interesting article from the motley fool....
Crazy Market, Stocks Are for the Long Term
A case for American Express
By Matt Richey (TMF Verve)
February 28, 2000
It's time once again to allocate a fresh $500 to our portfolio. In pondering this month's decision, it occurred to me that the way I think about stocks versus the way I think about a portfolio of stocks are two entirely different matters. For example, I think Cisco (Nasdaq: CSCO) is a fantastic company, maybe even the best-managed and t-positioned major corporation in all the public markets. But should the Rule Maker Portfolio purchase additional shares of Cisco right now? Hmmm, with 20% of our port already invested in Cisco, and with Cisco hovering around its all-time high -- no, I'm not compelled to buy more Cisco for this portfolio at this time.
More or less, the same can be said for all of our technology-related holdings. The stocks of Intel (Nasdaq: INTC), Yahoo! (Nasdaq: YHOO), Cisco, Nokia (NYSE: NOK), and JDS Uniphase (Nasdaq: JDSU) are all on a terrific run. Microsoft (Nasdaq: MSFT) is our one tech exception, and it would surely also be among that group of high fliers if it weren't being weighed down by this antitrust lawsuit. All of these tech companies are making rules and taking names. Cisco, Intel, Microsoft, Yahoo!, and Nokia are our highest-scoring Rule Makers on our RM Ranker, with each one qualifying as a Top Tier Rule Maker. More likely than not, these stocks will continue to lead the market. But should we buy more Intel? Should we add to an already large Yahoo! position at this point? Consider that even without adding to these positions, our portfolio is already positioned to benefit mightily if these stocks continue to soar.
But what if market conditions change so as to favor some of our portfolio's laggards? The likes of Pifzer (NYSE: PFE), Schering-Plough (NYSE: SGP), Coca-Cola (NYSE: KO), Gap Inc. (NYSE: GPS), T. Rowe Price (Nasdaq: TROW), and American Express (NYSE: AXP) only make up a combined 26.6% of our portfolio (as of Friday's closing prices). The Darwinian forces of the market cause our best companies to become an increasingly larger portion of the overall portfolio. I like this dynamic very much. I want Cisco to be our top holding right now. I prefer that we be overweighted in Yahoo!, Intel, and Microsoft. But -- yes, here's the "but" -- I also want our portfolio to be prudently diversified in case the market shifts. Does anyone think we've reached a permanent era in which only tech stocks will show gains?
I think the human mind has an unfortunate tendency to project the future based disproportionately upon what's happening at this very moment. Take the pharmaceutical stocks, for example. Right now, the market universally despises the likes of Pfizer, Schering-Plough, and Johnson & Johnson (NYSE: JNJ), even though these companies continue to have some of the most compelling economics of any business sector. Not that there aren't some current problems among these companies. Pifzer faces extra risk as it seeks to integrate its hostile acquisition of Warner-Lambert (NYSE: WLA). And, Schering-Plough's top product, Claritin, will be genericized in two years, with little in the way of a strong pipeline to fill the gap. Even so, the pharmaceutical sector still offers the long-term potential for high profit margins, steady revenue and profit growth, and high barriers to entry.
All of our portfolio's laggards -- American Express, T. Rowe Price, Pfizer, Schering-Plough, and Coca-Cola -- face a strong headwind because of the current predicament of rising interest rates. But if interest rates stabilized or reversed course, and if economic conditions cooled, then many of these stocks would once again be the vogue, just like they were for so much of the 1990s.
Take the pharmaceutical stocks, again. By mid-'98, the pharma stocks were every investor's favorite because -- as the story went -- you could count on consistent 20% earnings growth from the big pharmas no matter what economic debacle rocked Asia or Russia. Today however, with concerns of a financial crisis gone for the meantime, and with worldwide economic growth seeming to be a sure thing, capital has flowed out of defensive issues and into high-growth sectors, namely technology and biotech. Wadaya know, markets shift. But should we as long-term investors constantly rejigger our portfolios attempting to chase the market's every twist and turn? Not without plenty of Pepcid AC on hand.
Many of today's hot sectors deserve our consideration, but within the MakerPort, our time horizon is 10 years, not 10 minutes. That's why I think it's important to maintain a portfolio diversified among several attractive industries, even if not all of them are Wall Street's current favorites. From that perspective, as I look to some of our underweighted Rule Makers, my eye is drawn once again to American Express. (My favorable opinion on AmEx must've leaked over the weekend because the shares soared from the get-go today and closed up 6.3%.)
AmEx is the leading branded global financial services firm with a long track record of building value at a market-beating pace. Recent initiatives such as Internet banking and discount brokerage services, combined with AmEx's long-standing reputation for superior customer service, have fueled steady sales and profit growth of 14-15%, which is ahead of our usual 10% benchmark. At $130 per stub, American Express is valued at $59 billion. That's 6% less than where the shares traded back in July when I last suggested we add a few shares to the port (see RM 7/29/99). Since that time, the shares traded up to an all-time high of $169 on Feb. 1, but it's been all downhill since then.
Why the 23% collapse? The only rationale I can find is investors' current aversion to interest rate-sensitive sectors, which includes financial services firms. The way I see it, interest rates will rise and fall (and rise and fall) over the next 10 years. What matters is strong and sustainable business fundamentals, and that, AmEx has in spades. American Express' current situation is exactly the type of bargain I'm inclined to take advantage of with our monthly $500 allotments.
I mentioned the company's strong fundamentals, of which one particularly eye-catching aspect is its strong cash flow generation -- stronger than you might expect at first glance. Here's a situation where our new Cash King Margin proves especially revealing. Using the trailing 12 month financials through September 1999, the numbers shake out as follows:
Metric Formula Value
1) Net Income $2,399M
2) Free Cash Flow $5,095M
3) Revenue $19,626M
Net Profit Margin (1 / 3) 12.2%
Cash King Margin (2 / 3) 26.0%
As you can see, AmEx is raking in a full 26 cents of free-and-clear cash for each dollar of sales. Nice. That's more than twice as profitable as indicated by the 12% net profit margins (as derived from the sometimes misleading income statement). A 26% Cash King Margin represents an outstanding level of profitability, and well ahead of our 10% minimum threshold.
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