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Posted
to the Gilder forum - December
8, 1999
Thanks
RJA!
posted: Wed Dec 8, 1999
4:41pm
author: RJA <b.auffenberg@att.net>
subject: Denny's Pearls II
As
regular readers of the board are well aware Denny has been
rather prolific recently other than an occasional hiatus. In
order not to overwhelm the board with Denny's insights and
investment philosophy I decided to post another collection
of his "pearls" before they became too long. I hope you
enjoy them as much as I have.
These
"pearls" and the others I posted before seem to me to be a
good "companion reader" to the GTR as they are filled with
practical advice mixed with philosophical musings and
humorous anecdotes.
Again,
thanks to Denny for his invaluable contributions to the
board.
rja
(Bob)
1.- There are many investment styles: Value, growth,
contrarian, gorilla, day trading, astrology (The Stock Split
Report), small cap, large cap, micro cap, penny ante,
Telecosm, Yardeni?, charting, just to name a few that come
to mind.
You
cannot mix and match all the techniques from all of these
styles and use them all in a significant way. Let me list
some of the techniques I don't use:
- Charting
(except that I do look at price charts to see a general
picture)
- Astrology
or astronomy
- Yardeni?
- Price
targets (good for cyclical and value plays)
- P/E
ratios (not for gorillas anyway)
The
most useful techniques for me are:
- What
business are they in? Are they good at it — first
or second in market share?
- Are
revenues growing fast enough? Do they have earnings? Are
the earnings growing fast enough?
- Do
they have patents (good). What are the barriers to entry.
Do they have law suits? (for or against, both
bad)
- Specially
in non gorilla type companies, do they have good
management, excellent execution?
- In
gorilla type companies, how big and valuable is the value
chain?
There
are a few no-nos:
- Bulletin
board
- Penny
stocks (under about $10, the 12 1/2 was also in jest but
serious jest)
- Law
suits for or against
- Poison
pills
- Most
non US stocks
Most
of the other facts and figures are useless noise for
investors and useful fodder for writers.
A
recent article about George Gilder describes how he
investigates Telecosm companies. He does not talk to the
CFO. He goes and talks to the engineers. He reluctantly
talks to the CEO hoping that they (the CEOs) "get it!" For
ten years I was a management consultant. One of the most
difficult tasks with some of the clients was to try to
explain to them that we wanted to talk to the troops and not
just to the Board of Directors. We wanted to go out with the
sales force on sales calls. We wanted to go out with the
collections departments to collect. We wanted to walk around
the plants and talk to the blue collar guys that make it
happen. The only thing we wanted to ask the Board of
Directors was: "Where do you want this company to go?" Peter
Lynch invested in Hanes after his wife told him how
convenient it was to buy pantyhose (L'Eggs?) in the
supermarket. Lynch discovered the best retailers by going
shopping with his daughters. He avoided the bad ones because
his daughters would tell him: "But Dad, no one ever shops
there anymore!"
Or
as Yogi said: "The place is so crowded that no one goes
there anymore!"
There
are three essential ingredients to investing: decisions,
decision and decisions. You have done the first one. Now do
the next one when you think the time is right!.
There
are three negatives to investing: greed, fear and hope, keep
them at bay!
2. After reading the book [Gorilla Game] my question
was: "How do I apply the technique described to the
Telecosm?" Doing this made me realize that Qualcomm and Arm
Holdings are up and coming gorillas and JDS Uniphase is a
very powerful king. I am now searching the Telecosm for more
of these beasts and royals.
3. http://garage.com/
GG is both an angel and an advisor there.
4. I'm just not interested in spending any time
investigating it [A stock trading on the bulletin board
at less than $4.]
5. Sorry, but that is a silly statement [The stock is
one I could afford.]. If you have only $300 to invest,
buy one share of JDSU. If you have $400, buy one share of
QCOM.
6. There are no stupid questions, only stupid people who
insist on staying stupid.
7. Thanksgiving is a truly American celebration, this
holiday is not observed anywhere else in the American
continent but maybe it should be. After all, the benefits
and happiness that emigrants earn when they reach the USA,
my family also received when we arrived in Venezuela.
Hopefully Thanksgiving will become another American export
to the world.
8. As GG has pointed out, one of the principal scarcities is
life time. This should be reason enough for the average
individual investor not to read the reports sent to the SEC.
All you need are the vital statistics. Peter Lynch in "One
Up on Wall Street" points out what these are: Revenues,
earnings and quick ratio, and that, just about sum it all
up. Once in the life of the investment, that is to say,
before you invest, you do a more thorough investigation but
the GTR and certain other publications often give a better
insight than a report to the SEC which has many of the
failings of PR pieces that you have often pointed out.
Besides, who needs all those caveats that the lawyers force
management to put in there?
9. I use mostly Yahoo. You can search the news for recent
earnings reports both from the companies themselves and from
news services.
10. The only way you can find out is by study. Study the
back issues of the GTR. Read good investment books:
"One
Up on Wall Street"
by Peter Lynch; "The
Gorilla Game"
by Geoffrey A. Moore, Paul Johnson and Tom Kippola;
"Stocks
for the Long Run"
by Jeremy J. Siegel; "Money" by John Kenneth Galbraith;
"Reminiscences
of a Stock Operator"
by Edwin Lefevre. Learn technology, read "Microcosm" by
George Gilder; Gene Prescott has a wonderful list of books
to read that are technology oriented. I just ordered
"Optical Networks" by Rajiv Ramaswami and Kumar N. Sivarajan
[too technical, try "Understanding
Fiber Optics"
by Jeff Hecht instead - Denny]. GG has a great list of
recommended books in the GTR site.
Build
a short story for each stock and see if you like it: What
business is it in? Competition? Patents? Revenue? Earnings?
Management ability? Periodically you review the stories to
see if it is a hold, a buy or a sell.
11. If you want a dip, go to a soda fountain. If you want
JDSU, go to your broker. My choice between JDSU and GBLX
favors the equipment maker over the service provider. I have
5 times as much JDSU as GBLX even though I paid 25% LESS for
JDSU (a six bagger since January)
12. I'm not ready to invest in e-business, a field which,
IMHO, will not support gorillas.
13. I have no idea if it will happen or when it will happen
but it might happen, the bubble might burst. And my question
is: "If and when it does, what are you going to do about
it?" "How are you preparing yourself for this highly
unlikely eventuality?" I'll tell you what I am doing about
it. I want to continue to use a buy and hold strategy
because it has proven itself to be superior to market
timing. My fear is that I might be scared out of this
conviction when the market or my portfolio starts to drop
like a stone (at one time, I lost 25% in 3 or 4 months!).
But if and when the dread event comes, I'll be able to face
it in a cool, calm and collected way. I will have banished
(I hope) fear! You might well say: "But you have not really
done anything!" and you are, of course, right. But I will
have prepared my mental attitude and I should be able to
continue to use the buy and hold strategy.
14. The bible says that work is punishment imposed on man
for his sins. That is the kind of work that I want to avoid.
Rational acts are holding me in the market. The type of
analysis that you do based on Gilder and The Gorilla Game
are not an emotional exercise, they are an exercise of the
use of reason. Let us remember that lower animals,
non-rational beings, have only two ways of meeting danger:
fight or flight. We humans have a third way, reason. And it
has been reason that has built up the civilization that we
live in and enjoy. Fight or flight produce wars and refugee
camps. Reason produces a higher standard of living in a
peaceful society.
15. Never bet against gorillas except when they are
dead!
16. How trusted is this trusted friend [who recommended
a particular stock]? Will this trusted friend give you
back your money should this stock tank? My advice is that
you should make up your own mind and then you can take the
blame or the glory yourself.
17. Gorillas are not about size, elephants, whales and
certain dinosaurs are a lot bigger. The first two were in
danger of extinction and the latter are up in
DinoHeaven.
18. GBLX is a sea calf and it will become a cash cow, so you
see, it is still in its infancy!
19. ARMHY, ARMHY, ARMHY, ARMHY.
Why?
Every person in the world will eventually have a mobile
something and at least half of them will have "ARM"
inside!
Being
a fab-less chip maker, an IP (Intellectual Property)
company, they have zero "bricks and mortar" costs just like
the internet Godzillas but they don't have to give their
product away for free and there are high barriers to entry
in their business, money is not enough, you need the
smarts.
ARMHY
is a cross between a Gorilla and Godzilla (a Godrilla? a
Gorzilla?).
Lots
of room to grow. Compare market caps:
- ARMHY
10B
- GBLX
34B
- JDSU
40B
- QCOM
60B
ARMHY
is the great undiscovered El Dorado, undiscovered by the US
financial folks. Compare volume:
- ARMHY
76K ADRs
- GBLX
13.9M
- JDSU
2.6M
- QCOM
6.3M
Compare
growth from Dec. 28, 1998 to Nov. 29, 1999:
- ARMHY
989% - 10 bagger
- GBLX
193% - 2 bagger
- JDSU
643% - 6 bagger
- QCOM
1399% - 14 bagger
ARMHY
is growing 30% slower than QCOM, 1.6 times faster than JDSU
and 5 times faster than GBLX. Disclosure: 3rd largest
holding after JDSU and QCOM at 12% of portfolio.
20. I now look at the P/E ratio in a totally new
(contrarian) light. If it is below 50 or so, the buying
public is not enthused and, if there are no buyers, the
price cannot go higher! If it is above 50, I just ignore it
(the P/E, that is).
21. Can you find something that is growing faster now
[ARMHY]? Do you see storm clouds on the horizon? I
gave my opinion in the post above, why should I change it 24
hours later? But of course, I could be wrong and Telepathy
could make a breakthrough within the next 18 months and the
whole Telecosm spiel will go out the window and George
Gilder will take up potato farming in Utah!
22. If management does not have the smarts, intellectual
property quickly turns to garbage. Examples abound: Xerox
missed the GUI game they invented at PARC. I firmly believe
that Microsoft's success depends more on Bill's smarts than
on anything else. Likewise for GE, it was Jack Welsh; for
Dell, it was Michael Dell; for WalMart, it was Sam Walton;
for the old IBM, it was both Tom Watsons.
That
said and acknowledged and never forgotten (it led me to sell
Terayon and Broadcom), the concept of the "value chain" is
very powerful. While I was an IBM salesman it worked in my
favor: "You cannot lose your job if you buy IBM." While I
was an NCR salesman it worked against me: "You cannot lose
your job if you buy IBM."
The
third point to keep in mind is that you must not jump in too
early. You have to give management time to prove itself, you
have to give them time to build, or at least start, the
"value chain."
If
you keep these ideas in mind, the hunt for gorillas can be
very profitable. If you don't play the game right, you'll be
a loser like anybody who plays the right game with the wrong
strategy and tactics.
Last
but not least, I have stressed that The Gorilla Game is an
excellent companion to the GTR. There are 8 or 10 thousand
stocks out there and most of us, and I include myself, are
not smart enough or have time enough, to sift through the
noise to find the signal. The GTR does an absolutely superb
job of getting rid of 99.7% of the noise. The Telecosm
paradigm identifies, at this time, 28 potential Telecosm
winners. By doing due diligence, the GTR readers can add a
few more to the list and you [GG] have been kind
enough to ratify some of our picks as worthy of inclusion in
the list. This expanded list is where we should hunt for
gorillas. You will have to admit that it is very difficult
to make costly mistakes by following this rule. And it is
highly likely that if we tilt our holding toward gorillas
and away from technologically able chimps, monkeys, princes
and serfs, the yield of the portfolio should be
enhanced.
23. Price/Earnings. Price we know is right, it's what the
last buyer gave the last seller.
Earnings?
It's the output of a convoluted arithmetic system whose main
purpose is to evade taxes and whose secondary purposes are
to capture capital, to pay optionees lots of money and to
beat analysts expectations by just a little bit (you can
tell as many lies with accounting as you can with
statistics).
A
P/E ratio of 70 means that, if the company is not growing,
it will take 70 years of similar earnings to earn the price
of the share. Does not sound like a good deal. Value
investors like P/E ratios of 5 to 10! But that is just not
available in Telecosm. But if earnings are growing at 50%
per year, then it will take just under 9 years to earn the
price of the share. And if the P/E ratio is 200 then, at 50%
earnings growth, it will take about 11.5 years to earn the
price of the share. Still fairly close to what a value
investor might find acceptable.
Let's
take a company that is showing some totally unbelievable
earnings growth. One of the GTR stocks' earnings grew 4
fold. This cannot be sustained so let's assume that in year
2 earnings grow 2 fold, in year 3 they double, in year 4
they grow 50% and from there on they grow at a 25% rate.
Would this company justify a P/E ratio of 400? Well, it
would earn the price of the share in just under NINE years!
A value investor should be happy with that!
You
don't believe me? Take out your spreadsheet and do the
calculations. Compound interest does amazing
things.
The
arithmetic does not lie but we have to check to see if the
growth rates are feasible or ridiculously high. Arithmetic
will not figure it out for you. You have to understand the
company and the industry. You have to understand the will of
the people to communicate. You have to understand the huge
amount of people on this earth. You have to understand price
elasticity. You have to understand the S curve growth
patterns.
If
you believe that we are in the infancy of Telecosm. If you
believe that without a cold war raging we have lots of
capital to invest in the Telecosm infrastructure. If you
believe that service providers are galloping at break neck
speeds to try to achieve first comer advantage. Then you
should believe that for a short few years, maybe 5 to 10 we
will be able to sustain such incredibly high earning growth
rates at least in some of the Telecosm
industries.
My
own take is that the service providers will wage enormous
price wars and that very few of them will make any money at
all. Only the ones with the best execution will make money.
But the companies that will supply the equipment to the
price warriors and the rest of the supply or value chain
will earn heaps of money for several years. Long term buy
and hold could be as short as three to five years in this
crazy infrastructure build out. After that I think that
things will tend to go back toward "normalcy," at least,
somewhat.
Anyway,
that is what I have to believe to stay in this
market!
24. The object of the Investing Game is not to be right but
to make money. If this technology proves to be a market
success, you have plenty of time to get in when the risk
level is much lower. After the first or second quarter with
"real" earnings might be a good time and you should still
get a five or ten year ride. In the mean time, put your
money to work elsewhere with less risk (any one of the
Gilder 9 will do).
25. One good way to make money is to be alone in your field
of endeavor so that everybody has to buy from
you.
Barriers
to entry were high in the Mafia business because competitors
were liquidated. If the wars got too hot, they divided the
territory and signed a peace agreement.
In
regular business barriers to entry might be patents (QCOM,
Intel), need for very deep pockets (Globalstar), first entry
advantage (no one ever lost his job buying IBM). I don't
think this information is collected anywhere but as you get
to know the companies, and even more important, the
industries, these things will show up.
26. GG likes to use the comparison: "content vs. conduit."
Conduit is the Telecosmic infrastructure. It's the
collection of optic fiber, satellites, cell phone systems,
radio systems and the equipment and software that it is made
up of. Practically all of the companies that make up the GTR
paradigm list are Telecosmic infrastructure
companies.
27. Ross Perot has a sign in his office: "Eagles don't
flock. You have to catch them one by one." Same with
investment picks (except for the Gilder flock of companies
<VBG>). A hunter or fisherman knows what he is looking
for and he knows the most likely place to find it. (As my ex
partner used to say: "If you want to kiss, you have to look
for a mouth!") RFMD and some other stocks I found through
Navellier's MPT Review. MUSE I found by reading a McKinsey
report. ARMHY I heard mentioned on this board and I
remembered them from Apple Newton days. Once you find a
likely candidate, you have to do your Due Diligence, analyze
it according to sound investment criteria, revenues,
earnings, competition and, very important, management. The
Gorilla Game should give you some good pointers as what to
look for.
28. Both MUSE and ARMHY happen to have a list of customers
and partners that is a Who is Who of high tech. Some
companies might give an arm and a leg to have such
customers. The right questions in my mind are: "Can these
companies grow into their outrageous valuations?" "What
about competition?"
ARM
Holdings shipped "only" 50 million processors in 1998. The
forecast is for 100 million in the year 1999. I think the
market may be several billion. It is highly likely that most
intelligent portable gadgets will have "ARM
Inside."
MUSE
is becoming the leader in its field, monitoring and managing
networks.
29. The only Telecosmic software that I really like so far
is Micromuse (MUSE) and I keep searching.
30. You guys seem to forget that where people work is just
as important as how smart they are. In a stifling atmosphere
most people will wilt while in a go-go atmosphere they will
reenergize each other. The same amount of smarts will do
less for AT&T (unless they throw out the CEO with the
bath water) than for GBLX.
31. Yes there are bubbles but generally the market knows
what it is doing. You might want to read about Competitive
Advantage Period (CAP) which explains the current
"ridiculously high" valuations. My opinion is that
collective intelligence tends to out perform experts. That
is why Democracy and Capitalism work while Socialism and
Communism don't.
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