The Evening News - Thursday, February 27, 1997

HEROES

CULBRO CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CBO)") else Response.Write("(NYSE: CBO)") end if %> gained $6 to $88 as the diversified holding company will cash in on the cigar "Great Awakening" via its offering of shares of General Cigar. General Cigar, which produces the Macanudo, White Owl, Tiparillo, Partagas, Garcia y Vega, and Wm. Penn cigar brands, plans to offer six million shares at $14-$16 this week in its initial public offering, but demand for the offering may push the offering price higher. According to the Cigar Association of America, the cigar market has grown 8.8% per year since 1993. While supermarket notion shelf items such as White Owl might not be doing that well, premium brands such as Macanudo are in high demand. Funny, though, that no one is fretting over the lawsuit risk in this or companies such as CONSOLIDATED CIGAR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CIG)") else Response.Write("(NYSE: CIG)") end if %>. On the other hand, brand loyalties are high in this market and there is a core demand that creates a steady stream of high-quality cash flows.

Transmission equipment and cutting tools company REGAL-BELOIT <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: RBC)") else Response.Write("(AMEX: RBC)") end if %> gained $2 to $22 7/8 after announcing last night that it will acquire Marathon Electric, a manufacturer of electric motors and generators, for $240 million in cash. Regal-Beloit, of Beloit, Wisconsin, makes power transmission systems, axles, gearboxes and other sorts of seemingly boring stuff that goes into machine tools and capital equipment. Regal-Beloit generates about $22 million in free cash flow after dividends, and has nearly $30 million in cash with negligible debt. If it can run the new company with the same results, the company's size will double, offering its owners attractive upside potential if it can pay off the debt needed to complete this acquisition within five years.

Teleservices firm ATC COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATCT)") else Response.Write("(Nasdaq: ATCT)") end if %> jumped $1 9/16 to $8 3/16 following a decline in its shares earlier this week. A newsletter writer mentioned the company on CNBC's Squawk Box this morning. In response to a question from Mark Haines on why the stock has fallen, he said the Motley Fool is involved with it. We would guess that the Fool Portfolio's involvement is less of a factor in the fall than the company's poor earnings and flat outlook for the next couple quarters. Another factor helping the stock today -- ATC said that it has hired a marketing firm to help it build its image and drum up sales. Fine idea.

QUICK TAKES: ENAMELON INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ENML)") else Response.Write("(Nasdaq: ENML)") end if %> jumped $2 13/16 to $12 5/8 after Investor's Business Daily talked about the possibility that the company's new toothpaste can reverse tooth decay... Computer distributor CHS ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CHSE)") else Response.Write("(Nasdaq: CHSE)") end if %> gained $3 7/8 to $23 on reporting Q4 sales of $860 million and earnings per share (EPS) of $0.57 (before charges), beating estimates of $0.33... CADUS PHARMACEUTICAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KDUS)") else Response.Write("(Nasdaq: KDUS)") end if %> rose $2 1/2 to $17 after signing a biotech research agreement with SMITHKLINE BEECHAM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBH)") else Response.Write("(NYSE: SBH)") end if %>... THERMO ELECTRON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TMO)") else Response.Write("(NYSE: TMO)") end if %> papermaking equipment subsidiary THERMO FIBERTEK <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: TFT)") else Response.Write("(AMEX: TFT)") end if %> gained $1 1/8 to $11 1/2 after announcing that it will acquire Black Clawson, a manufacturer of brown paper recycling equipment.

GOATS

It seems as though the 3COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %> merger deal with U.S. ROBOTICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USRX)") else Response.Write("(Nasdaq: USRX)") end if %> has hit investors over the head with the confusion bat today. Worries about the two companies' combined muscle pushing U.S. Robotics' Total Control access systems hurt the shares of ASCEND <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASND)") else Response.Write("(Nasdaq: ASND)") end if %>, down $5 5/8 to $56 3/4, and to a lesser extent CASCADE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCC)") else Response.Write("(Nasdaq: CSCC)") end if %>, off $2 1/2 to $30 1/8. The combined companies will have more capital strength and cash flow to develop and acquire companies in the local area and wide area network spaces, which pushed CISCO SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %> $3 1/16 lower to $55 1/16. CABLETRON SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CS)") else Response.Write("(NYSE: CS)") end if %> lost $2 1/8 to $29 1/4, while BAY NETWORKS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAY)") else Response.Write("(NYSE: BAY)") end if %> was up minimally. PC card connectivity company XIRCOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: XIRC)") else Response.Write("(Nasdaq: XIRC)") end if %> fell $2 5/8 to $21.

Client-server software company CITRIX SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CTXS)") else Response.Write("(Nasdaq: CTXS)") end if %> was blasted for a $15 5/8 loss to $10 5/8 after MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> said it will build into its Windows NT client-server software features now found in Citrix's WinFrame products. WinFrame allows remote users to access and manipulate Windows-based software. With the plan of Microsoft to be on everyone's desktop and to spread NT across all enterprise markets, this move should not be all that surprising. One analyst called Microsoft's move an "ugly" one, and he expects that Microsoft will need to license or buy Citrix's software anyway.

PERIPHONICS CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PERI)") else Response.Write("(Nasdaq: PERI)") end if %> crashed $11 3/4 to $13 1/4 today. The company said this afternoon that it will earn between $0.15 and $0.22 per share in its third quarter, meaning it will just meet the current estimate of $0.22 if it does well. The company earned $0.33 per share in Q3 of last year. Periphonics makes another sort of system for accessing data -- its interactive voice response systems are used by businesses and phone companies. While the company says the "long-term" outlook for product demand looks good, the implication in today's press release was that order flow this quarter was a little bumpy.

The whole personal computer food chain took it on the chin today, as everything from the chip equipment makers to the box-makers fell. APPLIED MATERIALS (Nadaq: AMAT) lost $4 5/16 to $47 1/2, INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> gave up $6 21/32 to finish at $139 21/32, and DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> slid $5 5/8 to $70 1/8 on downgrades "based on price." The disk drive and components sector didn't like the turbulence today either: WESTERN DIGITAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WDC)") else Response.Write("(NYSE: WDC)") end if %> ticked down $4 1/4 to $63, READ-RITE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RDRT)") else Response.Write("(Nasdaq: RDRT)") end if %> fell $3 5/16 to $29 3/4, HUTCHINSON TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HTCH)") else Response.Write("(Nasdaq: HTCH)") end if %> lost $3 1/8 to $32 3/8, and APPLIED MAGNETICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: APM)") else Response.Write("(NYSE: APM)") end if %> lost another $7 1/4 to $38.

CORRECTION: In yesterday's Evening News, ETEC SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ETEC)") else Response.Write("(Nasdaq: ETEC)") end if %> was mentioned in the Goats section as having dropped because of a product being delayed in October and in its quarter-just-ended. In both instances, the company experienced product delays, but those were different products in each case.

QUICK CUTS: NOVELL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NOVL)") else Response.Write("(Nasdaq: NOVL)") end if %> fell $2 1/4 to $10 5/8 after reporting Q1 sales of $375 million and EPS of $0.15, missing estimates of $0.18... U.S. SATELLITE BROADCASTING <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USSB)") else Response.Write("(Nasdaq: USSB)") end if %> lost $1 7/8 to $12 3/8 after Unterberg Harris downgraded its rating to "sell" following the NEWS CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NWS)") else Response.Write("(NYSE: NWS)") end if %> deal with ECHOSTAR <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DISH)") else Response.Write("(Nasdaq: DISH)") end if %>... Consumer product network marketing company AMWAY JAPAN LTD. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AJL)") else Response.Write("(NYSE: AJL)") end if %> was peeled back $2 to $13 after saying that it expects sales to be flat in 1997 and earnings to drop 6.8% in yen terms... BIOVAIL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BVF)") else Response.Write("(NYSE: BVF)") end if %> slid $2 3/4 to $23 7/8 on reporting Q4 EPS of $0.26, beating estimates by a penny... Oil and gas company STONE ENERGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SGY)") else Response.Write("(NYSE: SGY)") end if %> fell $2 to $22 3/8 after announcing year-end reserves and a 1997 development budget of $104 million... ROHR INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RHR)") else Response.Write("(NYSE: RHR)") end if %> lost $1 3/8 to $17 7/8 after the aerospace company reported Q2 EPS of $0.19, which beat estimates, but warned of 1997 operating margins below 9% and that it may take a loss on its contract with MCDONNELL DOUGLAS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MD)") else Response.Write("(NYSE: MD)") end if %>... Technical school DEVRY INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DV)") else Response.Write("(NYSE: DV)") end if %> fell $1 5/8 to $21 3/4 after the company and insiders filed to sell two million shares... Outlet stores real estate investment trust HORIZON GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HGI)") else Response.Write("(NYSE: HGI)") end if %> fell $1 to $13 5/8 after reporting Q4 funds from operations (FFO) of $0.51 per share and saying FFO for 1997 will continue to lag last year's results... MEDCO RESEARCH <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: MRE)") else Response.Write("(AMEX: MRE)") end if %> tumbled $3 5/16 to $9 11/16 after the FDA voted against approval of the company's congestive heart failure drug.

FOOL ON THE HILL
An Investment Opinion by MF Templar

Irrational Exuberance

Price is incredibly important when purchasing the merchandise we politely call "stock." Although in many areas of our daily lives we are cunning consumers, always seeking to shave costs where we can in order to increase our savings, for some reason a culture of impulsiveness driven by an overall short-term mentality dominates the world of investing. Deploying hard-won savings becomes a hurried procedure riddled with anxiety, all for wont of a rational way to approach the "science of stock valuation," as Ben Graham called it in his classic work, The Intelligent Investor.

For many investors, looking logically at the price/sales ratio and the company's operating margins is a way to help guide them through the perilous straits. The price/sales ratio is essentially the market capitalization of a company divided by the trailing sales over the past four quarters. This is a quick measure of how the company is being valued relative to the sales that it generates. In the in Fool News we often go one step further and compare the market capitalization plus long-term debt (as an acquiring company would get this as well) minus cash (an acquiring company would get this as a benefit of an acquisition) to the current sales, something called the enterprise value-to-sales ratio. Operating margins are the company's profit before taxes and interest income or expense, giving a quick sense of the money a company makes in its core operations.

It is nothing short of a tragedy that shareholders in CENTENNIAL TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CTN)") else Response.Write("(NYSE: CTN)") end if %> have become the unfortunate dupes of fraudulent information published in Securities & Exchange Commission (SEC) filings. What is even more unfortunate is that many of these shareholders invested at levels where a reasonable return on capital was almost impossible, even given the fraudulent statements. With only $74.2 in made-up sales and god knows how little in real sales, given the Chief Executive of the company was purchasing company goods through his margin accounts, the valuation remained extreme for months. With 17.33 million shares outstanding, even at $20 the company traded at 4.1 times sales. As for investors who bought shares on Tuesday knowing that the company would be delisted from the New York Stock Exchange and knowing that the financial statements were fraudulent, today's $11 1/4 loss to $3 1/2 is a painful lesson of a different sort. Both the Nasdaq and the American Stock Exchange have confirmed they will not list the stock either.

CITRIX SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CTXS)") else Response.Write("(Nasdaq: CTXS)") end if %> represents another interesting data point in the evolving thesis that when a company's stock attains a high price/sales ratios, risk outweighs reward. Before today's $15 5/8 plunge to $10 5/8, the company traded at a hefty 27.7 times trailing sales. Certainly, the 36.5% operating margins warranted a higher than average valuation, prompting some to even suggest it might be fairly valued in the high 40s. (As is unfortunately the case, margins that high inevitably attracted interest from competitors -- in this case industry giant MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>. Thus, even when the fundamentals appear to be intact, companies with high price/sales ratios are the ones that come crashing to earth the fastest, causing all sorts of pundits in retrospect to identify shaky business models and questionable thinking by proponents. One important point that I did not stress enough in the original article (Evening News, 1/21/97) is that the company's net profit margin of 38.7% was buttressed by a lot of interest income. As you do not buy a company so it can make money investing its cash in short-term investments, operating income is something that I use as a comparative measure.

Simple odds suggest the higher the price you pay for something, the less likely you are to see an appreciable return on that capital. Short of that, there are unfortunately very few rules that one can point to in order to identify what sort of valuation is reasonable relative to sales. In his 1984 work Super Stocks, Ken Fisher suggested that buying companies with price/sales ratios of 1.0 or below was the right level. James O'Shaughnessey's What Works on Wall Street used the behavior of the stocks with the 50 highest and lowest price/sales ratios to help determine his Cornerstone Growth strategy, which suggested that price/sales ratios of below 1.5 made for the best fodder.

Unfortunately, even these general rules fall apart on close inspection. Price/sales ratios are highly correlated with a company's operation margin. Value-added resellers like INGRAM MICRO <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IM)") else Response.Write("(Nasdaq: IM)") end if %> or discount retailers like K-MART <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KM)") else Response.Write("(NYSE: KM)") end if %> often trade with price/sales ratios below 0.20 because their operating margins are barely 1.0%, if they are lucky. On the flip-side, people who have purchased MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> with price/sales ratios of between 5.0 and 10.0 have made a ton of money because Microsoft consistently has operating margins in excess of 30% despite a maturing core product line, a rarity in the world of business. So the price/sales ratio or enterprise value/sales ratio that you pay for a company should be concomitant to the operating margin.

As a general rule, if the multiple to sales is more than 20 times the operating margin expressed in decimal format, you are getting into serious nosebleed territory. Thus, with the above example of Citrix with a 36.5% operating margin, red warning lights should have flashed at a price/sales or enterprise value/sales above 7.3 (20 times 0.365). Although there has been absolutely no statistical verification of this hypothesis, this is something I have been playing with for a few years now. If investors only use it as a caution flag, it should be an excellent guide. Furthermore, if the price/sales ratio is below 10 times the operating margin expressed in decimal format, then the stock might be undervalued. The range in between is what I would call the yellow light area, or the theoretical continuum of fair value. Again, I want to stress this is completely unverified by other than anecdotal information, although Fool HQ scribes are planning some comprehensive backtesting to check for relevancy. The key is to balance the risk of missing a Microsoft with the larger risk of catching a Citrix or Centennial, a delicate operation where many have currently no guide but the P/E-to-growth ratio.

CONFERENCE CALLS

3COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %> -US ROBOTICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USRX)") else Response.Write("(Nasdaq: USRX)") end if %>
To Discuss Merger Proposal
(800) 633-8284 (code 2531747) -- replay

LIMITED INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LTD)") else Response.Write("(NYSE: LTD)") end if %>
(800) 805-3502

MORROW SNOWBOARDS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MRRW)") else Response.Write("(Nasdaq: MRRW)") end if %>
(201) 628-6885 replay until 2/28

ELTEK LTD. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ELTKF)") else Response.Write("(Nasdaq: ELTKF)") end if %>
(913) 661-0487 code: 314285

HOME DEPOT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %>
(402) 220-3005 -- replay until 2/28

ORTEL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORTL)") else Response.Write("(Nasdaq: ORTL)") end if %>
(402) 220-5186 -- replay through 3/7

NOVELL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NOVL)") else Response.Write("(Nasdaq: NOVL)") end if %>
(402) 280-9008 -- replay

INTUIT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTU)") else Response.Write("(Nasdaq: INTU)") end if %>
(800) 938-1160 -- replay

02/28/97 (Friday)
DUFF & PHELPS CREDIT RATING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DCR)") else Response.Write("(NYSE: DCR)") end if %>
(Call discussing the subprime auto finance industry)
10:30 a.m. EST
(888) 659-7023 (password DCR) -- live
(888) 441-5984 (password DCR) -- replay @ 12:30 PM EST only

ANOTHER FOOLISH THING
New and Improved Spreadsheet!

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The spreadsheet is available at keyword: FoolMart for AOL Fools and at FoolMart on our website. It will be delivered to your e-mailbox electronically in your preferred format (Excel 4.0, 5.0, 6.0, or 7.0 only).

MORE FOOLISHNESS
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Randy Befumo (MF Templar), a Fool
Fool On the Hill

Dale Wettlaufer (MF Raleigh), another Fool
Heroes & Goats

Brian Bauer (MF Hoops), one more Fool
Editing

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