Stock Gumshoe

This one’s a little bit different, since the Motley Fool is selling not a subscription necessarily, but a special report called “The NEW Rule Makers: 5 Power Stocks You’ll Never Want to Sell.”

Rule Makers is an old term from the Motley Fool lexicon, they’re the ideal evolution from the “Rule Breakers” that Dave Gardner looks for in the Rule Breakers newsletter service (and before that, in his Rule Breakers Portfolio in the late 90s when the Fool really hit its stride and did well with picks like AOL, etc.). If you remember, the Gardners had a pretty popular book back in 2000 called Rule Breakers, Rule Makers … so, we get it, catchy names.

They consider Rule Makers, as I understand it, to be companies that dominate markets and can be held to infinity (more or less) — they set the “rules” for the market and are generally, as far as I’ve seen, large cap growth stocks.

This is also somewhat of a subscription tease, since you can either buy the Rule Makers report for $59 or get it free when you sign up for a $99 subscription to their Stock Adviser newsletter — which is their cheapest and most general newsletter, the one that pits brother versus brother. I’m guessing they’re mostly hoping to bring in more SA subscribers, but I don’t really know.

But anyway — they do provide some clues for these stocks, so let’s think on them for a bit:

This is how they describe the Rule Makers: “These are true industry leaders that will earn their rightful place in every serious investor’s portfolio by making the rules that lesser companies follow.”

“And today, you can get their names, backed by detailed stock write-ups from our expert analysts, in The Motley Fool’s just released premium report… ” bla bla, I already told you the name of the report.

And this actually is a case where the report is pretty recent — they tend to keep their “special reports” around for years as long as the company is still promising, I think I saw teaser emails for the Special Report for Inside Value that teased Markel as the successor to Berkshire Hathaway every few months for close to two years. But this Rule Makers one, as far as I can tell, is new within the last month or two.

And while this teaser isn’t quite as crazy long as the ones I usually get in my inbox from the Gardner gang, it does take a few moments to emphasize Tom’s great investing performance, with his Simpleton Portfolio from the late 90s that I gather followed a similar strategy to this one. So they note how listening to Tom mten years ago would have you rolling in the returns from Cisco, Dell and America Online. Not bad, especially since that means you would have held through the bottom in the internet crash. They report that the Simpleton Portfolio would have given you 600%+ returns over the decade beginning in 1995, more than four times better than the performance of the overall market.

They also emphasize that these are generally lower risk stocks that won’t crash and burn in a day, which I guess is largely true for all the examples they gave

In their words: “Tom custom designed the Rule Maker system for prudent investors who didn’t want to risk money on upstart companies, but who were still looking to make serious money in the stock market.”

OK, so what are the Rule Makers that we’re talking about here? What kind of teaser action can we get from this ad? Companies that the Fool believes are “some of the safest plays you can possibly make, given the current environment of volatility and uncertainty?”

The analysts that they used to put together the Rule Makers are names that are likely familiary to any Fool watchers out there — Philip Durell from Inside Value, James Early, the new guy at Income Investor, and Seth Jayson and Bill Mann from Global Gains.

And here’s what they like: Rule Maker #1

“This payroll services stalwart has been around for over half a century and now literally DOMINATES its industry. Yet, you probably don’t know its name and almost certainly don’t own it. “

Presumptuous, eh? Ok, so technically I don’t own it … but I have heard of it and you may have, too.

Some clues:

Revenues of “more than $7.6 billion” for 2006.

“Ninety percent client retention”

20% return on invested capital.

So … enough blathering from your friendly neighborhood Gumshoe … we throw the switch on the Thinkolator and after a few minutes of careful humming it tells me that this stock must be …

Automatic Data Processing (ADP)

The one thing that strikes me as odd is that they’re underplaying the revenues — ADP had sales of getting near $9 billion in 2006 according to numbers I’m looking at. But since they tease this as the “payment services stalwart” that dominates its industry, it pretty much has to be them.

ADP is about 50% larger than its next biggest competitor, Paychex, and they must have some seriously different business mix, since Paychex goes for close to 10X sales and ADP for more like 3X sales. ADP does much more non-payroll work, from what I can tell, including brokerage data management, etc.

PAYX does have significantly better growth in recent quarters, and a richer valuation to match, but analysts don’t seem wildly optimistic going forward — their Price/Earnings/Growth ratio is 1.77 at the moment, compared to the more average 1.45 for ADP.

So … there’s something to get you started with the first Rule Maker — to me, it looks like a pretty standard blue chip growth company, valuation a little rich but not so much that it gets your palms sweaty, and while I’m sure there are plenty of economic shocks that might cause them to trip, they are quite a monster so perhaps they’ll do fine in the event of a big drop in unemployment or a recession … I couldn’t tell you, but I can tell you that someone over at the Fool seems to really believe in them. I’m guessing this is James Early’s pick, but that’s just a guess.

And we move on … to Rule Maker #2

“This 157 year old financial services company is so solid that Warren Buffett himself is a major holder. No wonder. It enjoys strong, sustainable competitive advantages, a brand name that’s trusted worldwide, and mouth-watering financials.”

OK, so you might well know this one already, eh? Buffett’s holdings aren’t exactly a secret (though you’d think they were, given the number of tout services that promise to “reveal Buffett’s picks” … but that’s neither here nor there)

But a few clues, for those not yet caught up with the class:

38% return on equity

“Seeks to return 65% of the capital it generates to its shareholders”

“BusinessWeek just ranked its brand ahead of Gillette, Pepsi and Budweiser in its 2006 list of most valuable brands.”

This must be the Phillip Durell pick, because he’s quoted as saying that this company “is better positioned to achieve growth and outstanding results NOW than anytime in the last half-century.”

So, ready for the big drumroll? This mysterious rule maker, revealed here for your researchification pleasure, is …

American Express (AXP)

So again, not a real big shocker out of left field, eh? A blue chip financial services firm, a species not terribly in favor in recent weeks, and a major Buffett holding (along with Wells Fargo and US Bancorp and, more recently, Bank of America, in case you want to catch up on his financial industry investments). Durell is the value picker at the Fool, which makes sense because I don’t remember ever seeing AXP trading at a discount to the market, which it appears to be at the moment with a forward PE of around 14. As you might imagine, the shares have been relatively flat over the last several years as the PE ratio degraded to the current levels, and apparently the Fool folks think it’s time for them to pick up again.

I looked briefly at American Express back when the Mastercard IPO was getting everyone hot and bothered, but didn’t buy at the time, and I can’t give you any brilliant insights into their business — they did sell off their advisory business so now they’re really the payments and travel company that the rest of us always thought they were anyway … if you like those businesses, and believe this is a long term growth stalwart and that the brand will remain dominant internationally, you’ll probably like the price you can pay for the shares today.

And suddenly, the clues and the teasers dry up … what happened to our other three Rule Makers? Are the Foolies running in fear from the Gumshoe’s powerful Thinkitationizer? Perhaps.

But they do also throw in a sixth company, with a few clues …

Or, as they put it, “why only hit 5 home runs when you could hit 6?”

This sixth company is on the “fringes”, as they put it, of the Rule Maker criteria, but they like the growth potential.

“This under-the-radar juggernaut owns a stable of instantly recognizable brands millions of Americans shop daily.”

Growth is coming from overseas, where the company already operates in 100 countries, with 34,000 locations and $9.5 billion in sales.

And operating profits are growing at 31%.

So what’s this near-rule maker? What would we call that, anyway … Rule Proposer?

I’m pretty sure, after a few patient moments dethroglifying the Cognitator engine, that this company is …

YUM Brands (YUM)

Their sales were $9.561 billion last year, they do say that they operate in over 100 countries and have over 34,000 locations. And clearly, as anyone who has followed the China story knows, this is a growing company largely because of their dramatic success with Pizza Hut and KFC in the Chinese market. You’ll hear folks like Robert Hsu talk about Yum Brands as a compelling “China play,” too, so the Fool is certainly not alone in liking this one. The valuation seems right about where you’d probably guess it would be — a PE of around 20 and a bit of a premium to the market, but, as befits a fast food purveyor, you don’t have to pay up for it quite as much as you might for a Starbucks.

Can’t really complain about any of these picks, of course — they’re all valued with the expectation that they’ll see continued growth, but they’re all also massive companies that seem to have excellent market positioning and, probably, plenty of growth potential still extant. I have no idea whether you’d be overpaying for them at this point, that kind of valuation is something only you can do for your own money and comfort zone, but they certainly seem to be rock-solid large cap growth companies — more or less as promised for potential “rule makers.”

I don’t own any of them, just to be clear in my disclosure here, and I don’t expect I’ll be placing an order for any of them anytime real soon, either, though neither do I harbor negative feelings about ADP, YUM or AXP.

And unfortunately, the other three recommendations on the “Five (really six) Rule Makers” will have to wait until they decide to market this report a little more vigorously with some more teaser emails … they didn’t provide a single clue about the other picks in the report. Maybe, since the Gumshoe got you started here, the Fool will be willing to sell you just the three picks you don’t already know for half price?

Probably not, huh?

Well, who knows, if you like the kind of explanations and followup that they give for their stock picks, and want to make sure you stay on their email list to continue receiving heavy doses of teasers for other Fool services, maybe it’ll be worth it for you to subscribe. But for those of you who were just hoping to find a few “rule makers” for free … well, there you go. Start your research, and let us know what you think about American Express, Automatic Data Processing, or Yum Brands.

I’m finding that sleuthing out stock picks is a healthy way to indulge in my stock market addiction on days like this, when I would otherwise be throwing money at what look to me like serious bargains, only to watch them fall a further 10 or 20% in the minutes following my purchase.

So in an effort to save my sanity, I’ve been reading another email from the Motley Fool — for those keeping score, that means I’m writing up two in a row for Tom Gardner here at the Gumshoe! This one is for the Motley Fool Stock Advisor newsletter, which is the oldest and, I think, least expensive of the Fool newsletters ($99 on sale a the moment).

The letter, from Stock Advisor’s publisher, promises to identify the latest stock that has a singular, almost-guaranteed-to-win characteristic.

In his words, “while thousands of issues trade on the U.S. markets every day, a GRAND TOTAL OF 19 STOCKS have surfaced with this ONE defining characteristic going back to April 2002 … [and] stocks like this have earned investors average PROFITS of 79.3%”

That sounds halfway decent, no?

And he’s ready to tell us the name of the latest stock to meet this criteria … if we’ll just sign up for our trial subscription (naturally).

“I don’t exaggerate when I say the stock we’re discussing today comes … Closer to being a SURE THING than anything I’ve come across in a very long time. “

The “defining characteristic” that is being teased here is that the stock has been re-recommended by Stock Advisor. These, clearly, are the stocks that the Gardners feel most passionately about — examples given include Quality Systems, which is certainly a nice performance to aspire to over the past few years.

So, what company are we talking about here? We get several clues:

“$65 million in free cash flow annually”

“has nearly $400 million in cash, zero debt, and not so much as a single inventory or accounts receivable cost?”

Growing free cash flow 20% a year.

“Just like Dell in the 1990s, this company is the top-rated consumer brand and undisputed leader in its category — shipping a staggering 1.4 million units per day nationwide.”

They have 6.8 million customers already.

And apparently growth is projected, still: “the company expects to blast through the 10 million subscriber mark within the next two years and to surpass 20 million before 2012″

The company was founded in 1997, and the founder is still at the helm and is a major owner (more than $60 million in stock)

And the key:

“A recent 25% drop in share price makes NOW the time to get in”

So … we insert the relevant data into the Wisdomization Thoughtifier, and find that this company is …

Netflix (NFLX)

I know — quite a letdown, eh? Always sad when you get tantalized by a company that it turns out you already know quite well. And if you’re listening to the Wall Street cognoscenti, you probably hate this one. The shares are down quite a bit more than the “recent 25% drop,” the shares did indeed have a couple 25% drops this year, but overall are down almost 50% from the Winter price near $30, and even down quite a bit from the $20-30 range they’ve traded in for the past two years.

And you probably know the story quite well — Netflix vs. Blockbuster vs. whatever-the-online-movie-delivery-thing-is-going-to-end-up-being. Netflix’s recent decline is because they had their first quarter in memory in which they LOST customers (bringing them from that 6.8 million teased number down to 6.7 million), and they’re losing them to their archrival, Blockbuster, which is offering that “in store trade-in” option for movies that Netflix can’t compete with.

The good news is that Netflix is MUCH stronger financially than Blockbuster — so if this ends up being a protracted price war, Netflix might win.

But the bad news is, price wars don’t often generate much in the way of sustainable earnings growth, the kind of growth that Netflix enjoyed when they had the subscription movie rental business more or less to themselves, and Blockbuster has the secret weapon of thousands of local stores that they could use to raise cash or generate other revenue streams (their head guy now is, if memory serves, a convenience store veteran who wants to use the stores more effectively). Depending on which analysts or journalists you read, those stores are either Blockbuster’s achilles heel, or their secret weapon … personally, I’m undecided on that dispute.

Netflix has been a Motley Fool favorite for years and years, so you’ll find lots of articles on their site about the company even if you don’t subscribe to the newsletter, if you just want to get a handle on things. Tom Gardner may well be right, it might be that the visionary leader of Netflix will see them through this market turmoil the same way he has in the past, and help to build a stronger company. Netflix certainly has lots of cash, and they’re reportedly spending it to build better delivery systems for if and when online movie rentals become viable for the masses.

The founder, Reed Hastings, is also on the board of Microsoft, so we can be assured that he’s pretty well connected in the industry should he decide to sell to a bigger company (that’s been the rumor for quite some time, whether it’s Microsoft or Amazon or Google or someone else doing the buying).

It’s certainly true that this company developed a new market, and became the market leader by taking some of Blockbuster’s customers … whether you want to bet that they’ll do so again, well, that’s up to you. I’ve looked at NFLX before and always found it too expensive to look into very thoroughly (though I am, personally, a subscriber), but it certainly looks like it might be more appealing at these prices if you’re not scared of price wars. As always, it’s your money so do your research, and let us know whether you think it’s curtains or showtime for Netflix.

When the Motley Fool Hidden Gems newsletter sends out a teaser email, I always pay attention — not only because I was a subscriber to that service a few years ago and generally liked the newsletter, but because it has recently ranked as the best newsletter in the country, according to Hulbert … and that’s saying something, though of course it doesn’t spin all of their picks into gold.

So what are they sending around now? And can we sniff it out without coughing up the $199 Tom Gardner charges these days?

“The Real Estate Rocket (yes, real estate!) No One’s Telling You About … you’ve heard all about the housing industry distress, the subprime crisis, the increasing mortgage delinquency and foreclosure rates. But there’s another side to real estate no one’s telling you about.”

That’s the big tease for you — this is a real estate company, but it’s related to commercial real estate, which hasn’t (yet?) hit the kind of problems that we’ve seen sinking mortgage lenders, homeowners, and banks.

Apparently they’ve recommended this stock as their top pick three times in the last four months. Sounds like a pretty strong focus for one stock, a little unusual.

So what other clues do we get in the (very long, naturally) email ad?

This company runs a website that helps people buy and sell (rent and lease, whatever) office space. The Fool calls it the “Match.com of commercial real estate.”

The company website has 2.2 million registered users (hah! The Gumshoe’s Mighty Irregulars could take ‘em! Oh, wait … that’s MILLION. I take it back. We surrender.)

Had 900,000 unique visitors in June.

566,000 properties listed ($440 billion worth for sale).

Users provide the content, and pay a monthly fee — so this must be very scalable, and pretty high margin.

Currently has 88,000 premium members paying “roughly $51 a month” to gain access to the most valuable information.

Revenue is about $50 million, revenue growth for the past three years has beeen 6.5% a year.

Operating margins are improving.

So, that’s a whole mess o’ clues .. should only take a few moments in the researchifier and we find that this company is …

LoopNet, Inc. (LOOP)

All the financials match, and it does indeed have 2.2 million registered users … pretty close to the number of “residents” of Second Life, to give you some perspective. I’ve never used either one and I own neither a virtual avatar nor any commercial real estate, so my expertise ends there.

This is indeed essentially an online commercial real estate marketplace, not too different from an eBay, or from a souped-up commercial version of the residential listing database that our realtors used when we bought our homes.

At a forward PE of 32, this seems a little pricey for a Hidden Gems stock, but the small cap service, though it has a reputation for value stock picking, does choose some fast growers as well … as long as they’re little.

And this one is pretty small, a market cap just around $750 million. They do have nice, beefy profit margins, and no debt, and with the numbers the analysts are pegging in for growth we get a forward PEG (price/earnings ration divided by growth rate) of about one and a half … not screaming buy land, but noth terribly expensive either. Again, that relies on the analyst numbers … and the analysts are getting a little more accurate with this one, LOOP has consistently surprised on the upside with earnings, but only by 8% last time they reported (compared to 44% last Winter). There have been pretty equal numbers of analysts upgrading and downgrading the numbers in the last few months, so maybe they’re still a bit confused, who knows.

Myself, I’m a little unsure of how to value this one - even though it’s essentially in commercial real estate, which indeed has so far been somewhat shielded from the subprime mess, I can’t imagine that a global debt freeze like we’re mired in now, at least temporarily, is good for deal volumes in any kind of real estate. People will always need offices, at least for the foreseeable future, but I don’t have a a handle on how much a smallish move up or down in commercial lease activity would impact LOOP.

Probably because I’m not sure how they make money — I assume it’s a listing fee of some kind, in addition to the premium memberships. That’s probably a decent thing to research a bit before jumping on this one, if you’re at all so inclined. They also have a much smaller business called BizBuySell that operates as an online marketplace for businesses, which also sounds pretty interesting, though I know even less about business brokers than I do about real estate brokers.

For what it’s worth, if Hidden Gems is as big as it seems there are at least thousands of subscribers who have probably bought this one in the last few months and want to hold on tight to it if the drum is being beat this loud for LOOP … what that means for investors who aren’t in the club, I don’t know.

In recent news, LoopNet just bought their biggest competitor CityFeet, which, in addition to the 100,000 listings CityFeet brought in, means that they also get a more robust new distribution network for real estate listings that includes many of the biggest newspapers in the country … at first blush, that sounds like a genius deal to me, though I don’t know if they paid a fair price or not. According to the releases, this is expected to cost them two cents on EPS this year, it was a fairly small acquisition at $15 million.

Definitely worth reading up on a bit more if you’re interested and not totally terrified of everything related to real estate — let us know what you think.