HEROES
Long-distance reseller TEL-SAVE HOLDINGS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TALK)") else Response.Write("(Nasdaq: TALK)") end if %> rebounded
$1 1/16 to $14 5/8 after "Bizinsider" Herb Greenberg wrote yesterday in the
San Francisco Chronicle that Homas Research of Boston was questioning
the accounting treatment of a cash advance that the company made to AMERICA
ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>. AOL will market Tel-Save's long-distance services
in return for a 50% to 70% cut of the pre-tax profits Tel-Save generates
on revenues created from AOL's marketing efforts. Homas claims that Tel-Save
should have expensed $12 million of a $111.7 million advance of cash and
securities paid to AOL. A glaring problem with this analysis is that expenses
should be matched with revenues. Without any revenues having been created
yet through this deal, booking an expense would violate the principle of
matching revenues and expenses. Tel-Save said
that it will discuss the full accounting treatment in a week or so. Any damnation
before that time might as well be accompanied by a damnation of accrual
accounting.
BALLY'S GRAND <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BGLV)") else Response.Write("(Nasdaq: BGLV)") end if %> surged $11 3/8 to $50 3/8 after the Las
Vegas casino owner announced the settlement of securities litigation with
Tower Investment and Executive Life of New York. Those investors alleged
that Bally's Grand sold property in Las Vegas to Bally Entertainment for
a price lower than fair market value, thus depriving shareholders and holders
of warrants of value. Bally's will buy back those shares for $52 3/4 apiece
and also buy back the warrants, at which point it will completely merge with
HILTON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HLT)") else Response.Write("(NYSE: HLT)") end if %>, which owns 85% of the company by virtue of last
year's $3 billion buyout.
QUICK TAKES: Pre-paid phone card company
SMARTALK TELESERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SMTK)") else Response.Write("(Nasdaq: SMTK)") end if %> rose $1 1/4 to $12 3/4 after
yesterday announcing an agreement to distribute phone cards in 2,800 CHOICE
HOTELS INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CHH)") else Response.Write("(NYSE: CHH)") end if %> locations... Swedish-based appliance
and equipment company AB ELECTROLUX <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ELUXY)") else Response.Write("(Nasdaq: ELUXY)") end if %> gained another
$7 1/16 to $76 9/16 after announcing job cuts and plant closures designed
to boost margins and reach its annual
return
on equity goal of 15%... Securities brokerage ADVEST GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ADV)") else Response.Write("(NYSE: ADV)") end if %> jumped $5 1/8 to $23 1/4 after Business Week's "Inside Wall Street"
column said a large shareholder of the brokerage has been approached by two
"major Boston banks"... International telecom company TELEGLOBE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TGO)") else Response.Write("(NYSE: TGO)") end if %> gained $2 5/8 to $35 7/8 on its second day of trading on the New York
Stock Exchange... SWIFT ENERGY CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SFY)") else Response.Write("(NYSE: SFY)") end if %> rose $1 5/8 to $26
5/8 after BT Securities started coverage of the onshore energy exploration
and production company with a "buy" rating, estimating 1997 EPS of $1.55
and 1998 EPS of $2.08... Equipment leasing company FINANCIAL FEDERAL
<% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: FIF)") else Response.Write("(AMEX: FIF)") end if %> added $1 5/8 to $22 1/16 after Piper Jaffray started coverage
of the company with a "strong buy" rating.
GOATS
MONSANTO CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MTC)") else Response.Write("(NYSE: MTC)") end if %> wilted $3 1/2 to $42 3/4 after J.P. Morgan
cut its Q2 EPS estimate to $0.65 from $0.70, saying it sees lower growth
in revenues for the company's Roundup pesticide, which accounts for 40% of
the company's operating profits. According to Dow Jones, J.P. Morgan
sees a longer-term problem for the company: "Monsanto will face a critical
juncture beginning in 2000," when its Roundup patent expires and its Searle
unit's Ambien sleep drug also loses patent protection. Some investors forget
that a company is worth the net present value of cash flows plus its theoretical
takeover, or residual, value. Looking long term at the expiration of such
a cash cow is the most prudent way to model Monsanto's cash flow. This is
a big reason why the Agricultural Products division is such a big focus at
the company, as the unit is expected to create new products that will be
the next Monsanto cash kings.
Real estate mortgage trust REDWOOD TRUST INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RWTI)") else Response.Write("(Nasdaq: RWTI)") end if %> experienced
a mini-crash today, falling $7 to $45 1/4 after saying last night that it
is seeing a squeeze in its interest rate spread, or the difference in the
rate of interest at which it has borrowed money and the rate of interest
it earns on its assets. Working in favor of the company, though, is a decline
in long-term interest rates, which raises the value of long-term assets on
its balance sheet. One analyst, Coleman Bitting of Stifel Nicolaus, called
the news "trivial." Investors wondering how to measure the interest rate
sensitivity of such as company should divide liabilities maturing in one-year
and under by the like assets. Before dividing, multiply the numerator by
the average interest rate on those liabilities and the denominator by the
average interest rate on those assets. The higher the resulting number, the
larger the "gap," or interest rate sensitivity of the income statement to
changes in short-term interest rates.Industrial equipment manufacturer
FEDERAL SIGNAL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FSS)") else Response.Write("(NYSE: FSS)") end if %> fell $1 1/2 to $25 1/4 after announcing
yesterday that it sees order deferrals from customers continuing longer than
expected and, as a consequence, it now sees Q3 EPS that will be flat compared
with Q3 1996. The company had previously said that it expected flat Q2 EPS
compared with Q2 1996. Another company warning about the second quarter was
poultry producer TYSON FOODS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TYSNA)") else Response.Write("(Nasdaq: TYSNA)") end if %>. Tyson lost $1 1/16 to
$20 1/2 after saying that it "continues to experience operating and margin
pressures," partly due to Russian export problems.
QUICK CUTS: Video chip maker ESS TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ESST)") else Response.Write("(Nasdaq: ESST)") end if %> lost $2 to $12 5/8 after pre-announcing Q2 operating EPS of $0.16 to $0.19, below analyst estimates of $0.34, which had already come down due to industry pricing and demand pressure... IDEXX LABORATORIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IDXX)") else Response.Write("(Nasdaq: IDXX)") end if %> lost $1 1/4 to $11 7/16 after the diagnostic products producer announced that it expects to report a second quarter operating loss due to lower sales and inventory work-downs... HUMASCAN INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HMSC)") else Response.Write("(Nasdaq: HMSC)") end if %> tumbled $1 3/4 to $7 1/4 after the medical instruments company said it expects a 4-6 month setback for the launch date of a breast screening device.
FOOL ON THE
HILL
An Investment Opinion by Randy
Befumo
Return on Equity, Part 3
Looking at the
profit
margins, NORFOLK SOUTHERN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NSC)") else Response.Write("(NYSE: NSC)") end if %> has a pretty solid business.
The company generated 15.7% profit margins over the last four quarters on
$4.7 billion in revenue. With the average public company generating profit
margins more in the 7% to 8% area and the average company in America in the
2% to 3% range, Norfolk certainly appears to have a nice business going for
it. With 15,000 miles of track in 20 Midwestern and Southeastern states,
the company competes with only one or two other players in its core rail
business, a nice oligopoly. With profit margins such a critical part of
return
on equity, it should have a substantial edge, right?
Or maybe not. Although profit margins are a crucial element in the return
on equity equation, the sales generated for each dollar of assets plays an
equally important role. Norfolk Southern has $12.4 billion in assets reported
in its last quarter, but it only generates a paltry 38 cents in sales for
every dollar of assets it has deployed. By way of comparison, DELL
COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> generated $8.7 billion in sales on $3.2 billion
of assets over the last year, or $2.71 in sales per dollar of assets employed.
Generating more sales on less assets means tying up less of the capital the
business generates in fixed assets. The term "capital-intensive" literally
refers to the way some businesses require more capital to function than others.
Given these two companies and their assets-to-sales ratio, it is clear that
Norfolk Southern is more "capital-intensive" as a business than Dell
Computer.
Asset management is probably one of the factors individual investors have
the most difficulty using to evaluate a company. Certainly you can compare
various asset management ratios for companies within an industry. How can
you tell if so much in sales per dollar of total assets is good or not so
good for a given company on more than just a relative basis? Looking at asset
management in the context of the total return on equity allows the investor
to balance a company's asset management ability with its profit margins and
the financial leverage employed in order to discern whether the actual business
is great or simply mediocre.
You cannot argue with the kind of profit margins that a railroad like Norfolk
Southern generates. However, because the company has to deploy and maintain
billions in assets to get those profit margins, the business is not necessarily
as exciting as it would otherwise be for the investor. Because Norfolk has
to maintain thousands of miles of track and hundreds of trains, it constantly
has put new capital into its assets in order to generate revenues. This means
that instead of being able to return the cash generated from operations to
investors, Norfolk has to reinvest it in its assets in order to stay in business.
In spite of this, Norfolk generates plenty of cash flow. If it could actually
improve its sales per dollar of assets employed, it could generate tons of
cash.
Five quarters ago, Dell Computer realized that one of the ways it could improve
shareholder return was to notch up its asset management policies. Specifically,
Dell realized that if it could more efficiently manage its inventory of computer
components, it could increase the return on equity. As inventory and accounts
receivable are Dell's two most significant assets, by minimizing these the
company could increase the sales per dollar of total assets employed and
therefore increase the basic return on equity of the business. The money
that went into inventories to generate a dollar of sales decreased, leaving
Dell with more cash on the balance sheet to distribute to shareholders in
the form of stock repurchases.
Because Dell has focused on direct sales since it was founded, except for
an ill-conceived venture into the indirect channel in the early '90s, the
company has always required less working capital than its indirect channel
competitors like Compaq Computer. However, Dell only became a full-fledged
asset management story five quarters ago when the stock got pounded because
of fears of slowing computer sales in early 1996. As a man who owned an enormous
percentage of the company's stock, Chairman Michael Dell knew that without
some kind of change Dell would always trade at 11 to 12 times earnings because
of the perception that it was in a low margin, commodity business. The question
was how could Dell Computer change the way that people saw its financial
model to increase the value of the company?
Dell conceived an ambitious and ingenious plan. It would launch itself pell-mell
into the high margin server business, either improving its own margins or
killing those of competitor Compaq Computer. At the same time, it would notch
up the number of times it could turn its inventory over each year. Inventory
turnover is one of the main asset management measures that investors can
easily calculate. Simply by dividing the cost of goods sold over a period
by the inventory left at the end of the period, an investor can see how many
times a company "turned" its inventory in that period. As a company like
Dell increases its inventory turns, it dedicates less assets to generate
a dollar of sales, increasing the amount of cash left over to do other things.
In Dell's case, the crucial third part of its plan was to use all excess
cash flow to repurchase the stock it viewed as undervalued, magnifying the
earnings per share growth.
Dell Computer is a clear case of how improved asset management can increase
shareholder return. Better asset management eventually shows up in the form
of high profit margins, but high profit margins by themselves do not guarantee
that shareholders will receive excellent returns. In order to ensure that
return on equity is high, investors must look for businesses that have high
margins and high asset turnover rates, whether it is sales-to-assets or looking
at the inventory turns, the days sales outstanding (or collection period),
the payables period, or the turnover in fixed assets. The last variable in
the return on equity equation that can affect overall return is financial
leverage, which we will cover Monday.
CONFERENCE CALLS
MICROSOFT <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>, COMCAST <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CMCSA)") else Response.Write("(Nasdaq: CMCSA)") end if %>
To Discuss Microsoft's investment in Comcast
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(800) 633-8284 (code: 2815407)
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ANOTHER FOOLISH
THING
Arizona Stock Analysis
Why Arizona? Because, like Delaware, many companies are chartered there, taking advantage of the beneficial business environment. Small, under-followed emerging Arizona growth companies were a terrific place to invest over the past few years and Stephen Barnes, the Editor of "Arizona Stock Analysis," believes this will continue in the future. His strategy of identifying winners before the Street catches on has been most profitable, with his average selection up an annualized 189% through March. Obviously, there can be no assurance that future selections will enjoy the same returns, but Yon believes there is considerable merit to picking up the winners before the Street's analysts pile on. Yon began sharing his views online in the fall of 1995 in the "Folly in Arizona" folder (part of the 50 states boards) and his analysis has led to the publication of the Arizona Stock Analysis, a monthly newsletter available by e-mail or fax. If this piques your interest, check it out at FoolMart or e-mail [email protected].
Randy Befumo (TMF Templr), a Fool
Fool Plate Special
Dale Wettlaufer (TMF Ralegh), another
Fool
Ups & Downs
Brian Bauer (TMF Hoops), and yet
another Fool
Editing