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How Did It Double?
A company succeeds and its stock is rewarded with higher prices -- this is how Wall Street is supposed to work. In the case of Tollgrade Communications, Wall Street is just now catching up to the company's story. Even though Tollgrade has accomplished some consistent and healthy growth, the stock only recently started to reflect this success.
Business Description
Based outside of Pittsburgh, Tollgrade Communications designs and produces network testing equipment. Its products allow phone and cable television companies to diagnose problems within their wireline networks from remote locations. The testing equipment can be used on networks composed of copper, coaxial, or fiber links.
Financial Facts
Income Statement
How Could You Have Found This Double?
Tollgrade Communications had many features Fools like to see in a small-capitalization stock. It had steady growth, essentially no debt, increasing margins, decent insider ownership, a healthy return on invested capital, and it consistently bested Wall Street's profit expectations. For those who follow the Foolish 8 screen, Tollgrade showed up on the list on Jan. 24 -- and since then the stock has appreciated over 130%.
Where to From Here?
It certainly looks as if the good times will continue to roll for Tollgrade in at least the near future. The company has a fairly significant backlog ($15.2 million at April 1), as well as several new products that are in high demand. If demand remains strong, Tollgrade should be able to continue to grow its sales faster than its expenses.
Ticker: (Nasdaq: TLGD)
Phone: 412-820-1400
Website: www.tollgrade.com
Price (5/24/2000): $59 3/4
Between its IPO in 1995 and mid-1999, Tollgrade's stock price was roughly flat. However, the company has surely and steadily improved its financials. Check out Tollgrade's trailing income statements:
(millions) '95 '96 '97 '98 '99
Sales $22.3 $37.5 $45.4 $46.3 $61.1
Earnings $2.5 $5.6 $6.9 $7.0 $10.6
EPS $0.28 $0.47 $0.58 $0.59 $0.89
Tollgrade continued to show steady growth through the beginning of this year, too. In the first quarter, the company recorded sales of $22.4 million and EPS of $0.39, versus $11.1 million and $0.13 in the same quarter of 1999. Gross profits expanded to 62.7% in the first quarter, and the company's net profit margin was a tall 23.2%. Make no mistake -- Tollgrade is a cagey little company that has been hitting perfectly on all cylinders.
When Wall Street awoke to the Tollgrade story, it awoke with a vengeance. A year ago one could have purchased Tollgrade for less than $8 a share, not far from where it was back in 1995. Just last week, Tollgrade made a new high above $86 per share, making the stock a 10-bagger inside a year.
The vast majority of Tollgrade's sales are to the regional bell operating companies (RBOCs), but a growing number of sales are being made to Internet service providers deploying broadband access networks.
Tollgrade was founded in 1988 and came public in 1995. The company has grown both sales and profits every single year since coming public (as well as for several years before that).
12-month sales: $72.4 million
12-month income: $14.4 million
12-month EPS: $1.15
Profit Margin: 19.8%
Market Cap: $809.4 million
Balance Sheet
Cash & Equivalents: $35.0 million
Current Assets: $68.2 million
Current Liabilities: $10.3 million
Long-term Debt: None
Ratios
Price-to-earnings: 52
Price-to-sales: 11.2
In addition, the company was trading at a low P/E ratio relative to its earnings growth. A year ago, those screening for low Fool Ratio (otherwise known as the PEG) stocks would have found a company trading at a P/E ratio in the 10-15 range, even though it was expected to have annual profit growth in the 40-60% range, giving a PEG well below 0.4. While investors should not rely on any single investing tool, the Fool Ratio is as good as any for painting a thumbnail picture of how small-cap growth companies are valued.
Over the longer term, Tollgrade appears to be positioned well to pace the overall growth of the Internet. The company's products, while small components in a network as a whole, are essential to firms looking to provide 100% uptime for their customers. Tollgrade looks especially well-positioned to take advantage of the current broadband DSL rollout, and the company also sells monitoring products that span essentially all network types.
Tollgrade may also be attractive acquisition bait for a larger network hardware company such as Cisco Systems (Nasdaq: CSCO) or Lucent Technologies (NYSE: LU). Tollgrade's product portfolio would make a nice complement to any number of networking firms looking to be "one-stop shops" for network equipment.
Either way, the three analysts covering the company expect Tollgrade to earn $1.21 per share this year and $1.59 per share in 2001. That would put the stock at roughly 45 times 2001 earnings, which is almost double the 20% expected long-term growth rate. This means the stock is no bargain today according to the Fool Ratio, but Tollgrade does have a history of topping published Wall Street expectations. Moreover, Tollgrade may continue to demand a premium valuation if it can sustain its consistent growth.
Tollgrade is an interesting little networking company that probably deserves a bit more attention that it has had in the past.
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