“Five Rule Makers: The Fool’s Power Stocks”

By Travis Johnson, Stock Gumshoe, August 29, 2007

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.


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August 29, 2007 8:11 pm

FWIW, Oxford Club has been pushing YUM Brands for some time now.

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