Drip Portfolio Sky Falls on Nortel?

George Runkle looks at the factors behind Nortel's recent drop in share price, including rumors and lower sales that might be seasonal, to evaluate whether the sky is falling on the company.

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By George Runkle (TMF Runkle)
November 22, 2000

Last week we saw another huge drop for Nortel Networks (NYSE: NT), as the stock went from about $37.88 a share on Monday to $34.06 on Friday. What happened?

Part of it is rumors that customers have jumped ship. Maria Bartiromo from CNBC reported that a Bank of America analyst told clients that Nortel had lost Qwest Communications (NYSE: Q) sales to Ciena Corporation (Nasdaq: CIEN). Nortel denied this, and David Chamberlin from Nortel stated to Investor's Business Daily, "We win and lose contracts every day, but we have not lost any significant contracts to Ciena or anyone else."

Another item that brought Nortel's stock down is that its revenues in the past quarter were 5% lower than the previous quarter. So, even though the stock beat analyst estimates on earnings, its stock price was hammered. There are also a number of reports of telephone companies encountering a cash crunch, which will slow down their installation of new equipment. So, the combined total of what is seen as bad news and rumors has caused this stock to tumble.

What follows is my opinion about what happened, and what I think about Nortel. First, I have to be straightforward. As my Fool profile shows, I own shares in Nortel. Now, let's look first at verifiable news: the revenue drop.

Nortel's revenue did drop, from $7.825 billion in the quarter ending June 2000 to $7.314 billion in the quarter ending September 2000. How does that compare to previous year? In 1999 and 1998, the revenue between the two quarters dropped slightly, too (a little less than 1%). In 1997's comparable period, the revenue dropped from $3.787 billion to $3.498 billion, which is a drop of about 7.6% -- pretty significant. We might find that we have a seasonal factor here. So, let's compare revenue this past quarter with the same quarter one year ago, to balance out any seasonal effects. We'll also see what revenue did in previous years:

        Q3 year-over-year 
Year      Sales Growth   
1998          18%
1999          30%
2000          36%
So, we've managed to see a steady growth in revenue when we seasonally adjust by only comparing third quarters.

The next item is the telecommunications slowdown. It is true that a number of telecom providers are in a cash crunch right now. This will certainly bring a slowdown in short-term spending for some of them. However, the demand for bandwidth will continue to grow long-term, and if telecom companies don't continue to upgrade their networks, they will lose market share to competitors. RHK, a company that specializes in telecommunications industry analysis, projects the optical transport market will grow from $3.5 billion in 1999 to $45 billion in 2004. Even if this number is 50% too high, strong growth would still occur.

The final issue is rumors. Sometimes rumors can be true, partly because people aren't very good at keeping secrets. However, we all know that rumors can get started by people who have their own agendas. The rumors of Nortel losing contracts have not been substantiated, and company spokespeople have flatly denied the rumors. The rumor of losing a contract to Ciena is also rather nonspecific. How big was the contract? Will other companies follow suit? None of this is known, just that Nortel reportedly lost a contract.

So I don't see that any of the company's long-term fundamentals have changed for the worse. However, it appears that emotion has ruled its stock price. Everybody had to get involved in investing in optics, yet it's an extremely difficult area in which to invest. Like investing in biotechnology, it takes a significant amount of study to understand these businesses. The terms can be difficult to understand, and it takes a lot of work to determine the leading players in the business.

Many people invested anyway, and as news comes out that appears to be less-than-rosy, panic sets in. Ultimately, the leading companies are still good investments. Is it time to back up the truck and buy more? No, I don't believe in trying to catch a falling knife, as no one knows where the bottom might be. However, it sure is time for me to continue dollar cost averaging by putting money away in my Nortel Drip. Too bad it only allows quarterly investments!

Let me close with a quote from Peter Lynch's book Beating the Street: "There is always something to worry about. Avoid weekend thinking and avoid the latest dire predictions of the newscasters. Sell a stock because the company's fundamentals deteriorate, not because the sky is falling."

Happy Thanksgiving and Fool on!

P.S. I can't go away too quickly without a couple of remarks. I'm still waiting for word on my Drip accounts in Scientific-Atlanta (NYSE: SFA) and Nortel Networks, which I enrolled in through Temper of the Times. The direct investments that I signed up for through Netstock Direct in Enron (NYSE: ENE) haven't started yet either.

Also, in a bout of blatant promotion, consider placing your order for our Industry Focus 2001. This popular annual product covers Optical Networking Components and Wireless Service Providers this year, which are of big interest to those of us investing in cutting-edge, Pathfinder companies. Also, this week I'm visiting Scientific-Atlanta to get an update on how things have changed in the past year.

Have a great long weekend!

Drip Portfolio


11/22/00 as of ~8:30:00 PM EST

Ticker Company Price
Change
Daily Price
% Change
Price
CPBCAMPBELL SOUPUnchg.Unchg.33.38
INTCINTEL CORP(1.44)(3.37%)41.19
JNJJOHNSON & JOHNSON(1.25)(1.28%)96.50
MELMELLON FINANCIAL CORP(1.19)(2.65%)43.56
PEPPEPSICO INC(1.75)(3.76%)44.75

  Day Week Month Year
To Date
Since
7/28/1997
Annualized
Drip(2.46%)(0.68%)(4.61%)8.91%30.37%8.31%
Comparable S&P 500n/an/an/an/a14.37%4.12%
S&P 500(1.85%)(3.32%)(7.49%)(10.00%)40.86%10.86%
S&P 500 (DA)(1.82%)(3.26%)(7.36%)(9.83%)43.48%11.47%
NASDAQ(4.04%)(8.98%)(18.23%)(32.29%)75.55%18.45%

Trade Date # Shares Ticker Cost/Share Price Total % Ret
9/8/9749.5166INTC24.2441.1970.20%
10/7/9837.3159MEL34.7743.5626.76%
11/14/9716.236JNJ80.1196.5021.69%
7/28/005PEP48.0044.75(6.77%)
4/13/988.403CPB53.9833.38(36.62%)

Trade Date # Shares Ticker Total Cost Current Value Total Gain
9/8/9749.5166INTC1,200.412,039.47842.65
10/7/9837.3159MEL1,297.431,625.57347.22
11/14/9716.236JNJ1,300.691,566.77282.14
7/28/005PEP240.00223.75(16.25)
4/13/988.403CPB453.61280.45(166.09)
 
Cash: 
Total: 
0.04
5,736.05
 


Key
• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Note
Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.