<FOOLISH FOUR PORTFOLIO>

The Big Picture
What balance sheets can tell us

by Chris Rugaber (TMF [email protected])

Alexandria, VA (May 6th, 1999) -- For the last two weeks, we've rather quickly run through some numbers and ideas related to fundamental analysis. We're doing this as a learning exercise, but also to build some common understandings so that we can look at our Foolish Four companies as the year progresses using the terms and ideas that have been discussed. In addition, many Dow 30 companies serve as useful learning tools, because their traditional business models are important to understand in order to appreciate the innovations that the Internet and other technologies are bringing about.

For example, last week we discussed cash conversion cycle and how it measured the amount of time that a company needed to turn its capital into cash profits. We saw that Caterpillar <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %> had a cash conversion cycle of 43.99, or about 44 days, in 1998, a noticeable improvement from 1997's 61, since the shorter the cycle, the better. We also compared it to Caterpillar's competitors and saw that Caterpillar was doing better than they were.

With these numbers in mind, let's consider the so-called "New Economy" companies out there. What are their cash conversion cycles? How do they compare to Caterpillar? While I don't necessarily endorse the current valuations of many of the so-called "Internet" stocks, we may at least get a sense of why these companies' shares prices have grown so tremendously in recent years when we look at some of these measures.

Dell <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>, for example, is the best-performing stock of the decade. Looking at some of the metrics we discussed last week, we find that Dell actually has a negative cash conversion cycle, primarily because of its quick inventory turnover. Here's what the numbers look like: Dell's 1998 Days Sales Outstanding was 41.09, only slightly better than Caterpillar's 47.6, but Dell's Days in Inventory was 7.05, while Caterpillar's was 69.01. That's a pretty amazing difference, obviously.

Caterpillar sells all its inventory 5.29 times a year, while Dell does so 51.78 times per year. Of course, the products each company sells make some of the difference. That's why comparisons within an industry are the most relevant. But Dell's super-fast inventory turnover is still noteworthy: even though Dell and Caterpillar actually had very similar revenues in 1998 ($19.97 billion for Caterpillar, excluding its financing business, vs. $18.24 billion for Dell), Dell had only $273 million in inventory by year's end, while Caterpillar had more than ten times as much, at $2.84 billion.

Thanks to Dell's quick inventory turnover, its cash conversion cycle in 1998 was -5.04, while Caterpillar's was 43.99. In essence, Dell gets cash before it sends out its finished product. No wonder it's the best-performing stock of the decade! Once we understand Caterpillar's more traditional business model, we can see a little more clearly why companies like Dell have received the attention they have.

Yet these kinds of efficiencies can also be found in more traditional businesses, another reason this is relevant for our Foolish Four companies. Dow company Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %>, for example, has used inventory-tracking software, among other things, to take its basic business of retailing to a more profitable and efficient level. Fortune magazine, in fact, recently noted the similarities between Wal-Mart and Dell in an interesting introduction to its "Most Admired Companies" article. Apparently, Wal-Mart has over 43 terabytes of data on sales trends, customer preferences, and so forth stored in its central offices, "more than any other company," and Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> has even hired away some of Wal-Mart's information technology managers.

Speaking of Amazon, as I briefly mentioned several weeks ago, it recorded no accounts receivable in 1998, since customers pay for their products before they're shipped. In last Thursday's Lunchtime News, Louis Corrigan pointed out that Amazon also has a negative cash conversion cycle and is essentially funding its growth with its suppliers' cash. Yahoo! <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YHOO)") else Response.Write("(Nasdaq: YHOO)") end if %>, meanwhile, recorded no inventories last year. And while Caterpillar had $4.8 billion in plant, property, and equipment on its balance sheet at the end of the year, equal to approximately 19% of its assets, Yahoo's $15.2 million in property and equipment comprised 2.4% of its assets. These kinds of light business models, more prevalent thanks to the Internet, are what have many investors excited. Check out this Rule Maker column for an example (it has different balance sheet numbers for Yahoo! because it refers to a quarterly, rather than an annual, report).

This is the larger context within which our Foolish Four companies operate. We'll look at how our companies are using technology to improve efficiency as the year progresses. In addition, we'll look at other metrics that measure efficiency, such as return on invested capital (ROIC), at some point in the next few weeks. If you want to read ahead, check out Dale Wettlaufer's excellent series on ROIC.

Fool on!

Today's Stock Lists | 1999 Dow Returns

05/06/99 Close

Stock Change Last -------------------- CAT + 1/4 65.38 JPM -3 11/16 135.31 MMM - 1/4 92.13 IP +1 3/8 57.88

Day Month Year History FOOL-4 -0.01% 3.31% 33.21% 35.19% DJIA -0.08% 1.46% 19.61% 19.14% S&P 500 -1.13% -0.23% 8.68% 8.95% NASDAQ -2.45% -2.78% 12.75% 14.30% Rec'd # Security In At Now Change 12/24/98 24 Caterpillar 43.08 65.38 51.75% 12/24/98 22 Int'l Paper 43.55 57.88 32.89% 12/24/98 9 JP Morgan 105.51 135.31 28.25% 12/24/98 14 3M 73.57 92.13 25.22% Rec'd # Security In At Value Change 12/24/98 24 Caterpillar 1034.00 1569.00 $535.00 12/24/98 22 Int'l Paper 958.12 1273.25 $315.13 12/24/98 9 JP Morgan 949.62 1217.81 $268.19 12/24/98 14 3M 1030.00 1289.75 $259.75 Dividends Received $29.45 Cash $28.26 TOTAL $5407.52 </FOOLISH FOUR PORTFOLIO>