The Daily Workshop Report
by Randy Befumo (TMF Templr)

ALEXANDRIA, VA (Sept. 17, 1997) -- Another screen that we provide in the Foolish Workshop area is the Falling Margins screen. Unlike the Rising Margins companies we covered yesterday, the Falling Margins screen highlights companies where sales are growing faster than earnings. Because we look for companies where sales are growing at least 15%, this allows us to find companies where the margin slippage is potentially quite large, highfliers that we can consider shorting if it appears they are about to short-circuit.

What we are looking for in this week's Falling Margin screen is a company where sales are growing quite a bit but earnings are just not keeping up. As you can see, we have eight potential victims. Of the group, I know that CKE RESTAURANTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CKR)") else Response.Write("(NYSE: CKR)") end if %> is in the fast-food business, an industry that has been pretty weak of late. Although I don't know much about CKE specifically, I do think given the weakness in the group where there is smoke there might be fire. CABLE DESIGN TECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CDT)") else Response.Write("(NYSE: CDT)") end if %> was a highflier that blew up about a year ago but has since recovered. Given that sometimes history does really repeat, this might bear further examination. HIRSCH INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HRSH)") else Response.Write("(Nasdaq: HRSH)") end if %> is a company that makes embroidery machines with a license from another foreign company that has had some issues because of questions as to whether that license would be renewed.

In fact, the only one I would throw out prematurely from this group is PRECISION DRILLING CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PDS)") else Response.Write("(NYSE: PDS)") end if %>, just because oilfield services is a specialized business I would have to take the time to study to really understand. Unlike a classic manufacturing business, when you are dealing with companies that move based on what is going on in a world market for a commodity, I think you need to decide whether you are going to specialize or whether you will avoid them altogether. Plus, to be perfectly honest, despite their recent popularity, oilfield services companies still make me very sleepy when I think about their businesses.

Looking for the widest gap between sales growth and earnings growth, and consequently locating the largest margin deterioration, COLORADO MEDTECH <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CMED)") else Response.Write("(Nasdaq: CMED)") end if %> and 4FRONT SOFTWARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FFST)") else Response.Write("(Nasdaq: FFST)") end if %> both pop out. My first move is a price check, just to see if these companies are above $5 and on the Nasdaq SmallCap exchange or the Nasdaq National Market -- therefore making them marginable. If you cannot margin them, you cannot short them, which basically defeats the purpose of this screen. If you check the quotes on Colorado MEDtech and 4Front, you see that both meet these criteria. The price is high enough and looking at the "Exchange," it says "Nasdaq," meaning the Nasdaq National Market.

A glance at 4Front Software's last earnings press release shows a U.K.-based software services company whose operating margins actually improved 0.7% year-over-year. Why did EPS grow so much slower than revenues? Dilution. The company had 6.8 million shares in the second quarter compared to 4.5 million a year ago, a pretty steep rise. Unfortunately, in my experience this kind of dilution normally augurs underperformance, but not necessarily a good short. Given the company's low margins, it is clear that although it labels itself as a software company, the services part of its business is significant. Services tend to carry much lower margins than software, but frankly, neither business is that thrilling from the looks of 4Front's income statement. With two brokerages estimating an average of $0.42 EPS from the company by the end of this year, at $5 3/4 it does not seem dangerously valued, meaning I go on to the next company.

Tomorrow, we will continue to look at the companies in the Falling Margins screen to see if we come up with anything worth looking at further as a potential short.