HEROES

Pharmaceutical and biotech company CENTOCOR INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CNTO)") else Response.Write("(Nasdaq: CNTO)") end if %> gained $4 5/8 to $36 1/8 after announcing positive test results for a Crohn's Disease treatment. Crohn's Disease is a hereditary chronic bowel disorder (somewhat similar to diverticulitis) that has been mostly treated through the administration of steroids, a blunt treatment with many unattractive side effects. Centocor will apply to European Union and U.S. authorities for approval to market its cA2 monoclonal antibody, which has excellent prospects for financial success given that the there are no competitive products that effectively target the mysterious illness.

ALEX. BROWN INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AB)") else Response.Write("(NYSE: AB)") end if %> was the big winner on the NYSE again today, gaining $9 5/8 to $54 1/4 on rumors that money center institution BANKERS TRUST <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BT)") else Response.Write("(NYSE: BT)") end if %> will take over the nearly 200 year-old brokerage and investment bank. The fit between the two is pretty obvious -- the larger Bankers Trust would be able to lend its financial resources to the well-respected Alex. Brown, giving it the muscle to move up in the underwriting world. As for the mix of the clients, the international facts of life for corporate clients would present cross-selling opportunities. On the retail side, however, some think the synergies are pretty weak. The market niche at Alex. Brown has always been well defined, and the rumor that it is being looked at is two years old. It's far from a sure thing right now -- the last merger in the field, between Dean Witter and Morgan Stanley, turned the favorite bet on its ear in that PaineWebber was left out in the cold.

The sector du jour? Semiconductor capital equipment. Earlier in the week, back-end assembly products manufacturer KULICKE & SOFFA <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KLIC)") else Response.Write("(Nasdaq: KLIC)") end if %> announced a large ball bonder order from Orient Semiconductor in Taiwan. Kulicke has also done quite well with its patron INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>, the industry dreadnought. The thesis goes, though, that more back-end equipment orders for wafer foundries means that conditions look more favorable throughout the industry. Others hold that companies are making strategic purchases, where orders are spotty but encouraging when looked at individually. Another factor that drove the industry's values higher, including that of front-end equipment maker NOVELLUS SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NVLS)") else Response.Write("(Nasdaq: NVLS)") end if %>, which gained $7 1/2 to $77, was the announcement yesterday of a $1 billion fab buildout from HEWLETT PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>. Industry leader APPLIED MATERIALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMAT)") else Response.Write("(Nasdaq: AMAT)") end if %> also had a big day, rising $3 3/4 to $52 1/4.

QUICK TAKES: A Digital subscriber line equipment company AWARE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AWRE)") else Response.Write("(Nasdaq: AWRE)") end if %> jumped $3 5/16 to $12 1/6 after announcing a license agreement with U.S. ROBOTICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USRX)") else Response.Write("(Nasdaq: USRX)") end if %>... Aware's chip supplier, ANALOG DEVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ADI)") else Response.Write("(NYSE: ADI)") end if %>, gained $2 1/4 to $26... ECLIPSE SURGICAL TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ESTI)") else Response.Write("(Nasdaq: ESTI)") end if %> moved up $1 to $6 after reporting favorable progress in a Phase II trial for a cardiac device... Imaging facilities operator U.S. DIAGNOSTIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USDL)") else Response.Write("(Nasdaq: USDL)") end if %> gained $1 5/8 to $7 1/8 after saying "No thanks" last night to a buyout offer from MEDICAL RESOURCES INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MRII)") else Response.Write("(Nasdaq: MRII)") end if %>... REGENERON PHARMACEUTICALS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: REGN)") else Response.Write("(Nasdaq: REGN)") end if %> surged $1 1/2 to $8 5/8 after announcing that it received a patent covering enzymes that regulate cell growth... ADTRAN INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ADTN)") else Response.Write("(Nasdaq: ADTN)") end if %> moved $4 1/2 higher to $28 1/4 after announcing a contract to supply digital subscriber line equipment to Pacific Telesis through 1997... On announcing its acquisition of MicroHelp Uninstaller, software utilities company CYBERMEDIA INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CYBR)") else Response.Write("(Nasdaq: CYBR)") end if %> rose $1 5/8 to $11 5/8... Business lender SIRROM CAPITAL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SROM)") else Response.Write("(Nasdaq: SROM)") end if %> jumped $5 3/16 to $33 1/8 on several of brokerage upgrades after the company said it will surpass Q1 earnings per share (EPS) estimates of $0.40... TERADYNE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TER)") else Response.Write("(NYSE: TER)") end if %> one of the world's largest semiconductor capital equipment companies, gained $3 1/2 to $31 on the whole industry's move higher today... Brokerage, investment banker, and asset management company HAMBRECHT & QUIST GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HMQ)") else Response.Write("(NYSE: HMQ)") end if %> gained $1 5/8 to $17 7/8 in the wake of Alex. Brown's rise... Broadcast equipment company ZENITH ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ZE)") else Response.Write("(NYSE: ZE)") end if %> added $1 1/4 to $11 1/2 on the FCC's busting open the high-definition TV pinata and giving away broadcast spectrum for free to the television industry... FALCON DRILLING CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FLC)") else Response.Write("(NYSE: FLC)") end if %> rose $3 1/8 to $35 1/8 on reporting that it has received multi-year orders for deepwater drilling ships currently under construction... Real estate investment trust ANGELES MORTGAGE INVESTMENT TRUST <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: ANM)") else Response.Write("(AMEX: ANM)") end if %> gained $1 1/8 to $14 3/8 after announcing a merger with property manager INSIGNIA FINANCIAL GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IFS)") else Response.Write("(NYSE: IFS)") end if %>.

GOATS

OFFICE DEPOT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ODP)") else Response.Write("(NYSE: ODP)") end if %> was routed by the FTC trojan horse today, falling $5 3/4 to 13 1/4$ after the trade panel voted down the company's proposed merger with STAPLES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SPLS)") else Response.Write("(Nasdaq: SPLS)") end if %>. The deal would have created a giant $10 billion discount office products retailer. The companies thought they had a deal with the FTC when they agreed to sell 63 stores to OFFICEMAX <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: OMX)") else Response.Write("(NYSE: OMX)") end if %> at a budget price. No wonder OfficeMax was down $1 1/8 to $11 7/8, since that deal was contingent upon the merger going through. Office Depot said the FTC's decision to deny the merger after hinting that the sale of the stores would satisfy antitrust concerns was "astonishing," and that the decision was "absurd." Staples was up fractionally today.

Another merger to fall apart today was the combination of retail inventory and transaction systems company CHECKPOINT SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CKP)") else Response.Write("(NYSE: CKP)") end if %> and security camera concern ULTRAK <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ULTK)") else Response.Write("(Nasdaq: ULTK)") end if %>. Checkpoint took a huge hit last night in after-hours trading, falling $4 3/8. The stock then opened down and fell $2 13/16 to $9 15/16 today as it forecast full-year EPS of $0.67, below the First Call mean estimate of $0.89. Part of that is due to other contemplated acquisitions being put on hold because of the Ultrak deal, but some of it is due to the company's forecast of better-than-expected results with its "comprehensive tag program" in Europe. Under that program, revenues are recognized over a number of years rather than at delivery. Ultrak also fell, dropping $4 5/8 to $11 7/8 after announcing that it expects to report Q1 EPS of $0.16 to $0.18, below estimates of $0.21.

QUICK CUTS:Specialty healthcare provider MEDICAL ALLIANCE INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MAII)") else Response.Write("(Nasdaq: MAII)") end if %> tumbled $4 1/4 to $4 3/4 after announcing it will miss the sole Q1 earnings estimate of $0.06 per share... GENSYM CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GNSM)") else Response.Write("(Nasdaq: GNSM)") end if %> lost $1 7/8 to $4 5/8 after the enterprise management software company announced it will miss Q1 estimates of $0.09 per share and will report earnings between breakeven and $0.02 per share... Projection systems company PROXIMA CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PRXM)") else Response.Write("(Nasdaq: PRXM)") end if %> joined the pre-announcement parade today in projecting an operating loss of up to $0.20 per share, undershooting estimates of $0.08 per share... Legg Mason and JP Morgan both downgraded FOOD LION <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FDLNA)") else Response.Write("(Nasdaq: FDLNA)") end if %>, sending it down $1 5/32 to $6 29/32 after the supermarket company reported Q1 EPS of $0.10 that missed estimates... AUTOCAM CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ACAM)") else Response.Write("(Nasdaq: ACAM)") end if %> melted $1 1/2 to $9 1/4 after the specialty alloy components company pre-announced Q3 EPS of $0.18 to $0.20, which will not meet estimates of $0.29...

FOOL ON THE HILL
An Investment Opinion by MF Templar

Selling Stocks, Part 2

Yesterday we covered one way a long-term investor can view the process of buying and selling businesses. Knowing when to sell a stock goes part and parcel with knowing why you bought it. Investors who have a clear sense of why they bought a particular security that they have codified in some way as well as an updated private-market valuation for the business allow themselves to have clear decision points as to when to sell. Regularly updating the perceived valuation for a company, recording the reasons why you bought a company, and writing out the "chain of events" that you envision occurring to the business in order to catalyze the process of unlocking value are key to making informed, intelligent selling decisions and not getting swallowed up by market strum und drang.

This position is very qualitative though and will not satisfy investors looking for a more automatic approach, like using a stop-loss. However, an individual investor who is purchasing businesses with a long-term orientation is best served by selling businesses when the underlying business dynamic changes or the asset becomes overpriced on an after-tax basis relative to what they could get elsewhere. Quantitative, mechanical selling strategies that might make sense for a speculator taking a more casino-like approach to the market simply do not function quite as well when an investor takes a long-term perspective. In fact, one could say that for a long-term purchaser of a business, a quantitative strategy like using stop-losses serves as an admission that your intellectual confidence in your ability to identify businesses that are undervalued relative to their current market price is low, and your ability to react when a business changes is impaired by emotional factors.

Selling based on changes in the business or the failure of the anticipated "chain of events" to materialize makes sense, although it is completely a judgement call. Selling based on valuation alone gets a little more complicated, and requires that the long-term investor do some regular work on the perceived value of the asset relative to its current price. Stocks offer a rate of return that is not guaranteed, but potentially higher than fixed income securities like bonds. While a large part of the investing process is the identification of quality businesses selling below their intrinsic value, it is just as significant to gain an acceptable return on your invested capital relative to the risk that you take on. As the stock market itself has returned 10.5% per annum pre-tax since 1925, this seems one of the more stable benchmarks to judge the long-term value of any stocks you purchase.

When I purchase a security, I set up a table that looks somewhat like this:

      Name     Ticker  Yield 1  Year  Target 
      A Stock   STCK    0.00%   $52  +14.29%

      2 Year Target Annualized
      $62  +36.26%     +16.73%

Not only do I look at the price targets I have set, targets that I am constantly reevaluating in light of new information, but I am also looking at the expected annual rate of return over a two year period. For instance, with the above stock (whose name has been changed to protect the innocent), I believe that it can return 16.73% on an annual basis over the next two years. Compared to the 8% to 12% that I anticipate stocks as a group could return, the returns for A Stock seem relatively attractive. As A Stock moves towards the $52 one year price target, the expected annual rate of return over two years drops from 16.73% to 9.19% -- not horrible, but a little less than the market should return over the same period.

If A Stock rose to $52, would it make sense to sell it? First, we would have to know whether or not it was in a tax-deferred account or not. Too many investors make buy and sell decisions without considering the impact of taxes on their overall rate of return. If the stock is in an account that does not have to recognize tax consequences, I would be more willing to take a profit than if it was not. However, given that the U.S. government in its infinite wisdom has seen fit to make it impossible for individual investors to put more than $2,000 per year in their individual retirement accounts, most individual investors putting their money into stocks are doing so on a taxable basis. (On top of the fact that the government is forcing people into a taxable environment while offering a pathetic rate of return on Social Security money that is literally taken at gunpoint, the $2000 amount has had a declining value over time as that amount has not been adjusted for inflation since the legislation was passed more than 15 years ago. With everything indexed to inflation on the spending side, like Social Security and other benefit programs, it is absolutely criminal that nothing on the savings side is indexed as well.)

The problem with taking a profit when you have to pay taxes is that about one-third of your gain, depending on your tax bracket, vanishes instantly. With A Stock, for instance, a $52 price would mean a profit of 74.89% before taxes. Assuming it was a long-term capital gain, 28% of that would disappear, reducing the real gain to 53.9%. The money that goes to the government would become money that is no longer working for you. Thus, even though the market may gain 10.5% next year, just because A Stock will only rise 9.19% is not a sufficient reason to sell it. To make the equivalent of 9.19% on that money after you pay a 28% long-term capital gain tax, you would have to make 24.1% after taxes, a huge hurdle.

Let's do this example again with some numbers in order to make it more concrete, as it is a very important point. This is the main reason why Warren Buffet and Charles Munger have not sold any of Berkshire Hathaway's holdings in Coca-Cola or other highly-valued consumer stocks, even though recently some columnists have taken pot-shots at them for making general comments on the market without selling stocks that are perceived as overvalued. Although a trader might simply choose to view taxes as a cost of doing business, Buffett & Co. have definitely considered long and hard that when a gain becomes taxed, the hurdle rate of what another investment would have to make in order to provide a comparable return becomes increased by a significant factor.

Say you were to purchase 100 shares of B Stock for $100. You believe that B Stock is worth $150 right now and that its earnings will grow at around 15% a year over time. Say you hold B Stock for a year, and on the 366th day it goes to $150, giving you a gain before taxes of $5,000 on your $15,000 position. Because a year has passed, you have raised your initial price target to $172.50 per share because you expect earnings to appreciate by 15%. (Given that stock price appreciation and earnings growth correlated to about 0.98 over long periods of time, this is a reasonable decision.)

Obviously, if you expect Stock B to return 15%, that is pretty good relative to the stock market's 10.5% historical return and the current rate of return on bonds, which we will say for the sake of argument is around 7.25%. For a 7.75% premium to the return possible in a long-term bond, Stock B looks pretty good and definitely looks better than the stock market's 10.5% hurdle rate. However, let's say that on the 367th day the stock goes to $172.50, your reasonable price target one year out. You now expect to make 0% over the next year, compared to 7.25% for bonds and the 10.5% market average. Should you sell and buy bonds? Should you look for a cheaper stock to purchase?

With Stock B at $172.50, you have a $7250 long-term capital gain on your initial $10,000 investment. The minute you sell, the government confiscates $2030 in that tax year, leaving you with a gain of $5220. If you just leave your money in Stock B, you will have $17250 invested. If you move it out of Stock B, you will only have $15220 to invest because of the tax consequences. This means that you will have to make a 13.3% return on the $15,220 you would have to reinvest JUST to end up with the same amount of money you had before you sold the stock. This is almost double what you could get in bonds and substantially higher than the long-term return in stocks, meaning that it is probably not a reasonable expectation.

Now, we said that $172.50 seemed like a reasonable price target one year out. How about two years out? If Stock B increases earnings at 15% again, all things being equal, it should be worth somewhere in the neighborhood of $198.375 in two years. This is about 7.23% a year, or about what you could get in bonds. While below what the market could return before taxes, when you account for the effect of taxes on your money, buying and holding starts to make a lot more sense -- even if you do not expect the assets you have purchased to increase over the next year or more. Why is this? The money that you will eventually owe in taxes does not have to be paid until you sell the stock. Until then, it is like an interest-free loan from the government. With Stock B at $172.50 in our example, the government will loan $2030 indefinitely at no cost if you keep your money there. This means that although you will only make 7.23% over the next two years on the $5220 you would keep if you sold the stock, you also make 7.23% on the money that the government is giving to you interest-free.

The conclusion here is that a stock should probably be significantly overvalued before you decide to sell it if it is in a taxable account, the same conclusion that Buffett and Munger have arrived at. Add to this the fact that you always know more about the businesses you have owned. The risk factor when you actually know a great deal about particular companies is significantly lower than it would be if you had to purchase a new stock. Essentially, in every sell decision, you fact two factors: (1) if it is taxable, you have to make a good chunk of change just to break even, and (2) every new company brings disproportionate risk because you know less about it. In his classic book Common Stocks & Uncommon Profits, Phil Fisher wrote, "If the job of buying a stock has been done properly, the time to sell is never." His basic thesis holds up if you look at it from a long-term point of view, taking into special consideration the two factors outlined above. Selling a stock really only starts to make sense when it approaches a two or three year price target, meaning that it is discounting years of profitable growth.

CONFERENCE CALLS

CASCADE COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCC)") else Response.Write("(Nasdaq: CSCC)") end if %>
ASCEND COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASND)") else Response.Write("(Nasdaq: ASND)") end if %>
To discuss merger announcement
(800) 475-6701 (code: 336788)

US DIAGNOSTIC INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: USDL)") else Response.Write("(Nasdaq: USDL)") end if %>
Replay available after 3:00 PM EST through 4/8
(303) 267-1074

THIS WEEK'S CONFERENCE CALL SYNOPSES

SHIVA CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SHVA)") else Response.Write("(Nasdaq: SHVA)") end if %> Q1 Pre-Announcement
PAYCHEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PAYX)") else Response.Write("(Nasdaq: PAYX)") end if %> Q3 Conference Call
COLUMBIA/HCA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: COL)") else Response.Write("(NYSE: COL)") end if %> Conference Call To Discuss Investigation

ANOTHER FOOLISH THING
Good Fool, Bad Villains, and You!

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MORE FOOLISHNESS
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Randy Befumo (MF Templar), a Fool
Fool Plate Special

Dale Wettlaufer (MF Raleigh), another Fool
Ups & Downs

Brian Bauer (MF Hoops), and yet another Fool
Editing