The Daily Workshop Report
by Randy Befumo (TMF Templr)

ALEXANDRA, VA (Sept. 15, 1997) -- Since Stocks Screens and the Foolish Workshop have been merged as far as an organizational entity, I thought that while Robert was gone over the next two weeks I would try to introduce the four stock screens we have run for almost a year now (with the able help of Sharon Hegeman, aka TMF Rockie) and explain how I use them and why I think they are valuable.

As I tried to illustrate last time I subbed for Robert, I don't think mechanical investment models are really the way to go when investing. The Dow Approach has a special place in my heart because I believe it is "investing on training wheels," giving investors a regimen for buying and selling and allowing them to learn about how stocks react to new information. Other than that, I think people risk getting involved in approaches where any excess returns on capital will be diminished over time as the stocks "discovered" by the screen become more efficiently valued. The much-publicized problem Value Line has been having with diminishing returns is, in my opinion, a result of their original formula (they have changed it several times) becoming so widely used that many of the companies it finds get bid up rather quickly.

However, there is room in anyone's investing approach for screens that identify likely possibilities among a sea of companies. One of the ones I use the most is Rising Margins. Rising margins identifies companies where earnings are growing at a faster rate than sales, meaning that their "margins" (be they profit, operating, or gross) are all increasing. The reason I like rising margins situations is because of magnification. When margins are rising, revenue growth is magnified by the rising margins and transformed into stupendous earnings growth. Sometimes rising margins will occur at the beginning of a period of significant earnings growth. To winnow down the number of possibilities, we set the lowest bogey for revenue growth at 15%.

The most recent iteration of Rising Margins from last week, Rising Margins 9/08 - 9/12/97, throws out a number of possibilities that I would take a casual look at to determine if there was anything worthwhile. A few obvious things strike me about this particular screen that would make me less likely to investigate some of the companies. These normally fall in three categories: "I Know Enough to be Cautious," "I Have Looked at It Before and Think It May Still be Overvalued" and "Interesting."

I Know Enough to be Cautious. FAIRCHILD CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FA)") else Response.Write("(NYSE: FA)") end if %> is benefiting from the current upswing in airplane demand, a highly cyclical business that I don't know enough about. As a general rule, I don't like to get involved in specialized industries where there are larger economic factors that drive earnings growth without knowing a lot about them. ART'S-WAY MANUFACTURING <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ARTW)") else Response.Write("(Nasdaq: ARTW)") end if %> probably falls in the same category, as it is an agricultural equipment company, although I have a little more basis for understanding this company because I am familiar with the stories at CATERPILLAR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAT)") else Response.Write("(NYSE: CAT)") end if %> and JOHN DEERE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DE)") else Response.Write("(NYSE: DE)") end if %>.

I Have Looked at It Before and Think It May Still Be Overvalued. STEWART ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: STEI)") else Response.Write("(Nasdaq: STEI)") end if %> is one of those deathcare companies I would love to own, but it never seems to get cheap enough. Of course, I may be valuing it the wrong way (looking too much at earnings instead of paying attention to cash-flow), but in the past three years I have looked at the group about six times and never come away with a really undervalued member relative to what else was out there, except when LOEWEN GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LWN)") else Response.Write("(NYSE: LWN)") end if %> crumpled in 1995. Also, TCBY ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TBY)") else Response.Write("(NYSE: TBY)") end if %> showed solid growth year-over-year, but I must confess that the crash of the frozen yogurt companies in the early 1990s and the fact that there seems to be no "moat" around the business would make me push it to the back of the list.

Interesting. What I love about the rising margins screen is the companies I did not know before they popped up on the radar. The one on the list that grabs me is ATEC GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATEC)") else Response.Write("(Nasdaq: ATEC)") end if %>, a company that grew sales by 49% and earnings by 100%. A quick look at the press release and I find that ATEC is a "leading system integrator and provider of a full line of information technology products and services to businesses, professionals, government agencies and educational institutions." The company "offers leading computer hardware, software, connectivity devices, multimedia products, data communication via satellite, video conferencing, Internet, Intranet and Y2K solutions to their clients." Seems too good to be true. A check of the price quote reveals that unfortunately, it is too good to be true. Priced at $25/32, ATEC is firmly in the world of penny stocks.

If is not bad enough, margins have only risen to 1.5% from 1.0% over the past year, meaning that this is not really a very high-quality business. Low-margin businesses that include a list of high-margin services in their company description always make me overly cautious -- particularly when the list includes everything that is currently "hot." The Year 2000 solutions in particular make me question how much this company is trend following in an attempt to get its share price up and how much value there really is here. I would put ATEC in the "Dismiss" category and move on to the next idea. With the example of how to dismiss false "positives" from your stock screen out of the way, tomorrow I will try to pick out a better company to look at and take you through the steps I would use to try to determine if it is worth doing more work on.