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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: Uncle Frank who wrote (25953)	6/7/2000 2:48:00 AM
From: Bruce Brown	Read Replies (1) \| Respond to of 54805

RE: Flowie... How do you use it to evaluate an individual company? UF, you use the Foolish Flow Ratio on a quarterly basis to see if the ratio is rising or declining. It takes only a few minutes to calculate. A one or two quarter rise is not a death call, but you watch for the trend to see if any red flags crop up. Obviously, a declining "flowie" trend line is what you want your individual company to have. With so many companies to invest in, there's really little point to choose investments that don't meet the criteria unless there is a damn good reason. Good management in companies know how to manage their flow ratio. For whatever reason, Lucent's trend line signals a flag. When I was raising my 30% comfort level cash position at the end of 1999 and early in 2000, I had to make a decision what was sold. I sold my longer term position in Lucent at the end of December based on this flow ratio flag which was not getting better quarter after quarter. I wasn't comparing it to any other company, simply with its trend. A large-cap gorilla who also executes well will usually have excellent metrics. We might forgive a gorilla a little bit if metrics sour in the short run, but a non gorilla with souring metrics that doesn't improve will not win my long term investment money. Yes, certain things can crop up in a company's business which alters the flow ratio for a quarter or two or three. Hence knowing the historical trend helps you judge the short term better. Y2K, components shortage, delayed product, earthquakes, pricing - all can contribute to a short term change in the trend, but one has to weigh all of that. Notice how well Cisco has done through all sorts of elements that crop up - they've managed to continue to produce an excellent flow ratio. As an example, outside of gorilla gaming, if you study the trend line for Dell Computers metrics throughout the 90's - you see a classic case of the metrics getting better and better. Then the net margin level started to decrease (which is not what you want with net margins), but is now rising back up. The market was not as forgiving with this declining metric and helps to explain why Dell has been churning since the first quarter of 1999. Yet, it's a well oiled machine that is very healthy from an evaluation point of view. If their management can continue to improve the metrics, chances are the market will cuddle up to it again. That's not to say the growth metric will return to previous levels at all, but the underlying metrics improving will help the 'cuddle' factor. We all have different opinions about Dell Computer now than we did before we read our books, but the underlying health of a company - no matter what part of the technology adoption life cycle or what sector it comes from is a valuable source of information to know as an investor. It's easy to say 'dump a prince or a king when execution falters'. However, knowing the metrics underneath the issue helps to view why something should be 'dumped' or not. That's why I am often stunned to see major Wall Street firms downgrade a company like an Intel or a Cisco that are both as healthy as it gets under the hood. Obviously I understand the 'business' and how the industry works, but the only way a retail investor can learn to ignore all of that is to evaluate the business for yourself. I would never compare net margins of Intel with Cisco because the semiconductor industry should be compared with each other. Look at the net margins of Intel alongside Qualcomm. The highest net margin gorilla is Microsoft. It makes twice as much profit per dollar than Cisco. Yet, is it fair to compare the two based on that one metric? Some industry sectors have higher profits than others. OEM computer box makers have a much lower profit margin than a software company. So do grocery stores, automotive companies and airlines. Microsoft made .422 cents on the dollar in profits last quarter, Siebel .149 cents, Intel .31 cents, Cisco .21 cents, Brocade .214 cents, Dell .072 cents and General Motors .037 cents. I believe Qualcomm was .31 on a pro forma basis, but I'm too lazy to look it up at the moment. Once again, knowing the trend line for the net margins is key to looking for red flags in this metric. I'm getting off track here in regards to the flow ratio, but it is all relevant... I like to also use the net margin (profit margin) metric as well which is a simple one to calculate = net income/sales. Net margins, gross margins and the flowie point right at the heart of a companies health. Any clogged 'blood flow' will crop right up in full view. Why is net margin a good metric? It means as more more products are sold, the company is becoming more profitable. A company that is becoming more profitable will use that cash to defend and extends its interests. Why are improving gross margins good? It shows that a company is able to match pricing power with manufacturing efficiency in order of extending the overall profitability. We have to argue that high tech tools have helped increase this over the last decade or two for many companies. The value that an SCM product like an i2 provides has fueled the health of many companies. That's not a plug for i2, just a fact that the business model adjusting to the JIT (just in time) manufacturing has really helped improve all the metrics of high technology companies that execute well. The good news about all of these metrics is it really takes about 15 minutes a year to calculate and shows you the instant health of the company. Less time than a doctor's visit actually and leaves more time for fishing. Most focus on a P/E metric and never get deeper, under the hood of a company's health. From a traditional point of view, I can understand the fascination that many have with such a metric. The question is what is happening with the underlying health of many companies and how those with the most improved metrics based on their business models should be valued using a P/E 'traditional metric'. Is it the difference between focusing on short term metrics or long term metrics? Since I fashion myself as a long term investor, it makes sense that the long term metrics meet my strategy for long range planning. As I mentioned, Tom Gardner is giving a 4 week seminar where all of these metrics, what they mean and how to apply them will be taught. It would involve about 2 to 3 lessons a week sent via email. Each participant would be assigned to a specific 'team' message board at the Fool where homework assignments would be carried out with your team and questions asked about the homework. It's a pretty leisurely pace. The seminar is about the style of investing in large-caps called Rule Makers. A close parallel to gorillas and kings is in this strategy, but extends to dominant companies outside of high technology as well. I'm not trying to hawk the seminar here. If anyone is interested, I think knowing how to evaluate the health of a business couples nicely with gorilla gaming. The Fool tells me that the sign up on their site should begin on Wednesday or Thursday. BB