Thursday, March 25, 1999
DJIA           9836.39 +169.55     (+1.75%)
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30-Year Bond   95 5/32  -23/32  5.58 Yield


Drug maker Duramed (Nasdaq: DRMD) experienced a hot flash today after announcing last night that the Food and Drug Administration (FDA) has approved Cenestin, a synthetic estrogen-replacement therapy for menopausal women. By the close of trading, the company's stock had soared $5 3/8, or 76.8%, to $12 3/8. Duramed officials said the company plans to introduce two dosage levels of the drug within the next 90 days, indicating the firm has already signed a preliminary distribution agreement with an unnamed Fortune 200 company. Duramed projects annualized sales for Cenestin could hit the $100 million mark 15 to 18 months after the launch. Since the company's sales for the first nine months of FY98 were just $36 million, Cenestin could have a major impact on the company's future. For more details, see this afternoon's Fool Plate Special.

Home and commercial appliance manufacturer Maytag Corp. (NYSE: MYG) moved up $5 15/16 to $60 1/4 after saying low mortgage and unemployment rates are fueling strong sales of higher-margin products, leading the company to expect Q1 EPS "above" $0.90. The First Call mean estimate had called for EPS of $0.81. That kind of performance was enough to prompt upgrades from Salomon Smith Barney and Brown Brothers Harriman. While the attention of many investors has lately been diverted to sexier Internet and telecommunications stocks and away from consumer durables like Maytag, the Newton, Iowa-based company has quietly put up some cyber-like returns of its own -- 67% growth in 1998 after an 89% rise in 1997. Over that span, Maytag has steadily raised its pre-tax margins to 11.6% from 7.6% and its return on average equity has climbed to 51% from 23%, showing that even a 106-year-old dog can learn some new tricks.

QUICK TAKES: Online auctioneer eBay (Nasdaq: EBAY) picked up $14 to $159 3/8 after signing a four-year strategic alliance with online services conglomerate America Online (NYSE: AOL). Under the deal, AOL will give eBay "prominent presence" throughout its family of brand-name websites and will help promote eBay's expansion into international markets. In return, AOL will receive $75 million in payments and all advertising revenues from eBay-AOL co-branded websites. AOL added $9 3/8 to $126 1/2... Internet navigation service MiningCo.com (Nasdaq: MINE) added another $11 7/16 to $58 15/16 after gaining 89% yesterday following its initial public offering of 3 million shares at a price of $25 per share... Consumer electronics retailer Tandy Corp. (NYSE: TAN) rose $4 7/32 to $61 thanks to a Salomon Smith Barney upgrade to "buy" from "outperform."

Mobile communications technologies firm Ericsson (Nasdaq: ERICY) rose $2 1/4 to $23 5/16 after announcing it has reached an agreement with rival Qualcomm (Nasdaq: QCOM) to settle all patent disputes between the two companies relating to Code Division Multiple Access (CDMA) technology. Ericsson will also acquire Qualcomm's CDMA infrastructure business and agreed to support a single world CDMA standard for future wireless devices. Qualcomm gained $11 1/16 to $98 7/16.... Furniture manufacturer O'Sullivan Industries Holdings (NYSE: OSU) gained $2 5/16 to $14 15/16 after a group led by senior management announced a plan to take the company private... Staffing services company Norrell (NYSE: NRL) climbed $13/16 to $13 7/16 after agreeing to merge with Interim Services (NYSE: IS) in a stock swap valued at about $553 million, including assumed debt. Interim Services fell $1 13/16 to $16.

Brokerage and investment banking firm Morgan Stanley Dean Witter (NYSE: MWD) traded up $5 1/2 to $103 7/8 after reporting fiscal Q1 EPS of $1.76 (excluding charges), up from $1.10 a year ago and ahead of the First Call mean estimate of $1.34... Several Internet-related companies got a boost today after NationsBanc Montgomery Securities started coverage of AOL and a slew of other firms with "buy" ratings. Yahoo! (Nasdaq: YHOO) picked up $18 1/2 to $179, Amazon.com (Nasdaq: AMZN) rose $16 3/16 to $139 7/8, Excite (Nasdaq: XCIT) added $8 7/16 to $133 5/16, @Home (Nasdaq: ATHM) advanced $10 1/4 to $146 1/4, Verio (Nasdaq: VRIO) tacked on $2 to $45, Xoom.com (Nasdaq: XMCM) moved up $2 1/8 to $71 1/8, and Infoseek (Nasdaq: SEEK) climbed $4 to $81 1/8.

High-end office furniture supplier Herman Miller (Nasdaq: MLHR) picked up $3/4 to $17 9/16 after Merrill Lynch raised its near-term rating to "accumulate" from "neutral" due to a recent uptick in bid activity and the company's attractive current valuation... Rural markets Internet services provider OneMain.com (Nasdaq: ONEM) jumped $17 9/16 to $39 9/16 after selling 8.5 million shares in an initial public offering at a price of $22 per share... Consumer products company Clorox (NYSE: CLX) climbed $7 15/16 to $121 3/4 thanks to a Morgan Stanley Dean Witter upgrade to "outperform" from "neutral"... Set-top box developer General Instrument (NYSE: GIC) rose $2 5/16 to $30 7/16 after Interstate/Johnson Lane raised its rating to "strong buy" from "long-term buy."

Electronic design automation (EDA) tools maker Cadence Design Systems (NYSE: CDN) rose $1 1/2 to $26 9/16 after signing a three-year deal yesterday to provide IBM (NYSE: IBM) with EDA software for designing integrated circuits, implementing printed circuit boards, and other applications... Electronic news and information company Data Transmission Network (Nasdaq: DTLN) rose $4 13/16 to $22 9/16 after announcing that its CEO and four directors stepped down and that it will hire an investment bank to examine ways to increase shareholder value, including a possible sale of the company... Mobile communications technologies firm Nokia (NYSE: NOK.A) rang up $8 to $151 following a Morgan Stanley Dean Witter upgrade to "outperform" from "neutral."

Internet services company Exodus Communications (Nasdaq: EXDS) moved up $28 1/4 to $150 after ING Baring Furman Selz started coverage with a "buy" rating and Hambrecht & Quist raised its opinion to "strong buy" from "buy"... Pediatrix Medical Group (NYSE: PDX), which provides physician management services to neonatal intensive care units (NICU) in hospitals, delivered a $14 1/16 gain to $34 after a months-long audit revealed that the firm would not have to restate its prior financial results. That allowed the company to report Q4 EPS of $0.51, topping the First Call mean estimate by $0.02... Chip enhancement technologies developer Rambus (Nasdaq: RMBS) gained $4 to $66 1/16 after Morgan Stanley analyst Mark Edelstone reiterated his "outperform" rating on the firm. According to Bloomberg News, dynamic random access memory (DRAM) chip maker Samsung reportedly told Edelstone that it plans to increase its production of Rambus-enhanced chips to up to half of its total DRAM volume by the end of next year.


A weeklong upheaval in the share price of seismic data acquisition systems developer Core Laboratories (NYSE: CLB) has left the stock sitting more than 25% below Friday's closing price following disappointing earnings and merger news. Today, Core lost $6 1/4 to $16 15/16 after reporting Q4 EPS of $0.18, down from $0.22 last year and missing First Call's three-analyst $0.22 estimate. A 25% year-over-year revenue boost, powered in part by newly introduced higher-technology services, was encouraging, but signs of a slowdown are imminent as demand for the company's traditional services has waned with declining oilfield activity worldwide. CEO David Demshur said, "Although we expect continued growth in 1999, it will probably be at lower than our historical rates." The stock dropped $1 5/8 yesterday after the company said it terminated its planned merger with fellow seismic data firm GeoScience Corp. (Nasdaq: GSCI). That move will mean a charge to cover $3 million in working capital advances and professional services fees that will be taken in Q1.

Okay, let's get this straight... Auto towing, impounding, and storage firm United Road Services (Nasdaq: URSI) said first-quarter earnings are likely to be hurt by the mild winter, but the company sees a turnaround coming in Q2. Isn't the spring usually warmer than the winter? United Road now expects Q1 EPS to come in between $0.08 and $0.10, with five analysts surveyed by First Call looking for an $0.18 per share profit. CEO Ed Sheehan said revenues improved in March and he believes business will continue to heat up heading into the second quarter, but some on Wall Street were skeptical -- BancBoston Robertson Stephens cut the stock to "buy" from "strong buy" today. The shares lost $5 13/16, or 48.8%, to $5 7/16 as the earnings news was compounded by the company's statement that "earnings per share for the full year may be affected by... the company's ability to continue to execute its acquisition strategy, which will be affected by its ability to access capital markets." The company spent well over $200 million in the past year buying up more than 40 companies, but with the stock now near its 52-week low, funding further purchases may prove difficult.

Electronics manufacturing services (EMS) provider SCI Systems (NYSE: SCI) shed $5 1/4 to $30 3/16 after warning that it expects revenue and earnings for the third quarter ending March 28 to be "upper single digit percentages below" current analysts' estimates due to a drop in PC sales in Europe and the devaluation of the Brazilian real. Wall Street was projecting EPS of $0.50. It's stock price cut nearly in half this year, SCI will be handing the reins over to long-time president and COO A.E. Sapp, Jr., who will replace Olin King as CEO beginning in July. Both have been with the company since the early 1960s. King will remain chairman. Although the company's statement makes mention of King's recently celebrated 65th birthday, it seems likely that the array of problems -- nicely detailed by the Fool's Dale Wettlaufer in a recent column -- that have pulled the stock price downward and soured the company's relationship with some investors had something to do with the CEO's decision to step down at the end of the fiscal year.

QUICK CUTS: Shares of cosmetic and personal care company Revlon Inc. (NYSE: REV) lost $11/16 to $21 9/16 today after The Wall Street Journal said the company isn't for sale; various reports circulating yesterday said otherwise, sending the stock up $5 3/16... Web address registrar Network Solutions (Nasdaq: NSOL) lost $8 15/16 to $101 1/16 as noted short-seller company Asensio & Co. started the company with a "strong sell" recommendation and said the company "has purposely disseminated misleading information, and failed to disclose material negative information" concerning its future prospects... Micron Technology (NYSE: MU) fell $4 9/16 to $47 7/16. The company reported fiscal Q2 EPS of $0.12 (before charges) last night, its first time in the black in four quarters, topping analysts' mean expectations of a profit of $0.01 per share but short of the most bullish forecasts of $0.20.

Electric and natural gas company New Century Energies (NYSE: NCE) moved back $2 3/16 to $36 1/2 after agreeing to merge with Northern States Power (NYSE: NSP). Northern States retreated $1 1/16 to $26 3/16 today... Cable Internet service provider SoftNet Systems (AMEX: SOF), which today said a Puerto Rican cable operator signed a 10-year Internet and telephony services agreement and agreed to buy $15 million in company stock, softened $1 1/4 to $35... Washington state commercial bank company Columbia Banking System (Nasdaq: COLB), which said Q1 EPS will fall short of consensus estimates of $0.26 and it is "too early to tell" whether full-year EPS will meet the market's $1.13 estimate, faded $1 5/16 to $15 1/16 today... Drug research company Pharmacopeia (Nasdaq: PCOP) watched its stock lose $1/2 to $7 after it said first-quarter revenues at its Teijin Molecular Simulations subsidiary -- it recently bought the 50% of the Asian joint venture it didn't already own -- will likely fall in the lower half of the range of recent analyst projections.

Diversified food company ConAgra (NYSE: CAG), which reported fiscal Q3 EPS of $0.36, a penny ahead of Street projections, nevertheless lost $2 11/16 to $27... Safeskin (Nasdaq: SFSK), a leading maker of high-quality disposable latex and synthetic medical examination gloves, gave up $25/32 to $7 19/32. Yesterday, COO Terrance Bieker resigned to pursue "other business opportunities," and chairman, president, and CEO Richard Jaffe stepped in with a vow to "take a more active role" in the company's day-to-day operations... Enterprise payment management software company Bottomline Technologies (Nasdaq: EPAY) gave back $4 1/16 to $67 7/16 after adding $19 yesterday after professional services company Arthur Andersen said it would offer Bottomline's PayBase electronic payment system to its clients.

An Investment Opinion
by Dale Wettlaufer

Valuation Myths

Once upon a time, value meant something to some investors, columnists, and commentators. "But it doesn't mean anything anymore," they now moan. Perhaps we can get a pharmaceutical company to develop an acute pain-management lollipop for the "deep value" investors because they're beginning to sound like a dog that's just been hit by a car. They may have to wait awhile for the next recession or interest rate spike.

When I put the phrase "value investors" in quotation marks, I'm talking about the people who haven't bought any stock since 1991, 1993, or 1995, and who think all great companies are ridiculously overpriced. The reason I'm so harsh about it is because I consider a focus on the market as a whole, rather than on individual companies and securities, to be an amateur exercise for investors. For traders, that's their job and I don't begrudge it. The skeptic asks why things are. The "value investor" wails and cries instead of spending time actually digging for value. Unless you've got tens of billions of dollars to invest and can't find companies that have the size requisite for effective investment, there's really no excuse for this.

Watching CNBC's Squawk Box this morning, one of the guests was talking about valuation parameters that have lasted for the last 56 years. Just as a study of religion or architecture will suffer without looking at contemporaneous culture, politics, and the general milieu of a certain time, a study of valuation over the last 50 years isn't going to tell you everything you want to know about valuation today. To wit, anyone who treats either today or 1974, 1929 or 1987, and 1933 or 1981 as the norms do so at their own peril. Of course, five sigma events happen, but extrapolating reality from them and wallpapering the world with that view is going to turn your brain into mush.

In the 20th century, major recessions and wars have been the exceptions, not the rule. It's the damaging exceptions, however, that give rise to both damaged perceptions of the world and to great advances of scholarship. Ben Graham's book Security Analysis was the product of the damaging exception of the market's behavior from the late 1920s into the first three years of the 1930s. The damaging exception of the Depression gave rise to GATT and Bretton Woods at the close of World War II. The rise of codified free cash flow analysis in the 1970s was due in part, I believe, to the damaging exception of the Nifty 50 crash. And it was the damaging exception of a severe spike in the price of money and oil (an inflation-adjusted anomaly over the history of oil) in 1973-1974 that has informed the entire traumatized worldview of a number of "value" investors today.

Not that I'm saying there is no danger in the market today. I couldn't agree more with an investor like David Dreman: Value is highly important. But I couldn't disagree more with the implications of Dreman's columns. While we would all like to have the great companies priced at levels that offer super-normal returns on investment, that's not how it goes in a low-inflation, high-growth environment with tons of long-term global opportunities. Just because there are a lot of companies that are carrying very high valuations doesn't mean that value does not exist today, and it's not just in companies that have been priced (by an efficient market) at a fraction of book value or revenues.

One must understand that valuation is a context dependent exercise, not one where absolute norms can be derived by taking the simple arithmetic means of past history. In the introduction to his Investment Valuation, New York University finance professor Aswath Damodaran lays out six myths of valuation. In my role as a communicator of useful information, as opposed to being only a progenitor of information, I pass these along to you, with comments that may or may not agree with Damodaran's.

Myth 1: Since valuation models are quantitative, valuation is objective.

I could make a series out of that one. If your investment banker comes to you and pitches you on taking your two-year-old money losing company public, and they put a price on your company based on price/sales and cash flow multiples of five publicly traded peers, it doesn't mean that reflects the intrinsic value of your company. It's a subjective data set.

It also means that I can make up whatever I want to in a spreadsheet. For me, the process of valuing a company isn't always determined by making my best judgment as to what I think the company can do over 20 years. Even if you run your own company and know it like the back of your hand, that can be very difficult to impossible. But you can reverse-engineer the expectations that a subjective market has baked into the current price of a company and then make a decision based on that process of discovery. Even then, that's a subjective judgment, but I believe part of Damodaran's point is that you can't get away from subjectivity in valuing a company.

Only if you have a crystal ball and can see cash flows in the future can you make a truly objective valuation that only requires you to plug in your own discount rate to arrive at a buy point today. Finally, this also means that investment valuation is as much art as it is science. For instance, the national income accounting equation that the Office of Management and Budget and the Congressional Budget Office uses is as much the product of political and philosophical biases as it is the result of very complex algorithms. You have to know that economics is a social science to understand it, just as you have to know that the process of valuation is a set of estimates based on certain facts.

Myth 2: A well-researched and well-done valuation is timeless.

The milieu affecting the value of a company can change every day. The world is not static and neither are securities prices. When the term "efficient market" is used, it means the market is pretty good at reflecting what is known and, as a complex adaptive system that works as mysteriously as an ecosystem, what is not generally known. "Efficient market" should not mean that no one can outperform the market or that you even need to be Warren Buffett to do so. Again, that's my own observation, not Damodaran's.

Myth 3: A good valuation provides a precise estimate of value.

First I'll say that intrinsic value can mean two things to two people, depending upon your required rate of return. If you have a five-year holding period in mind, Coca-Cola at $70 might not return any more than a five-year corporate bond, given that the market treats the company's payback potential as inevitable as the federal government's securities. This also means that you have to realize that you're not going to get every element of a valuation scheme right, no matter how good your skill at valuing companies. You can find out you don't know a darn thing about the dynamics of a company, and you can also be pleasantly surprised if you underestimate the quality of a company. But you can also overestimate the quality of a company in its ability to create the cash flows necessary to produce a satisfactory return on your capital. Also see Ben Graham's Security Analysis (1934 edition and 2nd ed. if you can find it), The Intelligent Investor, and the forthcoming The Rediscovered Benjamin Graham.

Myth 4: The more quantitative a model, the better the valuation.

Garbage in, garbage out, the saying goes. Better to be approximately right about something than precisely wrong, John M. Keynes observed.

Myth 5: The market is generally wrong.

Respect the power of the market. Sometimes you're just flat wrong. As for the value nuts out there today, the market is going to strive to discount equities such that returns on a longer holding period match the historical rate of return on equities. It would be nice to pick up Coca-Cola at 15 times earnings, but it's not going to happen unless California drops off the edge of the continent or someone nukes Manhattan.

Myth 6: The product of valuation (i.e., the value) is what matters; the process of valuation is not important.

If you construct a valuation model, it forces you to think about the business. Give me one investor who has looked at a bunch of canned data on a number of companies and give me an investor who has constructed the data him or herself and I'll say definitely that the second investor is better informed.


The market forces a discipline on investors, and that is to think about companies underlying the indices. The more you think about the index and the less you think about the underlying companies, the less you're going to understand what counts. If you spend a lot of time looking at companies and your daily conclusion is that things are just not cheap, that's one thing. But if you keep on checking in on a few companies and see that they're not cheap every time you look, well, you might have to wait around for a while. Value exists out there -- you just have to do some digging. Even then, the process of value discovery is a subjective one and everyone is prone to human failings, but the process makes you stronger intellectually and temperamentally.


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