<THE EVENING NEWS>
Monday, December 21, 1998
MARKET CLOSE
DJIA             8988.85     +85.22      (+0.96%)
S&P 500          1202.84     +14.81      (+1.25%)
Nasdaq           2138.03     +51.89      (+2.49%)
Value Line ndx    888.10      +7.22      (+0.82%)
30-Year Bond   102 30/32     -23/32  5.06% Yield

HEROES

Going once, going twice, going three times... Online auction sites were more like the Energizer Bunny than goods for sale today, as they just kept going and going. It all started when Onsale (Nasdaq: ONSL) announced a deal with portal company Yahoo! (Nasdaq: YHOO) to provide auction content for Yahoo!'s Small Business website. Onsale caught fire on the news, blazing ahead $24 5/16, or 55.7%, to $68 today. Meanwhile, competitors uBid (Nasdaq: UBID) and eBay (Nasdaq: EBAY) were caught up in the conflagration, rising $31 to $84 1/8 and $44 1/8 to $296 3/8, respectively. Both set all-time highs today. Yahoo!, which also announced the launch of Catalog City's online shopping content on its shopping site, moved up $35 3/16 to $247 1/2 on the day.

The online enthusiasm wasn't restricted to auctioneers today. Bolstered by an article in this week's issue of Barron's magazine profiling Morgan Stanley Dean Witter's Internet analyst Mary Meeker, a noted bull, Internet stocks rose across industry lines. Among the winners that actually reported news today: online services stalwart America Online (NYSE: AOL) won $12 1/4 to $116 1/2 after announcing a multi-year marketing agreement with PC maker Dell (Nasdaq: DELL) to ship AOL software with certain Dell computers; specialty and online retailer Sharper Image Corp. (Nasdaq: SHRP) advanced $3 3/16 to $13 1/2 on news of a promotional agreement with news site CBS MarketWatch.com; payment software and services firm CyberCash Inc. (Nasdaq: CYCH) rang up a gain of $2 7/16 to $15 5/8 after it said U.K.-based Barclays Merchant Services chose its products for a new electronic point-of-sale system; and e-commerce solutions specialist Digital River (Nasdaq: DRIV) took $4 to $34 after BancBoston Robertson Stephens reiterated a "buy" rating on the stock. It's been a wild year for Internet stocks -- click here for a review of the year that was.

QUICK TAKES: Biotech bellwether Amgen (Nasdaq: AMGN) raced ahead today, adding $12 3/16 to close at $100 5/16 after it surprised analysts by announcing late Friday it won an arbitration battle against pharmaceutical giant Johnson & Johnson (NYSE: JNJ) over rights to the next generation of a rapidly growing anemia drug. Head back to the Lunchtime News for more perspective... Drug delivery firm Alkermes Inc. (Nasdaq: ALKS), meanwhile, popped up $2 1/2 to $21 1/4 on residual optimism stemming from its deal with Johnson & Johnson to develop a competing drug. The legal decision steps up the importance of the pact... Specialty chemical company LeaRonal Inc. (NYSE: LRI) jumped $6 7/8 to $33 11/16 after Rohm & Haas Co. (NYSE: ROH) agreed to buy the company in a $460 million stock deal valuing LeaRonal at $34 per share, about a 27% premium to Friday's close.

The move in computer hardware makers wasn't confined to Dell (Nasdaq: DELL) today, which moved up $4 1/16 to $71 15/16. After announcing new storage software products for Windows NT systems, Compaq Computer (NYSE: CPQ), improved $1 9/16 to $44 1/4, while IBM (NYSE: IBM) gained $4 13/16 to $176 3/8... Telecommunications equipment and software company Lucent Technologies (NYSE: LU) won $5 1/2 to $103 7/8 as mobile phone maker Motorola (NYSE: MOT) announced that it is buying Lucent's cellular phone research unit for an undisclosed sum, which a Motorola spokesman reportedly said was less than $100 million... General Motors (NYSE: GM) drove ahead $2 3/16 to $73 11/16 after Toyota (Nasdaq: TOYOY) confirmed that the companies are in talks regarding the expansion of their alliance in advanced vehicle technologies such as electric vehicles, fuel cells, and other areas.

Network equipment companies got a boost today on expectations that increased Internet use will boost demand for their products and services. Data equipment giant Cisco Systems (Nasdaq: CSCO) added $4 1/4 to $94 11/16 after it announced the availability of version 12 of its IOS Internet systems software. Two Fools dueled over Cisco last week... Data networking firm 3Com Corp. (Nasdaq: COMS), meanwhile, spread $2 3/8 to $47 1/8 after it announced a $6 million investment in wireless data service provider and systems integration company Aether Technologies, expanding an existing partnership to develop a wireless enterprise platform for palm computing... Computer networking equipment maker Ascend Communications (Nasdaq: ASND) rose $4 13/16 to $64 7/8 after it said Buenos Aires-based Internet service provider Internet Argentina will use Ascend's MultiDSL products to supply its business customers with Web services.

Healthcare programs provider America Service Group (Nasdaq: ASGR) improved $2 1/8 to $12 after agreeing to buy MedPartners' (NYSE: MDM) government-services unit for $67 million... Propane and related products and services retailer Suburban Propane Partners (NYSE: SPH) wafted up $1 1/16 to $18 3/4 after Merrill Lynch upgraded the stock to "trading buy" from "market outperform"... Savings and loan holding company Peekskill Financial Corp. (Nasdaq: PEEK) spied gains of $2 5/8 to $15 7/8 after announcing plans Friday to commence a buyback of up to 800,000 shares, or 28% of its outstanding stock, beginning Wednesday... Systems management software designer New Dimension Software (Nasdaq: DDDDF) expanded by $2 3/4 to $41 after it won a $1.3 million contract from electrical products and services supplier Square D Co.

Information technology consultant AnswerThink Consulting Group (Nasdaq: ANSR) grasped $4 5/16 to $23 3/4 after Morgan Stanley Dean Witter upgraded the company to "outperform" from a "neutral" rating... Tire retreader and dealer Treadco Inc. (Nasdaq: TRED) rolled up $1 to $7 following Friday's news that it will report an additional $5.4 million in Q4 after-tax income because of a settlement agreement with from Bandag Inc. (NYSE: BDG)... Electronic communications products maker Brooktrout Technology (Nasdaq: BRKT) swam upstream $3 5/16 to $17 7/8 after BancBoston Robertson Stephens initiated coverage of the company with a "buy" rating... Computer data storage products manufacturer Iomega Corp. (NYSE: IOM) zipped up $13/16 to $8 3/16 after Salomon Smith Barney started covering the company with a "buy" rating.

Investment services firm Hambrecht & Quist (NYSE: HQ) improved $1 13/16 to $24 1/4 after CFO Patrick Allen, who said last month he was leaving the company to become president of a California investment bank, changed his mind... Sporting goods direct marketer Sport Supply Group (NYSE: GYM) jammed $1 1/4 to $8 1/4 after investment partnership Oaktree Capital Managment acquired a 5% stake in the company... Biopharmaceutical company Immunex (Nasdaq: IMNX) advanced $9 to $110 1/8 after Merrill Lynch raised its rating on the company to near- and long-term "accumulate" from "neutral" and Salomon Smith Barney reiterated a "buy" rating... Therapeutic and diagnostic medical systems developer Sabratek Corp. (Nasdaq: SBTK) rose $1 1/4 to $17 after BancBoston Robertson Stephens raised its rating on the company to "buy" from "long-term accumulate."

GOATS

Food and construction materials processing equipment maker Gencor Industries (AMEX: GX) dropped $1 11/16 to $8 9/16 after pre-announcing a fiscal Q1 loss between $0.15 and $0.20 per share due to citrus industry problems in Brazil and falling meat production prices. The results will fall short of the First Call mean earnings estimate of $0.39 per share. On the bright side, the company expects to meet analysts' earnings estimates for fiscal 1999. Next year, Gencor is expecting higher demand for its hot-mix asphalt highway construction machinery, which represented 55.3% of its fiscal 1998 revenues, thanks to a Congressionally mandated $167 billion increase in federal highway construction spending over the next six years.

Generic drugmaker Mylan Laboratories (NYSE: MYL) slid $3 5/16 to $26 3/4 after the Federal Trade Commission formally sued the company on antitrust grounds alleging "restraint of trade," a monopoly-related no-no. The suit revolves around the prices of Mylan's lorazepam and clorazepate dipotassium anti-anxiety drugs, which are generic versions of Wyeth-Ayerst's Ativan and Abbott Laboratories' (NYSE: ABT) Tranxene. The Fed's trustbusters will seek $120 million in damages to reimburse patient expenditures for the drugs, the prices of which have reportedly risen by as much as 400% over the past 12 months -- enough to throw the tranquilizer portion of the nation's producer price index out of whack earlier this year.

QUICK CUTS: Canadian fuel cells maker Ballard Power Systems (Nasdaq: BLDPF) was zapped $2 5/8 to $28 7/16 after Barron's reported that two of the three fuel-cell powered buses the company is testing with the Chicago Transit Authority were taken out of service earlier this year for modifications and upgrades due to problems with the fuel cells and powertrain designs... Document finishing and paper shredding products maker General Binding Corp. (Nasdaq: GBND) came unglued and lost $4 1/4 to $35 1/2 after saying Q4 earnings will be in the $0.34 to $0.39 per share range due to slumping domestic sales. The First Call mean estimate had called for earnings of $0.54 per share... Dental practice management firm Monarch Dental Corp. (Nasdaq: MDDS) chipped off $1 1/2 to $8 5/8 after Salomon Smith Barney lowered its rating to "outperform" from "buy."

Laser-based electronics manufacturing systems maker Electro Scientific Industries (Nasdaq: ESIO) gave back $2 to $42 after rising 30% Friday on announcing fiscal Q2 EPS of $0.16, which beat the First Call mean estimate by $0.02... Paging and wireless services company PageNet (Nasdaq: PAGE) lost $1 5/16 to $3 15/16 after saying higher operating costs from a new customer service program will impact its Q4 results. The company added that it sees the number of its pagers in service decreasing by 275,000-325,000 units in Q4, which is a higher figure than some analysts had been anticipating... Morton International (NYSE: MII) slid $1 7/8 to $23 1/16 after Salomon Smith Barney lowered its rating on the specialty chemicals company to "neutral" from "outperform."

Electronic transaction processor Concord EFS (Nasdaq: CEFT) slipped $1 1/16 to $38 following a downgrade from Legg Mason to "outperform" from "buy"... Reinsurer General Re Corp. (NYSE: GRN) fell $7 13/16 to $201 1/2 on its last day of trading before merging with Berkshire Hathaway (NYSE: BRK.A and BRK.B). S&P 500 index fund managers sold their GenRe shares to buy shares of its index replacement, Carnival Corp. (NYSE: CCL), which rose $3 1/16 to $42 13/16... Automaker Ford Motor Co. (NYSE: F) fell $1 1/2 to $55 3/8 after laying off 35% of its 8,000-strong Brazilian workforce due to economic uncertainty in the country. Separately, rumors that Ford is considering a bid for Volvo (Nasdaq: VOLVY) failed to prop up the Swedish automaker's shares, which fell $1 9/32 to $22 11/32.

FOOL ON THE HILL
An Investment Opinion
by Alex Schay

Return on Invested Capital -- Appendix A

In Dale Wettlaufer's (TMF Ralegh) concise five-part series on the topic of return on invested capital (ROIC), the fundamental equivalence of the operating rate of return and the financing rate of return were outlined. Many investors who haven't had the benefit of perusing the work of Bennett Stewart III in The Quest for Value have forwarded us additonal queries on this topic, that is, questions concerning the seemingly "multiple methods" of calculating a rate of return on total capital.

When asked, "What is the equation for determining ROIC?" The quick answer is invariably, "After tax operating earnings, over -- total assets minus excess cash, minus non-interest bearing current liabilities." So the investor then heads for that operating earnings line, slaps on a deduction for the silent business partner in Washington DC, and then does the necessary balance sheet work in order to calculate the figure in the denominator. While this is correct, it's really a "Cliff Notes" method of getting to ROIC, or more appropriate to the times, a PinkMonkey.com method of getting to ROIC. That's why Dale addressed the adjustments that need to be made to assets -- the addition of equity equivalent reserves to capital -- in order to get the same amount of capital that is found when calculating ROIC from the financing perspective.

The equation for ROIC outlined above is the rate of return on total capital taken from an "operating" perspective. This is in contrast to the rate of return on total capital taken from a financing perspective. Although the calculations seem different, they yield exactly the same results, thanks to the accounting equation, or what Bennett Stewart III describes as "the great duality in the universe (to say nothing of the miracle of double entry bookkeeping)." In true "Appendix" fashion, today's column will serve as a small supplement to Dale's ROIC series. More to the point though, it will provide some additional material on the two rate-of-return perspectives that would have only bogged down the original series.

Understanding the equivalence of the operating and financing approach can lead to the profound realization that competition for capital is really what ultimately drives stock prices. As Bennett Stewart notes:

"There is a sequence of events that ties together the operating and financing approaches. First a company raises a mix of debt and equity [capital defined from the financing perspective (1)] and then invests those funds in its business [in net working capital and net fixed assets comprising capital viewed from an operating perspective (2)]. Next, the business begins to generate sales and incurs genuine operating expenses and taxes [resulting in NOPAT from the operating side (3)], which, in turn, constitutes a pool of cash that is available for distribution to all financiers (4)." (Italics mine)

Starting at the beginning, capital is defined as the sum of all the cash that has been invested in a firm's net assets over its life (the issue of "financing form" is addressed when calculating the weighted average cost of capital). Net operating profits after tax, or NOPAT, is the profit derived from the firm's operations after taxes, but before financing costs and non cash items. In calculating the rate of return from an operating perspective then:

        NOPAT 
r = -----------
capital

where NOPAT Capital
= Sales = Net working capital
- Operating expenses + Net fixed assets
- Taxes


Since net working capital is defined by Stewart as current assets minus non interest bearing current liabilities (NIBCLS), it can be seen that our "quick definition" of capital provided at the beginning of the story (total assets minus excess cash minus NIBCLS) is algebraically equivalent to net working capital plus net fixed assets. Again, the "net" in net fixed assets reflects adjustments made to incorporate certain equity equivalents (like the deferred tax reserve, LIFO reserve, cumulative goodwill amortization, unrecorded goodwill, and net capitalized intangibles -- for a really comprehensive look, you gotta' get the book).

The NOPAT portion of the operating perspective equation reflects, literally, a top-down approach to the income statement, where: recurring operating expenses (including depreciation) are subtracted from sales and then "cash operating taxes" are deducted as well. These cash taxes are derived by taking the accounting provision for taxes and subtracting any increase in deferred taxes, and then any tax savings gained from the interest tax shield are added back to the total. OK, drumroll please, here is the equation for the rate of return from the financing perspective:

      NOPAT 
r = -----------
capital

where NOPAT Capital
= Income available to = Common equity
common + Equity equivalents
+ Increase in equity
equivalents
----------------------------------------------
Adjusted net income Adjusted common equity
+ Preferred dividend + Preferred stock
+ Minority interest + Minority interest
provision
+ Interest expense + All debt
after tax


Here we have two different ways of ending up with the same result. For the capital portion of the equation the equivalence is easy to see, simply because the accounting equation of assets minus liabilities equals owners' equity can also be stated as assets equals liabilities plus owners' equity -- a figure for capital can then be arrived at by mostly playing with the asset side, or the liabilities and owners' equity side, of the balance sheet.

The NOPAT portion of the financing perspective equation starts at the bottom of the income statement and works its way back up by adding back the necessary items (recall that operating NOPAT essentially does the opposite). They both seem to meet somewhere in the middle though, which despite what Jakob Dylan says, is a good thing for us.

Related Articles:
ROIC series -- Part 1 I Part 2 I Part 3 I Part 4 I Part 5 I Compromise ROIC

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