I. Market News: Pass the Chips, Please
II. Heroes: Semis, Kulicke & Soffa, Analog Dev., Eljer, Amer. Super.
III. Goats: Hamburger Hamlet, Triple S, Dave & Buster's, Quality Sys.
IV. Investment News: Dissecting Market Multiples
V. Calendar: Friday's Economic Events

MARKET CLOSE

DJIA: 4864.23, up 11.56 (RECORD)
S&P 500: 593.26, up 1.55 (RECORD)
NASDAQ: 1065.61, up 17.67

MARKET NEWS

Despite the fact that Washington Cowboys are playing games with a potential United States default, Wall Street chugged ahead today as technology stocks recaptured much of the week's earlier losses. Last night's semiconductor book-to-bill ratio announcement set off the buyers. Inflation at the wholesale level remains benign, according to today's Producer Price Index announcement, yet the bond market remained skittish because of the budget politics plaguing Capitol Hill.

HEROES

The semiconductor book-to-bill ratio, anticipated in the 1.08 range by many Street analysts, burst through all expectations last night, hitting the 1.18 mark. The fact that $118 in new orders came in for every $100 in orders shipped during October was enough to spark a rally in chip stocks, hit hard recently on downgrades from high-profile analysts and troubles for a few select corporations. Rick Whittington, Tom Kurlak and Cirrus Logic---the bugaboos of Tuesday---receded from the market's consciousness today as their downgrades all surged. Here's Whittington's flock of victims: Applied Materials <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMAT)") else Response.Write("(NASDAQ:AMAT)") end if %> surged $4 1/4 to $52, Lam Research rose <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LRCX)") else Response.Write("(NASDAQ:LRCX)") end if %> $3 to $57 3/4, Teradyne <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:TER)") else Response.Write("(NYSE:TER)") end if %> moved ahead $1 1/8 to $29 5/8, Megatest <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MEGT)") else Response.Write("(NASDAQ:MEGT)") end if %> tacked on $1 1/4 to close at $27, and Credence Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CMOS)") else Response.Write("(NASDAQ:CMOS)") end if %> was unchanged at $35. And Kurlak's pans: Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MU)") else Response.Write("(NYSE:MU)") end if %> up $2 3/4 to $64 3/4, Intel Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INTC)") else Response.Write("(NASDAQ:INTC)") end if %> rising $3 1/16 to $69, Texas Instruments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:TXN)") else Response.Write("(NYSE:TXN)") end if %> adding $4 1/8 to $63 3/8, Avnet <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AVT)") else Response.Write("(NYSE:AVT)") end if %> putting on $1 7/8 to close at $50 3/4, and LSI Logic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:LSI)") else Response.Write("(NYSE:LSI)") end if %> moving along $2 5/8 to $44 1/8. Basically, these issues made a round-trip back to Monday's levels from the bargain levels induced by the downgrades. Cirrus Logic <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CRUS)") else Response.Write("(NASDAQ:CRUS)") end if %> wasn't quite so lucky---up $1 1/2 to $30 1/8 today, but nowhere near the $42 level it enjoyed on Monday.

Kulicke & Soffa <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:KLIC)") else Response.Write("(NASDAQ:KLIC)") end if %> surged ahead $3 1/4 to $32 today after the company announced that it has located and fixed the problem with its 1488 Turbo Ball Bonder. Much ado about nothing? Seems so. The company stated that the correction, which involves tweaking the software which scans a specification of material for the balls, did not cost the company an appreciable amount. Caught early in the quarter, the company sees this minor hang-up only affecting about $5 million in revenues for the first quarter of 1996. With analyst estimates for first-quarter revenue sitting around $100 million, the fact that this $5 million worth of products will be delayed until the second quarter probably won't affect the first-quarter's earnings and definitely won't hurt earnings for fiscal 1996, currently estimated to clock in at $3.28 per share. With the stock at $35 before the bad news, it stands to reason that it is headed back in that direction again. Kulicke & Soffa makes front- and back-end manufacturing equipment for the semiconductor industry.

Like Kulicke & Soffa, Analog Devices <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:ADI)") else Response.Write("(NYSE:ADI)") end if %> had the good fortune to release news last night along with the stunning semiconductor book-to-bill ratio. Rising $2 1/2 to $36 1/2, Analog Devices benefited from Moody's upgrade of the company's debt because of improved performance driven by strong demand for the company's integrated circuits. Moody's believes that future volatility in the semiconductor industry may be less "dramatic" because of the rapidly expanding use of semiconductors and because of margin improvements across the industry. (This is Moody's, mind you, a conservative debt-rating agency.)

Eljer Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:ELJ)") else Response.Write("(NYSE:ELJ)") end if %> exploded today, up $3 5/8 to $8, following news that it is participating in a potential settlement involving polybutylene (PB) plumbing systems which have been used throughout the United States. Apparently, Eljer's subsidiary, U.S. Brass, made and sold plumbing with the PB plastic, which after some wear, leaks and necessitates expensive home repairs. U.S Brass, which filed for bankruptcy as a result of these claims, has no assets, so the lawsuit targeted Eljer. Eljer has to give up any money it gets from its liability insurance, a portion of the proceeds if the litigation it filed against its former parent---Household International <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HI)") else Response.Write("(NYSE:HI)") end if %>---is successful, $3 million in cash, a non-interest bearing note for $20 million (payable over 10 years), and 17.5% of the equity in Eljer Industries. Evidently, the market was anticipating that Eljer would be bankrupted by the claims, so the stock got a boost today. Although not bankrupt, it looks like the lawsuit still takes a big chunk out of Eljer's hide.

American Superconductor <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:AMSC)") else Response.Write("(NASDAQ:AMSC)") end if %> managed to rise $1 1/8 to $12 1/8 in spite of reporting a bigger-than-expected second-quarter loss. The company dazzled the Street by demonstrating a commercial-scale prototype of a "cyrogenically cooled power converter." The company hopes to launch this product by mid-1997. Patting themselves heartily on the back, management claims that they are giving this demonstration four months ahead of schedule and that the prototype exceeds performance expectations for the power converter by more than 30%. However fast they built the prototype, it's still a year-and-a-half until launch---quite a wait.

GOATS

It was tough finding stocks which fell today. Hamburger Hamlet <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:HAMB)") else Response.Write("(NASDAQ:HAMB)") end if %> had a rough one, though, down $1 3/4 to $13/16 (that's right. . . under a buck). The good news first: the company has settled a shareholder lawsuit for $1.47 million. The bad news? The loss of $0.48 per share it announced with the settlement puts Hamburger Hamlet in violation of its loan covenants and the bank promptly froze its $5 million line of credit. Ouch. On the lighter side, Dow Jones Wires first announced that Hamburger "Helper" was down 71%, not Hamburger Hamlet. We hope you didn't rush to the grocery store on the "news" to stock up on your favorite meat fixins at bargain prices.

Triple S Plastics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:TSSS)") else Response.Write("(NASDAQ:TSSS)") end if %> attempted triple-digit losses today, down $1 to $8 1/4 as earnings withered to $0.12 per share versus $0.20 a year ago. Revenues *increased* about 33%, meaning that the company has completely lost control of its gross margins. Earnings last quarter were flat, suggesting that any momentum in the company's business is negative. Shareholders should not be that surprised, though; the company stated that costs of training, new equipment and higher raw material prices would pressure margins for the foreseeable future. The opening of its injection molding facility this quarter in Georgetown, Texas, might be to blame for the results.

Ouch! Dave & Buster's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:DANB)") else Response.Write("(NASDAQ:DANB)") end if %> has been surging lately, talked up as the next great dining concept, but lost $2 1/8 to $13 5/8 today. Spun off last June from Edison Brothers <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:EDS)") else Response.Write("(NYSE:EDS)") end if %> of all companies, the shares have enjoyed quite a run as analysts tout the video-game-packed eateries as the next big fad. Apparently the shareholders of Edison Brothers agree; in fact, they might challenge the spin-off retroactively as contrary to the best interests of the company. All this after Monday's 7% surge for Dave and Buster's following a money manager touting them Friday on TV. Doesn't take much these days to set the ball rolling.

Quality Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:QSII)") else Response.Write("(NASDAQ:QSII)") end if %> made quite a run prior to releasing earnings as momentum investors attempted to pile in and benefit from any earnings surprise. The earnings came out, and they were great---up 200% from the same quarter a year ago on a revenue increase of 50%. So why is the stock down $2 7/8 to $23 5/8? Apparently Quality Systems (which is touted as the "next" HBO & Co.) either didn't produce earnings that were "good enough" or the crowd who jumped in took their profits quickly. Estimates for the year are $1.16, according to the lone analyst who follows the stock, so those numbers should be taken skeptically. With virtually no official coverage of the stock, it's bound to be all over the map. Wanna know whether it's a good buy? Call up the company and get the investors' packet; with no analyst coverage, the odds are that if it is a great company, you'll find out before most of the Street. That's the Foolish way.

INVESTING NEWS: Market Multiples: What Do They Mean?

Fooldom has often heaped scorn upon what it calls the "solo P/E" method of valuing a stock. You know the type, "The P/E of XYZ Corp. is 24! I never pay more than 10 times earnings! Never!" The fallacy of this approach to valuation is revealed by examining its core conviction---that a dollar of earnings is worth the same whether it comes from a decaying steel mill or an expanding software house. Anyone who focuses on the quality of the fundamentals underlying a company can tell you that the stock's multiple reflects the market's expectations for growth, discounted by the market's assessment of the risks involved in achieving that growth. The "solo P/E" approach completely throws aside the fundamental business in the same erroneous way that pure charting does.

Don't get us wrong, now; we have not gone "efficient market" on you here at the Evening News. We remain pretty skeptical of the "market's" ability to estimate growth or discount risk; it consistently errs on the side of hysteria in either direction. The reason we bring up the "solo P/E" valuation system today is not to ridicule it some more or attempt to prove that you should never buy a stock unless it has a P/E of four. Rather, we would like to examine how one fundamental piece of information does affect the multiples of all stocks on the market---the interest rate on the 30-year Treasury bond.

A few months ago, we received at Fool HQ a fascinating article by Warren Buffett from one of our many subscribers which got us thinking. In the article, Buffett advanced the hypothesis that a share of stock was simply a bond with no fixed duration and no fixed interest rate. Buffett went on to make a case for investing in stocks when the rate of return they offer is superior to the rate of return that one can get from a "risk-free" investment, U.S. Treasury Bonds.

Sure, with the prospect of a default by the U.S. Government looming, perhaps Treasuries are not as risk-free in this Republican Congress as they were when Buffett penned the article in the 70s. The core assumption, however, was that at some point, the yield available on the market would "inform" the prices of stocks, since in effect the fabled P/E, that Holy Grail of fundamental analysis, is nothing more than an inverted yield number.

Price divided by trailing twelve months' (TTM) earnings per share (EPS) is how one derives the P/E ratio. For instance, if a stock costs $10 on the open market and has earning of $1.00 per share over the past 12 months, it is said to trade at a P/E ratio of ten (10/1=10). Another angle to approach this is through the earnings yield, though, which makes the comparison appropriate against bond yields. That same company, XYZ Industries, currently sells for $10 and has a $1.00 in earnings standing behind it. It has "yielded" 10% in earnings ($1 divided by the $10 price).

Right now, the average P/E ratio on the S&P 500 is around 17, according to the latest issue of Barron's (a publication the Evening News, in its grand scheme of things, aspires to make obsolete). This means that for every $1 worth of earnings out there on the S&P 500, investors are currently willing to pay $17. If we invert this number to get an earnings yield, a curious thing develops; the current earnings yield is roughly 5.88%, very close to the 30-year rates which float at roughly 6.25% and almost exactly equal to the rates of 10-year Treasuries.

The more interesting numbers come up when you look forward to next year. According to consensus estimates as measured by First Call, investors are currently valuing the market at 13 times next year's earnings. Today, for $13, you get a $1 in earnings next year (unless those scalawag analysts are having some more fun at our expense). This is an earnings yield of roughly 7.7%. With interest rates headed down and inflation in check, many analysts are forecasting that long-term rates will be in the 6.25% range next year. If this is true, and the multiple grows next year to reflect this, then we could see next year's market P/E go up toward the 17 rang

Another way to look at yields is to use the overly simple Rule of 20. The rule of 20 holds that the average P/E should be equal to 20 minus the current yield on 30-year Treasuries. This would suggest that the market may be a little ahead of itself now, but has some room to appreciate into next year.

Obviously, we are not trying to turn on its head everything Foolish. We think that much more goes into valuing individual companies than the current yield. It is important, to realize, however, that stock market multiples exist in a context---that of the prevailing rate one could achieve as a risk-free return (unless Newt Gingrich wins his game of chicken with the White House, and then the rate of return will become "almost" risk-free). This is a fact that the bears out there should particularly take to heart; in all of the other historical situations when we have seen a low dividend yield and a subsequent market crash, interest rates have been much higher, the "risk-free" return on capital much greater, and the institutions had more incentive to get out of the market.

Not to say that this time is different, but the rates sure are.

CALENDAR: Friday's Economic Events

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Byline: Befumo/Sheard (MF Templar/MF DowMan)