<THE EVENING NEWS>
Wednesday, January 20, 1999
DJIA 9335.91 -19.31 (-0.21%) S&P 500 1256.62 +4.62 (+0.37%) Nasdaq 2415.49 +7.32 (+0.30%) Russell 2000 430.62 -0.27 (-0.06%) 30-Year Bond 101 7/32 -11/32 5.17 Yield
Avondale Industries (Nasdaq: AVDL), which makes amphibious ships for the U.S. Navy and double hull oil tankers for commercial clients, sailed $5 1/2 higher to $32 5/8 after agreeing to merge with nuclear aircraft carrier and sub builder and refueler Newport News Shipbuilding (NYSE: NNS) in a stock swap valuing Avondale at $470 million. That works out to $35.50 per Avondale share, or a 31% premium to the company's closing price of $27 1/8 per share last night. The combined entity, which will be called Newport News Avondale Industries, will be the only U.S. shipbuilder with operations on the East, West, and Gulf coasts, a feature fellow Naval shipbuilder and servicer General Dynamics (NYSE: GD) can't claim. However, General Dynamics also makes military products for terra firma, most notably the Army's Abrams tank.
Shares of office equipment and document management company IKON Office Solutions (NYSE: IKN) soared $2 13/16 to $15 3/16 after the firm announced that earnings for its fiscal Q1 ending in December would beat expectations. The company reported that earnings per share would fall in the range of $0.12-$0.15, well above the First Call analyst consensus estimate of $0.05 per share. This performance is being led by improved gross margins on sales and an "initial turnaround" in underperforming regions. Before getting too excited, however, don't forget that last year the company earned $0.24 per share ($0.33 excluding the company's recurring "transformation costs"). In other words, earnings will still be down significantly from last year. On the flip side, last night's news adds to the sentiment that IKON's worst days may be behind it, as outlined in greater detail in today's Fool Plate Special.
QUICK TAKES: Software giant Microsoft (Nasdaq: MSFT) moved up $7 to $162 5/8 after reporting fiscal Q2 EPS of $0.73, up strongly from the $0.42 earned a year ago and thumping the First Call mean estimate of $0.59. For more details on the earnings report, check out this morning's Breakfast With the Fool... Mixed signal chips designer Integrated Circuit Systems (Nasdaq: ICST) rose $1 1/4 to $19 3/4 after agreeing to a buyout offer from senior management, private investment firm Bain Capital, and Bear Stearns that values the company at $257 million, or $21.25 per share in cash. Additionally, the company agreed to sell its data communications intellectual property and hardware and software assets to 3Com Corp. (Nasdaq: COMS) for $16 million in cash, helping to boost 3Com's shares $2 1/4 higher to $48.
Radio station operator and outdoor advertiser Chancellor Media Corp. (Nasdaq: AMFM) tuned in to a $9 3/16 gain to $54 3/4 after hiring BT Alex. Brown to examine "strategic alternatives," including a possible sale of the company... Analog and digital signal processing (DSP) chip maker Texas Instruments (NYSE: TXN) gained $6 5/8 to $99 5/8 after reporting Q4 EPS of $0.59 (excluding charges) -- a nickel ahead of the First Call mean estimate -- thanks to higher operating margins. For a closer look at the company, see our recent Texas-sized Dueling Fools feature... Wireless communications radio frequency power amplifiers supplier Powerwave Technologies (Nasdaq: PWAV) surfed $6 7/16 higher to $26 5/8 after reporting Q4 EPS of $0.04 (excluding charges), down from last year's $0.29 but ahead of the Zacks mean estimate of breakeven results for the quarter.
Programmable logic chip maker Xilinx (Nasdaq: XLNX) jumped $7 1/8 to $82 1/8 after saying strong bookings resulted in fiscal Q3 EPS of $0.46 (excluding a charge), beating both the First Call mean estimate and last year's results by $0.06. The company also announced a two-for-one stock split and received upgrades from at least six brokerages... Interactive entertainment software developer 3DO Co. (Nasdaq: THDO) jumped $2 5/32 to $6 1/2 after saying its software revenues for the first half of fiscal 1999 surged 256% thanks to recent upgrades to its website, which are resulting in higher online sales... Automated test equipment and electronic equipment backplane manufacturer Teradyne (NYSE: TER) tacked on $5 1/2 to $61 1/2 after reporting Q4 EPS of $0.14, down from last year's $0.54 but ahead of the First Call mean estimate of $0.12.
Trucking, air freight, and logistics company CNF Transportation (NYSE: CNF) sped ahead $3 1/8 to $41 1/4 after BT Alex. Brown started coverage with a "strong buy" rating and a price target of $55 per share... Laser beam maskmaking equipment maker Etec Systems (Nasdaq: ETEC) picked up $10 1/4 to $52 after Salomon Smith Barney raised its rating to "buy" from "outperform" and Morgan Stanley Dean Witter lifted its price target to $55 per share from $45 per share... Fast food pizza shop operator Sbarro Inc. (NYSE: SBA) rose $1 9/16 to $26 7/8 as Dow Jones reported that the company agreed to a sweetened buyout offer from the Sbarro family valued at $389.5 million, or $28.85 per share in cash. In November, the family had offered $27.50 per share for the 68.5% stake in the company it does not already own.
ACT Networks (Nasdaq: ANET) up $1 11/16 to $14 11/16; fiscal Q2 EPS: $0.02 vs. loss of $0.05 last year; estimate: loss of $0.05
Avant! Corp. (Nasdaq: AVNT) up $1 11/16 to $23 9/16; Q4 EPS: $0.40 (before charges) vs. $0.24 last year; estimate: $0.39
Digital Microwave Corp. (Nasdaq: DMIC) up $1 5/16 to $10 1/2; fiscal Q3 EPS: loss of $0.11 (excluding charges) vs. gain of $0.20 last year; estimate: loss of $0.11
Household International (NYSE: HI) up $3 11/16 to $44 1/2; Q4 EPS: $0.71 vs. $0.41 last year; estimate: $0.71
Innovex Inc. (Nasdaq: INVX) up $3 1/4 to $19 1/2; fiscal Q1 EPS: $0.20 vs. $0.48 last year; estimate: $0.18
Level One Communications (Nasdaq: LEVL) up $2 3/4 to $41 3/8: Q4 EPS: $0.28 (pro forma) vs. $0.19 last year; estimate: $0.24
Plexus Corp. (Nasdaq: PLXS) up $2 to $38; fiscal Q1 EPS: $0.36 vs. $0.23 last year; estimate: $0.34
RemedyTemp (Nasdaq: REMX) up $3 to $17; fiscal Q1 EPS: $0.41 vs. $0.38 last year; estimate: $0.41
Software AG Systems (NYSE: AGS) up $3 5/16 to $17 11/16; Q4 EPS: $0.29 vs. $0.23 last year; estimate: $0.26
The outlook for computer disk drive maker Western Digital Corp. (NYSE: WDC) may be improving despite its losing $2 3/4 to $16 1/2 today after turning in a fiscal second-quarter loss of $0.93 per share just after yesterday's bell. While the loss was well off the year-ago $0.03 per share profit (before items), it outdid Wall Street's projections for the first time in a year by besting the market's consensus $0.99 per share loss estimate. CEO Charles Haggerty said indications are that PC sales -- the company sells drives to Compaq (NYSE: CPQ), Dell (NYSE: DELL), and IBM (NYSE: IBM) as well as to consumers -- in Q3 may be better than in recent years. He also said while a planned restructuring will hold a $45 million charge against Q3 earnings, it is expected to reduce losses by cutting staff and consolidating plant operations. Western Digital, which also filed a shelf registration with the SEC to sell up to $190 million in stock, earned an upgrade to "buy" from "market perform" from BT Alex. Brown today.
While the amount of burn-off among tobacco stocks was mixed today, the outlook was certainly a bit smoky following President Clinton's announcement last night that the Justice Department intends to sue tobacco companies for the costs that the federal government has incurred while treating smoking-related illnesses. Details of the suit -- which industry leaders vowed to fight, calling it "political" -- will be decided by a Justice task force. The administration also plans to push for a $0.55-per-pack cigarette tax hike and an anti-smoking bill. Justice, meanwhile, asked the Supreme Court to reverse a November ruling that prohibits the FDA from regulating tobacco as a drug, which could prove extremely costly to cigarette makers if the agency is given broad influence over how cigarettes are made. World leader Philip Morris (NYSE: MO) coughed up $2 5/16 to $48 1/2 today, while British American Tobacco's (AMEX: BTI) American depositary shares fell $1 3/16 to $20 9/16. Loews Corp. (NYSE: LTR) dropped $3 3/16 to $90 7/16, UST (NYSE: UST) slid $1 5/16 to $30 11/16, RJR Nabisco Holdings (NYSE: RN) slipped $1/16 to $27 15/16, and Brooke Group (NYSE: BGL) slumped $15/16 to $22 3/16.
QUICK CUTS: Online retailer Amazon.com (Nasdaq: AMZN) lost $26 13/16 to $113 after CIBC Oppenheimer analyst Henry Blodget, he of December's pre-split $400 price target, said in a research note he won't raise the figure -- recently eclipsed -- again. Blodget voiced concerns about deteriorating gross margins and a general trend toward wholesale retailing online in his note... Dutch enterprise software company Baan (Nasdaq: BAANF) fell $1 1/8 to $10 3/16 after preannouncing a Q4 loss of $1.22 per share, well off Wall Street's projected $0.07 loss... Car battery maker Exide Corp. (NYSE: EX) stalled $1 9/16 to $18 15/16 after it said it expects fiscal Q3 losses to be between $1.75 and $1.90 per share, compared with the market's projected $0.84 per share profit.
Internet portal and search engine company Excite (Nasdaq: XCIT) calmed $13 3/8 to $96 5/8 after jumping as high as $110 yesterday on news that high-speed cable-access Internet services provider @Home Corp. (Nasdaq: ATHM) plans to buy the company in a stock deal worth $6.7 billion. @Home lost $5 5/8 to $109 3/4 today... Several other Internet name brands lost ground today: Yahoo! (Nasdaq: YHOO) fell $35 13/16 to $287 3/16, while fellow portals Infoseek (Nasdaq: SEEK) dumped $10 1/2 to $66 9/16 and Lycos (Nasdaq: LCOS) gave back $8 1/8 to $104 13/16... Contract oil driller Rowan Companies (NYSE: RDC) leaked $1 1/8 to $9 7/16 after it said Amoco's (NYSE: AN) U.K. subsidiary terminated a drilling contract, alleging equipment problems. Rowan says it has upheld the contract and plans legal action... Asynchronous transfer mode (ATM) switching products maker FORE Systems (Nasdaq: FORE) lost $3 1/2 to $17 5/8 on news of fiscal Q3 EPS of $0.10, flat with last year's number and Street estimates.
Compuware Corp. (Nasdaq: CPWR), which provides software and information technology services, wore down $9 11/16 to $62 3/8 today. Worries about slowing revenue growth reportedly dulled the cheer about the company's fiscal Q3 EPS of $0.49 (before charges), which was a nickel better than the Street's consensus estimate... Premium loudspeakers maker Polk Audio (AMEX: PKA) quieted $5 to $12 after the company broadcast fiscal Q3 EPS of $0.23, better than last year's $0.20. The bad news is that CEO George Klopfer believes the outlook for the next two quarters is "problematic"... Security hologram maker American Bank Note Holographics (NYSE: ABH) blurred $10 9/16 to $4 9/16 after the company said it will restate results for Q2 and Q3 and warned that Q4 earnings are expected to come in below last year's figure (the company wasn't publicly traded at the time).
Industrial laser products maker Rofin-Sinar Technologies (Nasdaq: RSTI) was sliced $2 15/16 to $9 15/16 after preannouncing fiscal Q1 EPS of between $0.02 and $0.04, well off the two-analyst estimate of $0.13 provided by First Call. Shipments of the company's higher-margin marking lasers were lower than expected... Personal planner maker Day Runner Inc. (Nasdaq: DAYR), a recent Daily Trouble, slowed $1 7/8 to $10 3/8 after reporting fiscal Q2 EPS of $0.30 (before items), well off last year's $0.45 mark and $0.02 below First Call's four-analyst estimate... Firewall software company Check Point Software (Nasdaq: CHKPF) lost $10 1/2 to $45 after reporting Q4 EPS of $0.47, ahead of last year's $0.36 but flat with market estimates.
Business mailing and teleservices provider Compass International Services (Nasdaq: CMPS) wandered down $1 3/16 to $8 5/16 after it said Q4 EPS is seen coming in below Wall Street's $0.18 estimate. The company hired Lehman Brothers to help look at alternatives... Automated blood collection systems maker Haemonetics Corp. (NYSE: HAE) bled $2 to $21 1/4 after the company said it expects fiscal Q3 EPS of about $0.175, short of the $0.20 estimate provided by First Call... Online financial news and information provider MarketWatch.com (Nasdaq: MKTW) continued its slide from Friday's euphoric IPO highs, losing $23 7/8 to $72 1/2. Shares of the highly anticipated offering crossed $97 per share in their first day of trading but have lost steam since.
AMR Corp. (NYSE: AMR) down $4 7/16 to $59 13/16; Q4 EPS $1.09 vs. $1.16 last year; estimate: $1.16
General Electric (NYSE: GE) down $1 1/4 to $100 3/16; Q4 EPS: $0.80 vs. $0.70 last year; estimate: $0.80
Molex Inc. (Nasdaq: MOLX) down $5 1/16 to $31 3/8; fiscal Q2 EPS $0.28 vs. $0.29 last year; estimate: $0.33
Project Software & Development (Nasdaq: PSDI) down $8 7/16 to $31 3/16; fiscal Q1 $0.42 vs. $0.35 last year; estimate: $0.37
Qualcomm Inc. (Nasdaq: QCOM) down $4 1/2 to $62; fiscal Q1 EPS: $0.65 vs. $0.50 last year; estimate: $0.60
Systems & Computer Technology (Nasdaq: SCTC) down $2 7/8 to $10 1/16; fiscal Q1 EPS $0.13 vs. $0.18 last year; estimate: $0.14
SIFCO Industries (AMEX: SIF) down $3 1/4 to $11 1/4; fiscal Q1 EPS $0.17 vs. $0.47; no estimate
Market Bubble? Prove It
Two years ago, Federal Reserve Board chairman Alan Greenspan asked, "[H]ow do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions ...?" In other words, how do we recognize a stock market bubble that, when burst, will damage not just stock prices but the real economy?
The question has worried Greenspan ever since. After all, the Dow has since risen 45%, from 6,437 to 9,336, while the S&P 500 has soared 69%, from 744 to 1,257. Commentators have repeatedly argued, and often just assumed, that "the market" is overvalued. In my view, though, most of this talk is stupid and irresponsible because it's based on a misuse of historical market data, a misunderstanding of how stocks should be valued, and a misreading of Greenspan's own analysis of our economy.
Sure, changing economic conditions could make it clear that stocks have overshot their fair value and that the earnings growth figured into stock prices won't materialize. But I haven't seen a convincing argument for this so-called market bubble, and the clearest confirmation of my sanity is Greenspan's reluctance to do more than worry aloud about equity prices.
Let me show you what a misreading of our situation looks like. The New Yorker's August 17 issue featured a story called "Pricking the Bubble" by John Cassidy, that magazine's regular financial correspondent. Despite The New Yorker's well-deserved reputation for smart commentary, you would be hard-pressed to find an intelligent-sounding article that looked so completely wrong so quickly.
Written early in last year's market sell-off, Cassidy's piece argued that the market was still overvalued based on traditional metrics such as the price-to-earnings (P/E) ratio and average dividend yield, and that the Dow could fall to around 5,500. He quoted Milton Friedman and Paul Samuelson, Nobel laureate economists of very different intellectual schools, both of whom insisted that the U.S. markets were in the middle of a bubble. He then drew a lengthy comparison between the Federal Reserve's inaction in the period leading up to the Great Crash of 1929 and Greenspan's similar inaction in 1998, arguing that Greenspan simply had to prick this bubble to avoid a catastrophe.
Cassidy asserted that Greenspan would raise interest rates, "possibly as early as next week." He said the "official explanation... will be a revival of inflation fears, but the real reason will be the effect that the stock market is having on the economy." The market would then fall further since bear markets "are typically preceded by a shift toward tight money."
But things didn't turn out quite like Cassidy figured. Greenspan soon told us that it was during that very mid-August meeting that the Fed moved from a tightening bias toward a balanced stance that made a rate hike less likely. Indeed, Greenspan's speech on September 4 signaled that the chairman was probably thinking of cutting interest rates. Fears of deflation soon swept over investors. Perhaps the only thing that kept the U.S. markets from thoroughly joining and, inevitably, exacerbating the growing global financial panic was Greenspan's personal willingness to do exactly the opposite of what Cassidy had so recently concluded Greenspan must do.
Sure, a lot happened in the month or so after Cassidy's article appeared. Still, his entire argument turned on what was basically a lame use of "old methods of valuing stocks." Going back to 1928, the historical median P/E ratio of the S&P 500 is around 14.6; yet, it's stupid to assume that P/Es will or should return to that level.
Stocks valuations are rightly based on a discounting of future cash flow. High P/Es do signal high expectations for growth, but some of these expectations will be met. A classic example comes from Stocks For the Long Run, where Jeremy Siegel shows that in 1972, the so-called Nifty Fifty stocks traded for an average of 42 times earnings, more than double the P/E for the S&P 500 index at the time. Many believed the Nifty Fifty were way overvalued, and some individual stocks certainly were. Yet, Siegel argues that, as a group, their subsequent performance justified even their peak prices.
Other factors play into valuations, too. Earnings are simply worth more when inflation is low and alternatives to equities, such as fixed-income investments, deliver low returns. Also, the compositions of the S&P 500 and the Dow have changed over time. These indexes now include a number of leading companies, such as Microsoft (Nasdaq: MSFT), America Online (NYSE: AOL), Cisco (Nasdaq: CSCO), and Intel (Nasdaq: INTC) -- and even IBM (NYSE: IBM), Disney (NYSE: DIS), and Coca-Cola (NYSE: KO) -- that would be stunningly undervalued if priced according to current earnings and short-term growth prospects alone.
As long-term bull Abby Joseph Cohen of Goldman Sachs has argued, our economy has undergone major transformations. In the last seven years, technology has tripled as a percent of gross domestic product (GDP). At the same time, profit margins have risen to the highest levels in 25 years. Return on equity (ROE) for U.S. companies has shot up to an historic high. And return on invested capital (ROIC), a key measure of corporate profitability, has soared and remained high for several years now, as businesses make better use of their resources. To argue that "the market" is overvalued, one must explain away these facts.
Greenspan has also frequently discussed the role of technology-driven productivity gains in shaping what he has called a "virtuous cycle." Productivity growth fosters increases both in real wages and in corporate profits, which have spurred more spending on productivity-enhancing capital equipment and continued education, all of which helps moderate inflationary pressures. This cycle inspires confidence in investors, thus reducing the risk premium they expect for investing in stocks or bonds, which in turn cuts the cost of capital for companies looking to fund expansion.
"As I have testified before the Congress many times," Greenspan reiterated today, "I believe, at root, the remarkable generation of capital gains of recent years has resulted from the dramatic fall in inflation expectations and associated risk premiums, and broad advances in a wide variety of technologies that produced critical synergies in the 1990s."
Greenspan has repeatedly worried, as he said today, that the recent growth rates are unsustainable. "Through the end of 1998, the economy continued to grow more rapidly than can be currently accommodated on an ongoing basis, even with higher, technology-driven productivity growth." He's also noted, as he did today, "the possibility that the recent performance of the equity markets will have difficulty in being sustained" because the "level of equity prices would appear to envision substantially greater growth of profits than has been experienced of late."
Yet, does Greenspan think we're experiencing an economic and financial bubble? In short, no. My view is that he simply hasn't convinced himself one way or another. His speech today revealed his keen appreciation for the way that higher stock prices have fueled consumer spending and pumped up the economy. Greenspan wouldn't mind seeing stock prices hibernate a while. Still, he has said that bubbles are often only obvious in retrospect. That's partly because one cannot know until much later whether markets have discounted more growth than can ultimately be delivered. Yet, Siegel's example suggests the inverse is also true. Only years later could one say that the alleged Nifty Fifty bubble was actually an instance of the market discounting future growth almost perfectly.
Last April, Greenspan said he was willing to believe that the markets (with the Dow around 9,000 and the S&P around 1,120) were "fairly valued" assuming the virtuous cycle could persist. "I am not wholly alien to that point of view," he told a group of newspaper editors. He's clearly been entertaining this point of view as seriously as he's considered what might derail this economic expansion. So he surely recognizes the historically high P/Es and the low dividend yields, but he also knows that these metrics alone are almost meaningless. Context matters. The current context has encouraged him to watch and wait, to let this economic experiment play out since it offers the potential for a higher standard of living and price stability.
Reporters like Cassidy who fall back on the historical P/E factoid to argue that the market is overinflated are basically screaming that they have no idea how companies are, or should be, valued. My advice is for you simply to throw down any article where someone uses this stat uncritically and unqualified because the whole article is likely to prove dangerous to your wealth. Historical P/Es alone simply have nothing much to tell us about valuations today.
[Note: Look for our upcoming report on how some of the major magazines covered last year's market mayhem. Available tomorrow on The Motley Fool site.]
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