The Motley Fool, 7/11/97: The Evening News

HEROES

Offshore drilling services company READING & BATES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RB)") else Response.Write("(NYSE: RB)") end if %> spurted $2 7/16 higher to $33 7/16 on signing a definitive agreement to merge with FALCON DRILLING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FLC)") else Response.Write("(NYSE: FLC)") end if %> in a $5 billion merger of equals. R&B holders will receive 0.59 shares of the new company to be formed for each of their shares, valuing Reading & Bates at $34.15 as of yesterday's close. Falcon, then, believes R&B is worth 28.5 times trailing earnings and 14.2 times 1998 estimates, above the current multiples on GLOBAL MARINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GLM)") else Response.Write("(NYSE: GLM)") end if %>, one of Wall Street's favorite offshore turnkey drillers and drilling management companies, which currently trades at 20 times earnings. On price/book multiples, though, R&B was valued at 5.2 times book and Global Marine is priced at 8.9 time book value. Those book values, however, don't reflect the replacement value of either company's fleet.

Jack-up drilling rig operator CLIFFS DRILLING CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CDG)") else Response.Write("(NYSE: CDG)") end if %> gained $2 5/16 to $42 1/4 on the Reading & Bates - Falcon merger news. Land-based driller NABORS INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: NBR)") else Response.Write("(AMEX: NBR)") end if %> picked up $1 3/8 to $28 1/8, and DIAMOND OFFSHORE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DO)") else Response.Write("(NYSE: DO)") end if %> closed up $5 5/8 at $91 7/8. On 1998 EPS estimates, Cliffs is selling at 12 times estimates, Nabors is priced at 23 times September 1998 estimates, and Diamond Offshore is selling at 15 times estimates.

Although revenues fell 16% year-over-year and EPS of $0.27 fell nearly 50%, ATMEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATML)") else Response.Write("(Nasdaq: ATML)") end if %> rose $4 1/8 to $32 5/8 on reporting second quarter results. The company said its book-to-bill ratio was above 1.0 and that bookings increased sequentially, pleasing enough for Alex. Brown to raise its rating to "buy" from "market perform." Elsewhere in the semiconductor world, SILICON VALLEY GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SVGI)") else Response.Write("(Nasdaq: SVGI)") end if %>, manufacturer of wafer steppers, gained $4 1/4 to $34, likely getting a helping hand from news of a $150 million stepper order at ASM LITHOGRAPHY <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ASMLF)") else Response.Write("(Nasdaq: ASMLF)") end if %> earlier this week. CYMER INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CYMI)") else Response.Write("(Nasdaq: CYMI)") end if %>, which supplies excimer lasers to both of those companies, rose $4 3/8 to $61 1/4.

DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> gained $9 3/8 to $138 7/8 as analysts, investors, traders, and pundits celebrated COMPAQ's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPQ)") else Response.Write("(NYSE: CPQ)") end if %> earnings and the fact that Compaq executives say a price cut isn't the start of a PC price war. That's great to hear, but who believes that Compaq would come out and say that it is sending its boys to die at the front in the name of a globally destructive cause? Compaq has responded to price cuts from Dell, and both are driven by the inexorable forces of price deflation (or non-inflation) of semiconductors, disk drives, circuit boards, and other PC components in the annual drive to grow unit sales at a rate great enough to offset that price deflation. It's not Compaq the world needs to worry about, it's Dell, which says it's more concerned with growing operating dollars and not "taking margins to the bank." Of course, Dell doesn't want a price war either, so today's news is about as newsworthy as everyone's breathing a sigh of relief at seeing the sunrise today.

QUICK TAKES: AT HOME CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATHM)") else Response.Write("(Nasdaq: ATHM)") end if %> popped up $6 1/2 from its IPO price of $10 1/2 to finish the day at $17 with a market cap of just a tidge under $2 billion... TSR INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TSRI)") else Response.Write("(Nasdaq: TSRI)") end if %> surged $7 1/2 to $31 1/2 after yesterday saying that it has the low-cost Year 2000 fix... Bio-agriculture company DEKALB GENETICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DKB)") else Response.Write("(NYSE: DKB)") end if %> added $4 3/8 to $78 1/8 after reporting Q3 EPS of $0.72, beating estimates of $0.68, on a 30% increase in quarterly revenues... INFORMATION STORAGE DEVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ISDI)") else Response.Write("(Nasdaq: ISDI)") end if %> rose $1 15/16 to $9 7/16 after the voice recording and playback semiconductor company reported a Q2 loss of $0.09 per share, just below estimates of a loss of $0.08, on flat year-over-year revenues... Machine vision systems maker COGNEX <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CGNX)") else Response.Write("(Nasdaq: CGNX)") end if %> jumped $5 1/4 to $32 after announcing today that it will beat the mean First Call EPS estimate of $0.17 and that it expects revenues to top the previous record of $34.9 million... Michigan utility UPPER PENINSULA ENERGY CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: UPEN)") else Response.Write("(Nasdaq: UPEN)") end if %> jumped $3 1/4 to $21 1/2 on news that it will merge with Wisconsin electricity and gas company WPS RESOURCES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WPS)") else Response.Write("(NYSE: WPS)") end if %> in a stock swap.

TRANSACTION NETWORK SERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TNSI)") else Response.Write("(Nasdaq: TNSI)") end if %> moved up $2 5/16 to $15 3/4 after the transaction services provider reported Q2 EPS of $0.13, beating estimates of $0.12, on revenues of $15.4 million... APPLE COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> jumped $1 7/8 to $15 3/16, perhaps as the company's board members were taking under advisement the many hundreds of suggestions for improving the company made by Fools over the last 24 hours... GOODYS FAMILY CLOTHING <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GDYS)") else Response.Write("(Nasdaq: GDYS)") end if %> added $4 1/8 to $34 1/4 on a June same-store sales increase of 5.1%... LCD manufacturer THREE-FIVE SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TFS)") else Response.Write("(NYSE: TFS)") end if %> gained $1 13/16 to $18 9/16 after reporting Q2 EPS of $0.13 on a 29.6% increase in revenues... OAKLEY INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: OO)") else Response.Write("(NYSE: OO)") end if %> climbed $1 1/4 to $13 5/8 on the positive sign of same-store sales growth at SUNGLASS HUT INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RAYS)") else Response.Write("(Nasdaq: RAYS)") end if %>... KAYDON CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KDN)") else Response.Write("(NYSE: KDN)") end if %> moved up $4 3/16 to $55 1/4 after reporting Q2 EPS of $0.96, beating the mean estimate of $0.89

Annuities and insurance underwriter SUNAMERICA INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAI)") else Response.Write("(NYSE: SAI)") end if %> gained $4 3/16 to $57 3/4 on being included in the S&P 500 Index... HALTER MARINE GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HLX)") else Response.Write("(NYSE: HLX)") end if %> cruised $1 15/16 to $29 on announcing the acquisition of two shipyards, bringing the total number of shipyards in the company to 19... Offshore driller UNITED MERIDIAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UMC)") else Response.Write("(NYSE: UMC)") end if %> hitched onto the action in the drilling group today and gained $1 7/8 to $31 7/8... Transaction processing company NATIONAL PROCESSING <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: NAP)") else Response.Write("(AMEX: NAP)") end if %> added $1 1/16 to $10 3/4 on a "buy" rating from Salomon Brothers... Salomon also initiated coverage with a "buy" rating on healthcare benefits administration company ABR INFORMATION SERVICES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ABRX)") else Response.Write("(Nasdaq: ABRX)") end if %>, sending that stock up $2 to $30 1/8.

GOATS

Long-distance and data communications company MCI COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> plunged $7 3/8 to $35 after announcing that its push into the local loop is becoming more expensive than originally believed. The company said today that losses from its local phone operations will amount to $800 million, higher than the $400 million it originally expected, not because of spending itself but because Baby Bell "foot dragging" is restraining the company's abilities to build revenues in the local loop. MCI is as upset about "entrenched local monopolies" as those monopolies are about the "constitutionality" of the Telecommunications Act of 1996, as SBC COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBC)") else Response.Write("(NYSE: SBC)") end if %> put it. Because of the higher losses that MCI will have to incur to crack the local loop, which AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> has also said has been a major reason why it has missed earnings, the current terms of MCI's merger with BRITISH TELECOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BTY)") else Response.Write("(NYSE: BTY)") end if %> may be in doubt.

FEDERAL HOME LOAN MORTGAGE CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FRE)") else Response.Write("(NYSE: FRE)") end if %>, commonly known as Freddie Mac, slid $1 3/8 to $32 5/16, and FANNIE MAE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %> lost $1 15/16 to $42 5/8 on concerns over those companies' ability to grow their loan portfolios and the resulting earnings behind the growth of those assets. Fannie Mae says it's comfortable with estimates for 1997 and 1998, but drew downgrades from Morgan Stanley and Lehman Brothers, as did Freddie Mac. Fannie Mae yesterday reported Q2 EPS of $0.69, in line with estimates, but said "selective repurchases" of its stock helped it to make EPS goals.

QUICK CUTS: DUPONT PHOTOMASKS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DPMI)") else Response.Write("(Nasdaq: DPMI)") end if %> blasted downward $7 1/2 to $50 after pre-announcing revenues in line with expectations, with EPS 12% to 16% below estimates of $0.63 because of higher operating expenses... CROWN CORK & SEAL CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CCK)") else Response.Write("(NYSE: CCK)") end if %>, maker of packing closures, lost $6 7/16 to $49 15/16 on reporting Q2 EPS of $0.94, below estimates of $1.04... Internet bookseller AMAZON.COM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %> fell $3 1/4 to $27 1/2 on reporting its first earnings as a publicly traded company. The company lost $0.28 per share, better than expected, on revenues of $27.9 million. Alex. Brown raised its rating on the company to "strong buy" from "buy"... ROSS STORES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ROST)") else Response.Write("(Nasdaq: ROST)") end if %> declined $4 1/8 to $9 3/8 after reporting a 9% increase in June same-store sales... Pen maker A.T. CROSS <% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: ATX.A)") else Response.Write("(AMEX: ATX.A)") end if %> was slashed $2 1/8 to $10 5/16 on announcing that it expects to report a Q2 loss of $0.32 per share and that it plans to cut its dividend in half... Nyet! Closed-end mutual fund TEMPLETON RUSSIA FUND <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRF)") else Response.Write("(NYSE: TRF)") end if %> lost $9 5/8 to $51 1/16 after doubling, at its high today, over the last month... MORGAN STANLEY RUSSIA & NEW EUROPE FUND <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RNE)") else Response.Write("(NYSE: RNE)") end if %> followed Templeton down, losing $3 1/2 to $34 3/4.

Amway Asia distributor AMWAY ASIA PACIFIC LTD. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AAP)") else Response.Write("(NYSE: AAP)") end if %> fell $3 11/16 to $43 1/16 on reporting Q3 EPS of $0.52, better than estimates of $0.42... Poultry products company HUDSON FOODS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HFI)") else Response.Write("(NYSE: HFI)") end if %> was skinned for a $1 1/4 loss to $15 1/4 on pre-announcing Q3 EPS of $0.16 to $0.18 before a restructuring charge, missing estimates of $0.23... READERS DIGEST ASSOCIATION <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RDA)") else Response.Write("(NYSE: RDA)") end if %> shrank $1 7/8 to $25 on pre-announcing fiscal 1997 EPS of up to $1.45, below estimates of $1.69. The company also announced a 50% reduction in its dividend... Mexican Coke bottler COCA-COLA FEMSA SA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KOF)") else Response.Write("(NYSE: KOF)") end if %> slipped $3 1/16 to $48 15/16 after CS First Boston yesterday lowered its rating on the company to "hold" from "buy"... Brazilian telecom company TELECOMUNICACOES BRASILEIRAS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TBR)") else Response.Write("(NYSE: TBR)") end if %> shrank $7 1/8 to $152 1/2 after ING Barings lowered its rating on the stock to "hold" from "buy" based on valuation.

FOOL ON THE HILL
An Investment Opinion by Randy Befumo

Sell Sensibly

When do you sell a stock? The last time we covered this topic in early April, investors frightened by suddenly descending stock prices were chomping at the bit to dump everything and get into cash. Today with dozens of widely held companies taking out 52-week highs, the question comes up in the minds of many investors again. As multi-point moves become de rigueur and freaked-out investors are panic buying everything in sight, remembering our sensible approach to selling securities makes a lot of sense.

The recent parabolic gyrations are eerily reminiscent of 1996's great "growth-stock frenzy," when the Nasdaq Composite soared 14% from April 1st to May 31st as investors bought anything even remotely associated with the word "growth." At the time, many companies saw valuations so high the word "risky" actually would have been conservative. The Nasdaq proceeded to crash by 15% from June to July with many of the once highly prized growth names tumbling much more. Had an investor kept a keen eye on the valuation of the business as well as the inherent quality of the business itself, she might have avoided the entire ugly affair.

The investing approach we advocate here at the Motley Fool focuses on buying businesses with long holding periods in mind. However, this bias sometimes must be overturned when a company's shares become a little too richly prized by investors. It is clear that when the valuation increases to such a point that you stand to lose a substantial amount of your accumulated wealth should the way investors are pricing a company's stock suddenly shift, selling the stock to buy into another great business that might be more favorably priced is certainly an option that investors should consider.

Last April, we explored two reasons for selling a company's stock. The first was pretty straightforward -- the business has changed or is not what you anticipated. The business changing is simple. Either the company is falling apart at the seams or seeing its core market being shredded (a la Apple Computer or Novell), or the company has shifted its core business through a merger or acquisition (a la Dean Witter's merger with Morgan Stanley that turned it into much more of a full-service brokerage rather than a hybrid brokerage-financial services concern). The failure to meet your expectations is a little more complex, but certainly easily identified. Whatever assumptions you made when buying the company (operating margins will rise, shares outstanding will continue to increase, the new unit will become profitable this quarter) do not come to pass and therefore the company is not what you thought you purchased.

The second reason for selling a stock is valuation. Nothing has changed about the business, the assumptions are all intact, but the pricing has just gone from the cheap to the ridiculous. Having some idea of what a company might be worth in the future based on your earnings assumptions is key to being able to pull the plug on a company in your portfolio because of valuation. Last April, I showed the following table when discussing this point:

Name 1 Year Target 2 Year Target Annualized
A Stock $52 +14.29% $62 +36.26% +16.73%

First off, let's come clean with the identity of "A Stock" so we can talk specifics. "A Stock" was AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>. At the time, based on a hybrid valuation per subscriber and asset methodology, I figured in April the thing would hit $52 this year and $62 next year. This brings to mind point number one: always remember when you are valuing a stock you are valuing a moving target. As America Online continued to demonstrate success in the advertising arena and the company signed a number of multi-million dollar up-front cash payment deals with high-profile retailers and media companies, I reconsidered my valuation. Had I remained static and unwilling to change, the company would have blown through even my two-year price target and completely left me behind.

So let's assume that even though you have rethought the valuation based on all of the new information, the company still looks fairly priced relative to what it could trade at this year. Let's say we have "B Stock" that is worth $60 this year and $75 next year according to your best valuation work, and the company has just hit $60 a share. Suddenly, your table will look like this, assuming the two-year target is two full years out:

Name 1 Year Target 2 Year Target Annualized
B Stock $60 +0.0% $75 +25.00% +11.90%

Now that "B Stock" has hit $60 a share, does it make sense to sell it? I would argue no. In spite of the fact that it is fairly priced relative to this year's earnings estimate, the company is still generating annualized returns that will beat the average historical return of the S&P 500. Although I certainly would think hard about the valuation, I would not sell "B Stock" in this situation. The reason is because if I own "B Stock," I know more about it than probably anything else I might be able to buy. While the valuation is not cheap, my knowledge base about this company increases my degree of certainty that the valuation targets I have concocted are reasonable. With above-market returns still to come, I prefer to bet on the horse I know and avoid the tax-bite (assuming a taxable account) rather than taking the risk of breaking in another company. Risk, in my analysis, is one part valuation, one part knowledge of the company, and zero parts volatility (which means I don't really think very highly of beta as a valuation tool).

Let's say I made the right call and "B Stock" continues to rise to the two-year target of $75.

Name 1 Year Target 2 Year Target Annualized
B Stock $60 -20.0% $75 +0.0% +0.0%

At this point, I would either need to justify a higher price target through some material change in the business or I would probably want to consider selling the company. Even when you take into account the effect of taxes, when you are dealing with a company that you think could fall 20% in the near term and over the next two years the return will only be 0.0%, there is a lot of risk. Now, one approach might be to extend the valuation range to three years -- or twenty years. You only want to do this if the returns have a high degree of certainty about them, say like a Coca-Cola. Otherwise, the valuation itself will end up taking you out of the stock when two years of earnings have been discounted, as in my example. Investors who want to use three- or four-year discounts are certainly encouraged to do so -- the reason I focus on two years is that this is the "foreseeable" horizon for the majority of companies I follow. If investors keep in mind the reasonable valuations out two or three years when selling a stock, they will avoid what has been one of my most irritating investment mistakes -- selling a good company too soon.

CONFERENCE CALLS

HEILIG-MYERS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HMY)") else Response.Write("(NYSE: HMY)") end if %>
(Re: June sales and the purchase of Mattress Discounters)
(804) 254-3939 (option 1) -- replay

07/15/97 (Tuesday)
HARLEY-DAVIDSON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HDI)") else Response.Write("(NYSE: HDI)") end if %>
(402) 222-9905 -- replay

THIS WEEK'S CONFERENCE CALL SYNOPSES

MOTOROLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MOT)") else Response.Write("(NYSE: MOT)") end if %> Call

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It's Double Trouble!

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1) Learn about a new company -- what it does and how it's done.
2) Learn why it doubled or tanked -- how might you have found it yourself earlier, in time to profit from it?
3) Hone your investing skills. What business and investing principles are at play here?
4) Find out whether our Fools think the stock is poised to rise or fall now.
You'll find all this and more in the Daily Double and the Daily Trouble.

Randy Befumo (TMF Templr), a Fool
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Dale Wettlaufer (TMF Ralegh), another Fool
Ups & Downs

Brian Bauer (TMF Hoops), and yet another Fool
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