HEROES
Following last week's merger offer from CSX CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSX)") else Response.Write("(NYSE: CSX)") end if %>, CONRAIL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CRR)") else Response.Write("(NYSE: CRR)") end if %> shareholders are being asked to contemplate another offer which looks pretty darned attractive in the short-term. Not to be outdone by CSX, NORFOLK-SOUTHERN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NSC)") else Response.Write("(NYSE: NSC)") end if %> launched a $100 all-cash bid and announced that it will immediately buy shares tendered at that price. Depending on how Norfolk proposes to finance the $9 billion deal, this has the potential to install a good deal of leverage on the new company's balance sheet. For Conrail shareholders, though, the deal holds the prospects of increased efficiencies, which will be discussed in the Fool's Rails area. Financially, even if one doesn't build in any assumptions on cost savings, the combined company could earn $10.75 in 1997, far above what CSX shareholders are anticipating for next year. Following this news, Conrail shares were bid up $10 7/8 on the day, to $95 5/8.
WABAN CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WBN)") else Response.Write("(NYSE: WBN)") end if %> sped upward by $3 3/8 to close at $27 1/4 this afternoon after the warehouse retailer proposed a spinoff of its BJ's Wholesale Club unit to shareholders. Waban's HomeBase unit takes the blame for lack of shareholder wealth creation as that unit is being challenged by names like HOME DEPOT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %>. At the same time, though, BJ's isn't exactly unchallenged, as it competes with the mighty WAL-MART <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %> and PRICE/COSTCO <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PCCW)") else Response.Write("(NASDAQ: PCCW)") end if %>. In July, BJ's contributed 64% of Waban's $148 million operating income for the trailing 52 weeks, in part due to BJ's ability to create same-store-sales growth and HomeBase's failure to do so.
PEOPLESOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: PSFT)") else Response.Write("(NASDAQ: PSFT)") end if %> traded up $8 3/4 to $89 1/4, reporting a near doubling in sales and earnings, a stock split, and the purchase of its very own manufacturing division.
SYRATECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SYR)") else Response.Write("(NYSE: SYR)") end if %> jumped $4 7/8 to close at $31 1/8 after the company reported a 119% increase in quarterly per-share earnings on continuing operations. Furthermore, the company announced that it had received a definitive merger agreement with an investment fund, which offered $32 per share. Syratech, 10%+ owned by the Gabelli funds, is one of those companies the professional investor Mario Gabelli has mastered. The nondecscript Syratech manufactures flatware, silverware, and other tableware under the names of Wallace and International Silver, as well as "casual furniture." Sleepy stuff, but the better companies of this ilk are characterized by low capital expenditures, protected niche markets, and the ability to do private-market buyouts for cash. Gabelli has also bought into such snoozers as CARLISLE COMPANIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSL)") else Response.Write("(NYSE: CSL)") end if %>, the profile of which matches Syratech. Another company likely to be found in some less exciting portfolios is ONEIDA LTD. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: OCQ)") else Response.Write("(NYSE: OCQ)") end if %>.
QUICK TAKES: MOTLEN METAL TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MLTN)") else Response.Write("(NASDAQ: MLTN)") end if %> bounced $1 to $13 3/8 today after it announced a 8.5% stock repurchase ... PEDIATRIX MEDICAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PDX)") else Response.Write("(NYSE: PDX)") end if %> surged $1 5/8 to $43 3/8 after Hambrecht & Quist upgraded the stock to strong buy ... An estimate-meeting performance from STRUCTURAL DYNAMICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SDRC)") else Response.Write("(NASDAQ: SDRC)") end if %> powered the computer-aided design (CAD) software developer $1 3/4 to $19 ... Contract manufacturer and electronics distributor KENT ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KNT)") else Response.Write("(NYSE: KNT)") end if %> rose $1 3/8 to $23 1/8 after R.W. Baird initiated coverage with a buy ... APPLIED VOICE TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AVTC)") else Response.Write("(NASDAQ: AVTC)") end if %> soared $1 5/8 to $12 1/4 after beating consensus estimates by a penny ... ON ASSIGNMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ASGN)") else Response.Write("(NASDAQ: ASGN)") end if %> rallied $2 7/8 to $31 3/8 after reporting earnings of $0.29 EPS, in line with expectations ... After beating estimates and announcing $24 million in new orders, GLENAYRE TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: GEMS)") else Response.Write("(NASDAQ: GEMS)") end if %> scampered up $2 1/8 to $21 3/4 ... CS First Boston moved VANGUARD CELLULAR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: VCELA)") else Response.Write("(NASDAQ: VCELA)") end if %> up $1 7/8 to $17 3/16, upgrading the stock to strong buy.
GOATS
ELECTRONIC DATA SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EDS)") else Response.Write("(NYSE: EDS)") end if %> dropped $11 1/4 to $48 1/4 on sixteen times normal volume in spite of the fact that it was held for news pending twice during the day. The firm stated that it would face a tough fourth quarter, blaming slow growth in new business, Department of Defense cutbacks due to overspending on the Bosnia mission, and new GENERAL MOTORS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GM)") else Response.Write("(NYSE: GM)") end if %> business of less than 20%. With this quarter's earnings growth already lower than 10%, as the company reported $0.55 EPS versus $0.51 EPS a year ago, investors apparently figured any slower and it would start to be negative. The $23.4 billion dollar company has $14 billion in trailing revenues and $2.08 EPS in trailing earnings, netting out some one-time charges for the full separation from GM. COMPUTER SCIENCES CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CSC)") else Response.Write("(NYSE: CSC)") end if %> was down $2 1/2 to $77 3/8 in sympathy.
For those who thought things could not get any worse with ITRON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ITRI)") else Response.Write("(NASDAQ: ITRI)") end if %>, guess again. The stock plunged $5 1/4 to $15 today after reporting operating earnings four cents below already-low expectations of a loss of $0.15 EPS. The stock had dropped to the low $20s in mid-September when the firm announced that third quarter revenues would be "significantly" below expectations. This is the second quarterly disappointment in a row, as the stock fell from $50 1/4 to $34 on May 31st after the company made the incorrect prediction of "flat earnings" for the next two quarters running. The real losers here are those who bought the stock on April 30th at $58, after Hancock reiterated a "buy" rating. Itron makes wireless meter-reading equipment for utilities.
ST. JUDE MEDICAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: STJM)") else Response.Write("(NASDAQ: STJM)") end if %> dropped $1 1/4 to $37 3/8 after announcing that it was purchasing VENTRITEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: VNTX)") else Response.Write("(NASDAQ: VNTX)") end if %>, pushing the implantable cardiac defibrillator manufacturer up $15/16 to $21 9/16. Although a slight premium, the deal is a bum one for anyone unfortunate enough to have bought Ventritex in 1993 in the $40s. Shares of competitor GUIDANT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GDT)") else Response.Write("(NYSE: GDT)") end if %> dropped $2 to $41 1/2 on concern that the St. Jude-Ventritex combination changes the playing field in the cardiac rhythm management business. In spite of the fact that ANGEION <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ANGN)") else Response.Write("(NASDAQ: ANGN)") end if %> issued a press release saying it sees no effect from this on its business, investors were not buying that story, dropping the stock $13/16 to $5 1/16. Only industry-leader MEDTRONIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MDT)") else Response.Write("(NYSE: MDT)") end if %> appeared unaffected.
QUICK CUTS: ALEX BROWN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AB)") else Response.Write("(NYSE: AB)") end if %> dropped $4 1/8 to $58 7/8 after a Prudential downgrade ... BRITISH SKY BROADCASTING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BSY)") else Response.Write("(NYSE: BSY)") end if %> slumped $4 1/4 to $ 60 5/8 after British regulators ordered the company to cease a price-cutting promotion ... Even though the investment banker that helped bring it public rated it a "buy" today, shares of COX RADIO <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CXR)") else Response.Write("(NYSE: CXR)") end if %> fell $1 1/4 to $10 3/8 ... BOSTON BEER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAM)") else Response.Write("(NYSE: SAM)") end if %> took a spill for a $3 1/2 loss to close at $12 1/2 after a number of downgrades over concerns about next quarter's volume ... Browser-war also-ran SPYGLASS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: SPYG)") else Response.Write("(NASDAQ: SPYG)") end if %> plunged $3 1/4 to $13 3/8 as investors didn't like their growth numbers or the Alex Brown downgrade of the stock ... POLYGRAM N.V. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PLG)") else Response.Write("(NYSE: PLG)") end if %> was tuned out for a $2 1/2 loss to close at $46 1/2 following the company's announcement of a $90 million restructuring ... TECHFORCE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TFRC)") else Response.Write("(NASDAQ: TFRC)") end if %> slipped $1 1/8 to $6 5/8, doing an imitation of the company's sales, which fell from last year's third quarter level ... OAK TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: OAKT)") else Response.Write("(NASDAQ: OAKT)") end if %> fell $1 5/8 to $10 5/8 after revenues declined 66% in the quarter ... Forecasting little growth for the coming quarter, contract manufacturer DII GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DIIG)") else Response.Write("(NASDAQ: DIIG)") end if %> fell $2 3/8 to $19 5/8 ... ACTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ACTL)") else Response.Write("(NASDAQ: ACTL)") end if %> dropped $2 1/2 to $18 7/8 after the logic maker made showed a sequential decline in units sold in its non-fusable FPGAs ... DIAMOND HOME SERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DHMS)") else Response.Write("(NASDAQ: DHMS)") end if %> shed $2 1/4 to finish trading at $23 3/4 after the company reported sluggish earnings growth.
FOOL ON THE HILL
An Investment Opinion by MF Templar
Small Company Stocks
(PART TWO OF THREE)
THE RISKS AND REWARDS OF SMALL COMPANIES
I. The Odds Are Against You
Small company stocks are often held out as the Holy Grail of investing. Using rich analogies to seeds and acorns, investment prospecti love to imply that by simply putting money in tiny companies, your savings will one day become as mighty as an oak. Although there are a lot of excellent reasons to consider investing in small companies, the emerging statistical reality is that they may carry more risk for returns comparable to what you can get in larger, more liquid companies. This emerging body of thought is founded on consistent underestimation of the odds of a long shot and the "extinction" effect in the databases used to construct average historical returns for classes of stocks.
Common sense tells you that if you consistently bet on a 40-to-1 horse, you should win one out of every forty times, right? Theoretically, the odds given (3-to-2, 2-to-1 or whatever) are odds that are set by the market and should include no inherent advantage. However, rigorous statistical analysis of parimutuel betting by a number of scientific sources has found that people routinely underestimate the odds for the favorite and overestimate the odds for the dark horse. This means that the 40-to-1 horse actually ends up winning more like one out of every 45 times and the 2-to-1 favorite actually wins more like three out of every five times. So, if you go to the racetrack and consistently bet on the horse that has the best odds, over time you are likely to have a substantially better return than if you were to consistently bet on the horse with the worst odds.
The hypothesis that explains why the free market of odds-setting for parimutuel betting is inherently inefficient is called the "swinging for the fences" phenomenon. In baseball, if you are constantly swinging as hard as you can to try to hit a home run, your batting average plunges. The same is true of bettors who pony up their stake for the long shot, dreaming of the lottery-like riches that will come streaming back to them if they win. On a mass scale, this human tendency actually moves the odds so that long shots actually appear more likely to win than they will, in reality, win. Imagining how this effect can exist in the public markets is not all that hard and goes a long way to explaining why companies like COMPARATOR SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IDID)") else Response.Write("(NASDAQ: IDID)") end if %> CURTIS MATHES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CRTS)") else Response.Write("(NASDAQ: CRTS)") end if %>, and IMATRON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: IMAT)") else Response.Write("(NASDAQ: IMAT)") end if %> can suddenly surge in spite of the underlying fundamentals of the business. People hear the story, assume that the low stock price means it is "cheap," and then swing for the fences... often with disastrous results. The simple reality is that the odds are slightly against you in small company stocks.
II. The "Extinction" Effect
How can one reconcile the fact that the odds are actually against you when investing in small company stocks with the fact that as an asset class, small-capitalization stocks outperform large capitalization stocks over time? The first reason is because not all small-capitalization stocks are small-company stocks, as we learned yesterday. Small-capitalization stocks as an asset class include many medium and large companies that have been beaten down so much that their capitalizations have become tiny -- making them incredible bargains if they can actually get some leverage and turn their businesses around. Thus, when you see small-cap funds that say they invest in small companies but discuss the long-term benefits of investing in small-cap stocks, you now know that they are mixing up two different things in their arguments.
The second reason why small company stocks might actually have worse "odds" than medium and large companies is the simple fact that all of the historical data on small-company returns (separate from small-capitalization returns) has been biased by an effect statisticians call "extinction." Unfortunately, as many with a science background realize, most investment professionals are not scientists. When you see historical statistical returns on small companies versus large companies, this all comes from databases that have been marred by the routine removal of information about bankrupt companies.
Thus, when a company becomes "extinct," the fact that its effective return was negative 100% is not factored into the returns that you see. In most of the public data, small-company stocks return in the neighborhood of 13% per annum and S&P 500-type stocks return around 10% per annum. Some statisticians have argued that the entire 3% outperformance can be explained by the exclusion of this data. Thus, the fact that small companies disproportionately go bankrupt and disappear pumps up the compounded annual returns of their asset class. The suggestion that small company stocks might not actually outperform their large company brethren as a group could actually be accurate, given that the average annual bankruptcy rate of about 1% is weighted much more toward smaller enterprises.
III. Controlling Risk in Small Companies
A lot of the extra risk inherent in small companies as a group can be controlled if you just avoid the instances where the odds have been mispriced because the companies are such huge long shots. To achieve this as an investor, you must stop "swinging for the fences." If it is flashy, catchy and promises a hundred-fold reward, the odds of it succeeding have probably been shifted by hundreds of small investors hurling themselves at the stock like lemmings. This is the racetrack equivalent of betting on the horse with the "cool" name. As any child who has ever been to the racetrack can tell you, this is not the best way to make money. The two main "swinging for the fences" kinds of companies I will highlight are "development-stage" technology firms and small companies attempting to bust into huge markets already dominated by world-class firms.
What makes a small company "flashy" and a candidate for the "swing for the fences" folder? "Radical" new technologies, often promoted by the companies themselves or by small brokerage firms tied closely to the firms as underwriters or market makers. If it sounds like science fiction, odds are you are investing in something that will lose you a lot of money. People talk all the time about finding the next Microsoft or Intel, neglecting the fact that both companies were medium-sized firms already established in their industries when they came public. These supposed development-stage technology firms only come public early on when they cannot find a venture capitalist dumb enough to pump some dough into the firm. Given that venture capitalists have funded some pretty dumb deals, this really leaves the individual investor with dregs that are almost guaranteed to absolutely fail. Of course, there are exceptions to this, as with any rule, but as always, this does not make the rule invalid.
Small companies that are gunning for big markets dominated by large companies are also often the worst kind of investment. The odds of a small company breaking into the diaper market, the soup market, the operating system market, the applications market or even more contentious and lower-margin businesses, like personal computers or televisions, is always low. There are big companies entrenched there with an ample supply of capital to cut you off at the knees before you even get started. Occasionally you do see a small upstart come out of nowhere and redefine an entire industry. More often, though, you see a small upstart find a niche that is growing like a weed and use success in this niche to leverage its entry into the larger market, a la FORE SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: FORE)") else Response.Write("(NASDAQ: FORE)") end if %> buying ALANTEC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ALTC)") else Response.Write("(NASDAQ: ALTC)") end if %> to get into LAN switching from ATM switching. ATM switching was a niche market that FORE was very good at, and it used these profits to enter the larger market and become a player.
TOMORROW: AFTER ALL THIS, WHY INVEST IN SMALL COMPANIES?
YESTERDAY:
WELCOME TO SMALL COMPANY STOCKS
FOOL FEATURES
The Lunchtime News has a look at craft brewers on tap, as the previously foamy market for beer stocks has gone flat.
We've added even more calls to Earnings Central, including Cadence Design Systems, Chicago Miniature Lamp, RG Barry, Olympic Financial and more. It's a great place to find rapidly growing, Foolish companies.
CONFERENCE CALLS
ALLIED SIGNAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALD)") else Response.Write("(NYSE: ALD)") end if %>
after 11:00 a.m. EDT
1-800-633-8284 (access code: 1993247)
10/23/96 (Wednesday)
MURPHY OIL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MUR)") else Response.Write("(NYSE: MUR)") end if %>
after 3:00 p.m. EDT
1-800-633-8284 (reservation #1982043)
SARA LEE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLE)") else Response.Write("(NYSE: SLE)") end if %>
(402) 220-3124
Until 10/31/96
GENZYME TISSUE REPAIR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: GENZL)") else Response.Write("(NASDAQ: GENZL)") end if %>
after 6:00 p.m. EDT
(402) 220-6032 -- replay
COMPUTER HORIZONS CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CHRZ)") else Response.Write("(NASDAQ: CHRZ)") end if %>
(800) 938-0934
After Noon EDT, through Oct. 27
AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %>
Appointment of COO
(800) 216-1079 code 320002
After 4 PM EDT, through Oct. 25
ACE CASH EXPRESS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AACE)") else Response.Write("(NASDAQ: AACE)") end if %>
1-800/642-1687 Code 95753
After 4 PM EDT
ZYTEC CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ZTEC)") else Response.Write("(NASDAQ: ZTEC)") end if %>
1-800-839-5120
available at 1:00 p.m. EDT 10/23
LIVE CALL TOMORROW:
ICT GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ICTG)") else Response.Write("(NASDAQ: ICTG)") end if %>
11 am EDT -- LIVE -- call by 10:55 am
1-800-860-3035 (host: John Brennan, call title: ICTG)
Dale Wettlaufer (MF Raleigh),
a Fool
Heroes & Goats