W
e are now at the moment of truth, the moment when I will lay my investments at your feet—both good and bad—and explain my reasoning, or lack thereof. Some of my picks have done better than others. Luckily for me, the great ones have more than made up for the disasters. It’s because of the great ones that my initial investment has grown 30 times over.The poor picks, taken together, now make up less than 0.1 per- cent of my overall portfolio. Because they’re so negligible, I have a strange habit—I refuse to sell them. I keep the disasters in my port- folio to remind me of flashes of extreme stupidity, so that anytime I’m tempted to go off half-cocked again, I will think twice.
In this book, I have tried to convince you that doing your homework is worth the effort. While you may get lucky now and then with a blind pick, if you want to earn 25 percent or more on your money, you have to put in the time. I know this to be true.
Unfortunately, I have not always taken my own advice.
stuck to the rules laid out so far, but there have been a few times when I threw some money into the slots—betting on companies I knew next to nothing about. I bought stock in The Limited because a friend convinced me it was going to take over the teen clothing market. I bought stock in Canadian Southern Petroleum based on a tip from my broker.
I could go on, but I’ve got to retainsome level of dignity. The point is, I bought these stocks for the wrong reasons. I trusted some- one else’s judgment, rather than making up my own mind. Even though some of them worked out pretty well, they were slot-machine investments. I had absolutely no knowledge of these companies, but I threw money into them, hoping they’d hit (see Figure 12.1).
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COMPANY PURCHASEDATE PURCHASEPRICE* VALUE
Applied Materials April 1995 $14.00 $127.00
Boeing August 1992 20.00 41.44
Cisco November 1997 18.50 107.00
Compaq January 1993 3.66 27.00
Dell August 1992 0.30 51.00
Fannie Mae January 1991 9.60 62.44
Ford October 1993 18.50 53.31
Intel August 1995 14.00 85.00
Microsoft August 1989 0.75 117.00
PaineWebber January 1996 13.00 39.00
Figure 12.1 Mike’s Portfolio as of December 31, 1999.
*Adjusted for splits.
Note: These 10 stocks make up 99.9 percent of Mike’s portfolio. Not listed are the 0.1 percent that Mike keeps around to remind him of his mistakes, as mentioned in the text.
As I mentioned in Chapter 1, while I believe five to seven stocks is the right amount for the average investor, I spend so much time immersed in the market that I’ve chosen to hold more.
Let me state for the record that even with my experience, I’m not convinced that fattening my portfolio was a wise idea. Let me show you why.
99.9 percent of my stock pool is focused on 10 stocks. Seven of those stocks I know very well. The others I know less well. Of the seven I know very well, I’ve been averaging 25 percent per year or more on every single one. Of the stocks I know less well, I’ve man- aged 25 percent per year on only one. Learn from my mistakes (see Figure 12.2).
Known Portion
COMPOUND
COMPANY PURCHASEDATE ANNUALGAIN
Applied Materials April 1995 60%
Cisco November 1997 125
Compaq January 1993 33
Dell August 1992 101
Intel August 1995 49
Microsoft August 1989 63
PaineWebber January 1996 32
Unknown Portion
Boeing August 1992 10%
Fannie Mae January 1991 25
Ford October 1993 19
Figure 12.2 Well-Known and Unknown Stocks
in Mike’s Portfolio.
Let’s start with the known companies. What do I know very well? Well, I know high tech and I know the companies that I’ve worked for over the years.
Of the stocks that have done well in my portfolio, six are tech companies and one is a former employer, PaineWebber. Here’s a quick roundup of what I bought, when I bought it, and why.
Cisco
When Internet stocks started going through the roof, lots of investors threw their money at start-ups. I chose to leave the upstarts and e-businesses alone and invest in the Internet by invest- ing in the companies that supplied the infrastructure. One of those companies was Cisco.
Cisco supplies the products that route information through the Internet. I knew that if the Internet took off, Cisco’s sales would, too. As the Internet’s capacity increases, someone has to route the information.
I bought stock in 1997, when the investment community at large was sour on the company. It was cheap because of a minor problem that I knew the management would fix. I believed in the management, and I believed in the product. I did the math and realized that the stock was extremely undervalued. Public nervous- ness worked in my favor. I got a top company for bottom dollar.
Compaq
Summer 1992 brought the biggest change the PC industry had ever seen. As you may or may not recall from Chapter 6, that was when companies like Compaq and IBM started making the transi- tion to building computers from standard parts.
At the time, I wasn’t convinced that Compaq would be suc- cessful at making the switch. It had a bloated cost structure and had to either cut costs tremendously or quickly get its revenue up to cover them. While the company’s business model was in flux, it was also attempting to reduce its gross margin to a pittance of what it had been before, in order to compete on price.
By early 1993, it was clear the company was getting somewhere.
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In June 1992, a Compaq computer had cost customers 68 percent more than an equivalent Gateway machine. By early 1993, the dif- ference was down to 20 percent. The cut in premium, combined with its superior brand name, put Compaq back in the game. Com- paq also expanded distribution ferociously. Up until that point, both Compaq and IBM had limited who they allowed to sell their products. Now, at the height of IBM’s dysfunction, Compaq made its products widely available at through scores of distributors. I sus- pected that Compaq would be able to steal some of IBM’s market share while Big Blue was trying to get its act together. I bought in to Compaq.
The stock was a smart choice then, and it has remained so for most of the years since. But to be honest, I would have sold my shares in January 1998 if I had been allowed to do so. That was the month when I downgraded the stock for the first time in five years.
Unfortunately, while the people who followed my coverage were able to bail out, I was not. I would have liked to have jumped ship, but industry rules prohibited me from doing so at that time.
Intel
I bought Intel in 1995, in the midst of the PC gold rush, but at a time when the company itself was having some problems. Intel is the dominant player in computer processors. I thought the com- pany had fantastic management, and besides that, it had a virtual stranglehold on the industry, providing chips for almost 90 per- cent of new computers.
That was then, this is now. Because of its dominant position, Intel has grown along with the PC industry. However, with the acceleration of PC sales beginning to slow, the stock could hit some trouble. Intel is attempting to branch out into other areas—
networking, videotelephony, and application services. None have been all that successful as yet, but this doesn’t mean they won’tbe.
In addition to these individual plays, Intel stands to make good money by riding in on another company’s coattails. Microsoft, for example, is courting the high end of the server arena with Win- dows 2000, and should the product be successful, Intel’s chips will move into the high-end server arena along with it. Hewlett-Packard
has also committed to a relationship with Intel—HP is putting a new version of Unix on Intel’s 64-bit processors.
With all these irons in the fire, Intel is likely to come out a win- ner. Going forward, I don’t put the stock in the same class as Cisco, but I bought it cheap and I’m confident enough in the company to hold onto it and see how things play out.
PaineWebber
I didn’t exactly pick PaineWebber from scratch—I worked for the company and was given a certain number of shares along with my signing bonus. I did, however, choose to hang onto the stock long after I had left the company.
My reasoning was twofold. First, I knew the company well. I had observed management first-hand—after all, I worked there—and I agreed with the bulk of management’s decisions. For example, I thought it was a smart move when the company expanded its retail brokerage side to give clients options like mutual funds, money management, and proprietary products. I felt that this expansion would keep clients from going somewhere else for these options.
PaineWebber also had pretty good analysts (my colleagues) and a streamlined (if not so strong) investment banking side.
The second prong of my two-pronged positive analysis was this: PaineWebber, in my eyes, was ripe for acquisition. It was a smallish company, but a well-run one. In an age of consolidation, I was convinced that the company was a good target. Indeed, in the time I’ve held the stock, the company has come within a hair of being bought three or four times. I held onto the stock because I wasn’t losing money on it, and because I’d make a killing if the company was ever bought. That day has yet to arrive; but who knows, it may. Then again, with retail brokerage houses facing increasing danger from Internet sites like e-Trade, I’ll probably have liquidated this holding by the time this book hits the stores.
The Rest of the Successful Seven
My remaining three stocks are in Danielle’s portfolio as well: Dell, Microsoft, and Applied Materials (see Figure 12.3). Dell and
176 the big tech score
Microsoft are discussed at length elsewhere in the book, so I’m not going to go into our reasoning here. By now, it should be clear to you why I thought they were great investments.
Applied Materials makes products used in the manufacture of semiconductor chips. When a company like Intel makes a proces- sor, it uses special equipment to do so. When Micron Technology makes memory chips, it needs special machinery. Applied Materi- als is the number-one supplier of that equipment.
One need only look at the direction in which the world is head- ing to know why Applied Materials is a good investment. As we move toward a world in which all information is converted into bytes (music, video, text, services, etc.), semiconductor sales will become even more rampant. The equipment Applied Materials provides will be needed to create semiconductors not only for PCs, but for everything else—phones, digital cameras, cars, electronics, and handheld devices.
The problem with investing in semiconductors themselves is the cyclical nature of the industry. The demand for equipment is much less volatile. When demand for chips is high, semiconductor companies need more equipment to make them. When demand is low, new equipment is still necessary, because the old equipment becomes obsolete as technology improves. You can’t necessarily make a 64-bit chip with a 32-bit chip machine. The technology improves rapidly, regardless of whether the industry as a whole is growing. Because of this, I saw Applied Materials as a safe and
PURCHASE PURCHASE COMPOUND
COMPANY DATE PRICE VALUE ANNUALGAIN
Applied August 1995 $26.50 $126.70 43%
Materials
Dell November 1997 9.00 51.00 123
Microsoft June 1995 10.50 116.00 71
Figure 12.3 Danielle’s Portfolio as of
December 31, 1999.
interesting investment. I believed that it would outpace the semi- conductor area as a whole, and it has.