our Rule-Maker contestants on this metric.
7. Your familiarity and interest
What's in a name? Quite a bit. Your familiarity and interest with a company help you understand exactly what it does, and how it makes money, thereby lowering your overall investing risk.
Many people, like myself, know Priceline from the Shatner commercials. And even if they haven't actually used Priceline.com to book travel, the company has a simple enough business model that just about anyone can get their head around. Priceline, then, easily aces our final, Rule-Maker metric.
Priceline.com -- A classic Rule Maker
There's nothing whatsoever to qualify here: Priceline easily blows past all of our Rule-Maker metrics. As such, there's no question that the online travel site is a classic Rule Maker. Companies as reliable, long-term, profit-generating investments just don't get much better than this.
But always remember to check in on your Rule-Maker investments once a quarter by running them through this simple checklist. In Rule Breakers, Rule Makers, Tom Gardner goes into even greater depth and detail about what exactly makes a Rule Maker a Rule Maker. So I suggest you pick up a copy for yourself, and get the whole story from the man who wrote the book on it.
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Fool contributor John Grgurich owns no shares of any of the companies mentioned in this column. Follow John's dispatches from the bleeding edge of capitalism on Twitter @TMFGrgurich. Motley Fool newsletter services have recommended buying shares of Coca-Cola. The Motley Fool has a strangely gripping disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.