<THE EVENING NEWS>
Thursday, June 24, 1999
MARKET CLOSE
DJIA           10534.83   -132.03   (-1.24%)
S&P 500         1315.78    -17.28   (-1.30%)
Nasdaq          2553.99    -44.13   (-1.70%)
Russell 2000     443.16     -3.88   (-0.87%)
30-Year Bond   87 22/32     -6/32   6.16 Yield

HEROES

East Coast wireless telecommunications firm Omnipoint Corp. (Nasdaq: OMPT) jumped $7 15/16 to $28 3/4 after agreeing to be acquired by West Coast wireless firm VoiceStream Wireless Corp. (Nasdaq: VSTR) for $24.34 per share in stock and $8 per share in cash, based on last night's closing prices. Pulling the levers behind the curtain is Hong Kong-based Hutchison Whampoa, which will end up with a 30% stake in the new company after starting down the U.S. wireless yellow brick road in 1997 with a $74 million investment in former VoiceStream parent Western Wireless (Nasdaq: WWCA). Dwarfing that initial investment is today's $957 million cash infusion by Hutchison in the bulked-up VoiceStream, which will likely use the pocket change to create a coast-to-coast network in the U.S. based on the digital global system for mobile communication (GSM) wireless standard. Possible GSM network hole-fillers include Aerial Communications (Nasdaq: AERL), which rose $2 1/2 to $13 1/4, and Powertel (Nasdaq: PTEL), which gained $3 to $27 1/4.

Tektronix Inc. (NYSE: TEK) gained $3 1/4 to $29 13/16 after posting fiscal Q4 EPS of $0.53, down from last year's $0.83 but in line with the Zacks mean estimate. The company also said it will split its business into two separate publicly traded companies. One company, which will keep the Tektronix name, will include the firm's telecom and TV test and measurement equipment business, while the other unnamed company will consist of the firm's color printing and imaging business. Additionally, Tektronix said it intends to sell off or find a strategic alliance for its money-losing video and networking business. Tektronix shareholders, who will tentatively get the 85% of the imaging business not sold in a proposed initial public offering, could potentially end up with two highly volatile, underperforming stocks for the price of one if the recent past is any guide. Over the past two years, Tektronix's stock has gyrated wildly as the Asian financial crisis has taken its toll, leaving the firm's shares roughly at their 1996 level.

QUICK TAKES: Information technology support services provider Data Processing Resources (Nasdaq: DPRC) soared $11 1/8 to $23 3/8 after enterprise system implementation services firm Compuware (Nasdaq: CPWR) agreed to buy the company in a cash tender offer for $24 per share, a 96% premium to its closing price of $12 1/4 per share yesterday... Atlanta-based Internet services provider (ISP) MindSpring Enterprises (Nasdaq: MSPG) trampolined $3 1/2 higher to $82 1/8 after saying it is "in discussions regarding possible business combinations." The firm added that it will not say anything further about the talks unless they result in a definitive agreement... Aircraft spare parts supplier and repairer AAR Corp. (NYSE: AIR) rose $1 to $20 7/16 after reporting fiscal Q4 EPS of $0.42, beating the First Call mean estimate by $0.02.

Software and multimedia products and services provider Zomax Inc. (Nasdaq: ZOMX) zoomed $9 1/4 higher to $36 13/16 after saying it expects Q2 EPS of about $0.55, "significantly" exceeding the First Call mean estimate of $0.31... Specialty water treatment chemicals provider Nalco Chemical Co. (NYSE: NLC) cleaned up with a $3 1/2 gain to $40 3/4 on speculation that it is an acquisition target. Bloomberg News fingered oil refiner and specialty chemical firm Ashland (NYSE: ASH) and French water company Vivendi as two possible buyers... The American depositary shares of Japanese electronics firm Hitachi Ltd. (NYSE: HIT) moved up $4 9/16 to $89 13/16 after Merrill Lynch raised its near-term rating on the company to "accumulate" from "neutral."

Online travel services firm Preview Travel (Nasdaq: PTVL) voyaged $1 7/8 higher to $20 7/16 after signing a long-term advertising deal with office products superstore operator Office Depot (NYSE: ODP) and its www.officedepot.com e-commerce website... Vacu-dry Co. (Nasdaq: VDRY) sucked up a $1 7/8 gain to $9 5/8 after selling its apple-based industrial ingredients business to privately held Tree Top Inc. for $12 million in cash, helping to transition the company from the industrial ingredients business to the natural foods business... Specialty apparel catalog retailer Coldwater Creek (Nasdaq: CWTR) streamed $1 3/16 higher to $18 7/8 after posting fiscal Q1 EPS of $0.15, up from $0.07 a year ago and ahead of the First Call mean estimate of $0.11... Toronto-based pharmaceutical company Biovail Corp. International (NYSE: BVF) added $2 3/8 to $47 1/2 after Merrill Lynch started coverage with a near-term "buy" rating.

Internet IPOs: Real-time e-commerce transaction services firm CyberSource Corp. (Nasdaq: CYBS) climbed $2 9/16 to $13 9/16 after selling 4 million shares in an initial public offering at a price of $11 per share... Spanish-language Internet portal Quepasa.com (Nasdaq: PASA) moved up $5 1/8 to $17 1/8 following its IPO of 4 million shares at a price of $12 per share... Software.com (Nasdaq: SWCM), which develops e-mail and messaging products for Internet service providers, rose $3 1/16 to $18 1/16 in its first day of trading after selling 6 million shares at a price of $15 per share. The offering included 1 million shares sold by selling shareholders.

GOATS

Chip maker Advanced Micro Devices (NYSE: AMD) retreated $1 1/8 to $17 1/16 today in heavy trading. The company warned late yesterday that it will report a second-quarter operating loss of around $200 million, with revenues falling short of $600 million. That means a loss per share of $1.36, more than three times worse than analysts' mean estimate of a $0.40 per share loss. The company pointed to a "sharp decline" in average selling prices for its AMD-K6 family of processors and unit shipments that are "substantially below" expectations. CEO Jerry Sanders expects K6 prices will continue to fall. Pressure from aggressive pricing of Intel's (Nasdaq: INTC) Celeron chips and heavy discounting of Cyrix processors by National Semiconductor (NYSE: NSM) simply made matters worse. AMD hopes its new Athlon chip -- formerly called K7 --will be its white knight. Athlon is the company's fastest and most expensive chip yet: it will cost $699 for the 600 megahertz (MHz) version, $479 for the 550 MHz, and $324 for the 500 MHz. A 700 MHz model is due out in the fourth quarter.

Shares of cable modem supplier Com21 Inc. (Nasdaq: CMTO) unplugged $4 1/8 to $15 7/8 after its DOXport cable modem failed to earn certification from cable system operator organization CableLabs, generally considered the industry's seal of approval. CableLabs gave its thumbs-up to five other companies -- including Cisco (Nasdaq: CSCO) and Sony (NYSE: SNE) -- bringing the total number certified to 10. The testing process is intended to ensure that a product will be interoparable with equipment built by a range of CableLabs member organizations, so failing this not only means the loss of a nifty escutcheon but may also indicate that a product has a ways to go before becoming commercially viable. If that's not the case, however, there shouldn't be much of a delay for Com21, as the company plans to enter the next round of certification tests, results of which are expected to come out in August. In any case, the product is already shipping, and President and CEO Peter Fenner said any changes made will be available via software download, so investors may have overreacted today.

QUICK CUTS: Pharmaceutical contract research organization (CRO) Parexel International Corp. (Nasdaq: PRXL) coughed up $4 9/16 to $16 15/16 on rumors that its planned merger into Covance (NYSE: CVD) might be in trouble... Online investment research company Multex.com Inc. (Nasdaq: MLTX) fell $2 to $24 11/16 after agreeing to buy financial information provider Market Guide (Nasdaq: MARG) for approximately $149 million in stock based on yesterday's closing prices. Shares of Market Guide moved down $1 1/4 to $20 3/8... Financial services company FINOVA Group (NYSE: FNV) gave up $2 1/4 to $49 5/8 after closing four offices and firing 40 employees as part of a restructuring.

Publishing giant Gannett Co. (NYSE: GCI) announced it will acquire newspaper publisher Newsquest Plc of the U.K. for about 922 million pounds, or $1.5 billion in U.S. dollars, in cash plus assumption of debt. The company's stock retreated $2 3/4 to $70 11/16... Micron Technology (NYSE: MU), which reported a fiscal Q3 loss of $0.10 a share versus a loss of $0.51 last year, slipped $4 1/2 to $39 7/16. Analysts expected the company to break even this quarter... Digital smart card interfaces developer SCM Microsystems (Nasdaq: SCMM) slid $5 1/2 to $48 7/8 on last night's news that the company expects Q2 EPS of between $0.10 and $0.13 before charges, missing First Call's three-analyst $0.24 consensus projection.

Telecommunications services company CT Communications (Nasdaq: CTCI) retreated $5 5/8 to $38 1/8 after pricing a 1.1 million-share secondary offering at $38 per share, a 13% discount to last night's closing price... Vending machine currency acceptance technologies firm Global Payment Technologies (Nasdaq: GPTX) paid out $2 3/8 to $8 3/8 on news that the company expects full-year EPS to be about 15% better than last year's $0.52 mark but below company objectives... NTL Inc. (Nasdaq: NTLI), a U.S.-based company that provides telecom and cable service in the U.K., hung up $4 7/16 to $86 3/8 after last night saying it filed to sell 8 million shares of common stock and $400 million of NTL Communications Corp. convertible notes due 2009, which are convertible into NTL common stock.

Vacation planner and tour package marketer Global Vacation Group (NYSE: GVG) gave up $1 13/16 to $4 3/16 after the company said to expect Q2 EPS of between $0.02 and $0.04, well off First Call's $0.17 consensus estimate provided by a four-analyst panel... Telecommunications access products designer Premisys Communications (Nasdaq: PRMS) lost $1 13/32 to $6 31/32 after telling investors to expect fiscal Q4 losses of between $0.05 and $0.08 per share, missing First Call's estimated dime profit... Drug company MacroChem Corp. (Nasdaq: MCHM) fell $1 7/16 to $5 15/16 after the company said it is expanding its search for a licensing partner for its Topiglan erectile dysfunction gel. The company recently concluded an auction and believes it may be able to get more lucrative offers.

Online software retailer Beyond.com (Nasdaq: BYND) shed $5 1/16 to $27 13/16 after bagging $7 1/4 yesterday on rumors that e-tailing giant Amazon.com (Nasdaq: AMZN) was considering a bid for the company... High-speed data transmission chip developer Globespan Semiconductor (Nasdaq: GSPN) moved back $2 5/16 to $40 in the company's second day of trading. The stock raced up to $42 5/16 yesterday, a nifty 182%, after the company sold 3.25 million shares to the public at $15 each... Online business-to-business procurement management systems firm Ariba Inc. (Nasdaq: ARBA) cooled off $12 1/8 to $77 7/8 after snagging $67 yesterday as the company sold 5 million shares in an IPO at $23 apiece.

Advanced computer graphics company SGI (NYSE: SGI) pixellated $1 5/16 to $14 7/16 today. Lockheed Martin (NYSE: LMT) chose it to provide visual computing equipment for Air Force F-16 training simulators... Banking giant Bank One Corp. (NYSE: ONE) withdrew $3 to $54 11/16 today. The company lauNched WingspanBank.com, deemed "much more useful than any current financial site" by its press release writers... Low-temperature and cryogenic equipment maker Chart Industries (NYSE: CTI) melted $1 3/16 to $8 5/16 after McDonald Investments downgraded the stock to "hold" from "buy."

FOOL ON THE HILL
An Investment Opinion
by Warren Gump

What Do Valuations Mean?

As the U.S. bull market inches closer to the two decade mark, many people have de-emphasized valuation criteria from their investment strategies. The reason is quite simple: over the past few years, taking valuation consideration into account has often not only kept people out of the best-performing stocks, but also left them with companies that have achieved seemingly meager returns.

Someone using traditional valuation tools like the Price/Earnings (P/E) or Price/Earnings-to-Growth (PEG) ratios to evaluate stocks would have avoided market stalwarts stocks like Dell Computer (Nasdaq: DELL), Cisco Systems (Nasdaq: CSCO), America Online (NYSE: AOL) and Charles Schwab (NYSE: SCH). Over the past three years, these stocks have earned compound annual returns ranging from 69% (for Cisco) to 187% (for Dell). Instead of these hot shots, a value player might have purchased "old world" firms like Philip Morris (NYSE: MO) or Minnesota Mining & Manufacturing (NYSE: MMM). The compound annual return on these two stocks has been a relatively paltry 11% and 14%, respectively. We won't even talk about the poor saps who put their money in "small-cap" stocks, many of whom are sitting on losses.

Does the success of the high-growth stocks mean that investors should completely ignore value? A person considering valuation would probably have stayed away from Schwab this past January because it was trading at 66x earnings for the prior year. That "high valuation" (more than three times those of most other brokerage firms) hasn't stopped the company from rising another roughly 60% since its release of 1998 earnings. The stock is now going for 90x earnings over the past twelve months. Similar tales can be told of the other highflying stocks. While earnings for the companies listed above have been rising, their P/E multiple has been rising even faster.

What exactly does a rising P/E mean? Basically, it means that you are paying more for a specified level of earnings. When you invest $100 into a stock trading at a P/E of 20, you are in effect "buying" $5 of earnings. (You can calculate this for any stock by dividing the amount invested by the P/E ratio; in this instance, $100/20=$5.) Of course, you are not just getting those earnings for one year. You are getting the earnings the company will generate every year in the future.

If the company experiences 15% earnings growth, the $5 in the current year will grow to $10.06 in five years. On the other hand, if earnings grow at 30% per year, $5 in earnings will turn into $18.56 five years down the road. That difference shows the major power of growth: in this example, a 15 percentage point difference in earnings growth rates results in 85% higher earnings after just five years. Many people seem to be comfortably assuming that the power of compound earnings will bail them out of today's higher market multiples.

I used a P/E ratio of 20 in the example used above. Let's see what happens if we actually use figures from a company actually trading on the market. As mentioned above, Schwab is at 90x trailing earnings. That means an investor is getting $1.11 in earnings for every $100 invested. Assume that earnings grow 25% over the next 5 years (an ambitious assumption, considering that analysts actually project 22% long-term increases). At the end of that period, the $100 initial investment would represent earnings of $3.39, implying an "earnings yield" of 3.39%.

To put that in comparison, you could put money into a 30-year treasury bond and earn a virtually guaranteed 6.16% on your investment every year starting today. In year one, you would earn 6.16%, not the 1.39% provided by Schwab. Of course, that yield is fixed. Regardless of what happens in the macroeconomic environment, buyers of the bond today are stuck with that 6.16% return. On the other hand, Schwab (and other equity investments) have the potential for growth. For Schwab's earnings yield to surpass the bond's yield, it will have to post eight years of 25% earnings growth (from today's record levels). While that's not impossible, it's a tall order to deliver on. And don't forget that while it hasn't happened much recently, the possibility that business conditions deteriorate and earnings decline exists for any stock.

I like figuring out the projected earnings yields at various points in time to get a back-of-the envelope idea of what I'm earning from a company's underlying business operations. If you want to get much better valuation information, you should learn how to construct a discounted free cash flow (DCF) model. An unwieldy mouthful, to be sure, but one that is quite informative if you want to understand what a company might be worth using various sets of assumptions.

A DCF involves projecting how much cash an enterprise will generate every year after paying for all capital expenses. These annual "free cash flows" are then discounted back to the present at whatever rate you want to earn on your equity investments. If you expect to earn a 15% annual return, you should discount future projected cash flows at 15% per year. If you're satisfied with a 10% return, that should be your discount rate. These models can be fairly time intensive to create, but could be worth the effort if you are a die-hard investor who likes numbers.

I'm in the middle of reading Tom Wolfe's latest book, the slow-starting, but ultimately engaging A Man in Full. A major portion of the plot deals with an Atlanta real estate mogul, Charlie Croker, who is on the verge of bankruptcy because of the failure of Croker Concourse, a huge development built in the heyday of speculative office buildings. Prior to construction, Charlie's lender enjoyed the "coup" of getting the $175 million loan for the prominent project. After all, with booming real estate rates and sales prices, how could the deal fail? Such an important, seemingly "no-brainer," piece of business was expected to ensure that the bank would remain a great Atlanta institution.

After Charlie defaulted on the loan, the bank was in a much different position. At the point where I had to put the book down to get some sleep, Ray Peepgass, a bank officer, envisions the bank selling the property for $50 million, resulting in at least a $125 million loss on the building. Peepgass commented, "Banks get caught up in the boom mentality, too." If news of the how lax the bank's underwriting standards became during the good times, he feared "it would become perfectly obvious that we were fools."

Don't let yourself get so caught up in a stock market boom mentality that you overlook the underlying business fundamentals of the companies in which you invest. Otherwise, you might look like a fool rather than a Fool at a later date.

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