The Daily Workshop Report
by Randy Befumo (TMF Templr)

ALEXANDRIA, VA (Sept. 18, 1997) -- Yesterday we took a first pass at the Falling Margins screen for this week. The Falling Margins screen looks for companies where sales are growing quite a bit but earnings are not keeping up. Of the eight potential victims, yesterday we looked at 4Front Software. Today we will continue to fish through the list looking for likely prospects to sell short.

Shorting, unlike buying a company normally, is a bet that the share price will decline. In order to profit from this, an investor borrows the shares from a broker, sells them, and hopefully repurchases them in the future at a lower price in order to repay the share loan. Although many people are fixated on only buying companies that they think will go up, shorting can make a nice hedge against disaster or against specific business risks that could affect other holdings, allowing an investor some downside protection. The reason we are looking to short companies with falling margins even though they are growing revenues at 15% is because many of these companies are "growing broke," meaning that even though they are booking earnings, the falling margins indicate a cash flow squeeze.

Because we are looking for a company with actual operating problems, we will throw out any company whose perceived falling margins are the result of issuing more shares during the year. For instance, looking at the press release we can see that in spite of the fact EPS growth at HIRSCH INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HRSH)") else Response.Write("(Nasdaq: HRSH)") end if %> was lower than revenue growth, it was because the company issued 15.3% more shares over the past year. Profit margins stayed flat at 7.3%, so the operating problems we are looking for in a short just are not there. With the company only trading at 11.5 times earnings estimates in spite of the 25% estimated earnings growth, we can further conclude that Hirsch does not meet anything close to the criteria we are looking for.

CKE RESTAURANTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CKR)") else Response.Write("(NYSE: CKR)") end if %> was another possibility we cited, particularly given the weakness in other fast-food companies, with the exception of recent double FOODMAKER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FM)") else Response.Write("(NYSE: FM)") end if %>. One of the best approaches to shorting I have used has been to look for companies with significant operating problems due to industry issues and then find similar companies where investors have not fully recognized the risks yet. For instance, MICRO WAREHOUSE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MWHS)") else Response.Write("(NYSE: MWHS)") end if %> blew up because of problems with Macintosh sales months before MULTIPLE ZONES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MZON)") else Response.Write("(Nasdaq: MZON)") end if %> did, which died months before GLOBAL DIRECTMAIL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GML)") else Response.Write("(NYSE: GML)") end if %> finally dived as well. Unfortunately, CKE Restaurants is also a case of dilution causing the growth disparity, not falling margins. Margins, according to the press release, actually increased.

GIII APPAREL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: GIII)") else Response.Write("(Nasdaq: GIII)") end if %> actually did see margins slip 0.3%, although this is hardly the end of the world. It is difficult to assess what the valuation on the company is as the company only has one 10-Q filed in the EDGAR system, and the last press release doesn't give trailing 12 months earnings. Based on annualized sales, the company has a price-to-sales ratio of 0.51, hardly the first indication of overvaluation. From the press release we can see the company sells leather goods through retail stores, sales of which have a certain trendiness about them. Although I would toss aside GIII at this point, I would keep in mind what it does and maybe check back every few months to see if it has raced up as the result of a fad surge and is set for a fall.

The last possibility we have left, CABLE DESIGN TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CDT)") else Response.Write("(NYSE: CDT)") end if %>, seems to present the best possibility. Margins have slipped 0.5%, growth in cable equipment has stunk over the past year, the company has previously imploded, and the multiple to trailing earnings is 15 despite the fact that earnings are only estimated to grow 12% next year. Tomorrow we will look at the company's financials in more depth to see if it really is a possibility.