Levitt's Bold Statement[Fool on the Hill] February 18, 2000

An Investment Opinion

Levitt's Bold Statement

By Bill Mann (TMF Otter)
February 18, 2000

Last weekend I had the opportunity to attend the Los Angeles Times Investment Strategies conference as part of our Foolish delegation. At the conference we had the satisfaction of meeting many of our Southern California community members. The conference had presentations and booths by many of the usual suspects -- mutual fund companies, full-service brokers, online brokers, and a market timing company or two.

News Flash -- timing the market has never worked, and it never will. If Indigo, one such company offering an expensive software suite that generates buy and sell signals, had really developed a way to successfully time the market, do you honestly think they would sell it to you? Heck no, they'd just go off and make billions themselves doing it.

Arthur Levitt, the chairman of the Securities & Exchange Commission, was one of the keynote presenters for the conference. Once again, seeing him speak gave me some comfort that there is someone in Washington looking out for the individual investor.

Levitt pointed out several real threats to individual investors, many of which are things that we here at the Fool also rail against. First and foremost is that, particularly in ebullient markets, investors must manage risk by remaining disciplined and doing adequate research to determine a company's value before and after they choose to invest.

Amen, brother. We see over and over the stories on message boards and in the media about companies that have skyrocketed in price, making investors rich in the process. I don't doubt that these stories are true. But if these gains are not based on actual underlying value, it is an unfortunate fact that the very same companies are going to make a great deal of investors much poorer as well.

I also appreciated the comments on the risk investors are taking when they increase their exposure to margin, particularly when they do not consider the potential for downside. Look, I'm no Chicken Little screaming that the sky is falling, but eventually most of the highflyers of today's equity market are going to take a dive. Anyone who is holding these companies on margin will find out about that special kind of pain associated with paying interest on money they no longer have.

But most interesting were Levitt's warnings to investors about taking analyst research as face value:

"A lot of analysts work for firms that have business relationships with the same companies these analysts cover. And sometimes analysts' paychecks are typically tied to the performance of their employers. You can imagine how unpopular an analyst would be who downgrades his firm's best client. Is it any wonder that today, a 'sell' recommendation from an analyst is as common as a Barbara Streisand concert?

"The fact is, many of today's business practices often lurk in those gray areas well beyond the bright line of right and wrong."

Levitt is taking to task organizations with vast influence both in commerce and in politics. Several partners at Goldman Sachs (NYSE: GS), for example, were among the largest contributors to Bill Clinton's presidential campaigns. But rest assured that Levitt tempered his remarks somewhat to avoid rankling these interests too much. Fortunately, I used to work in a lobbying organization, and as such am pretty good at translating. What Levitt was actually saying was:


What was amazing was that in the same room, some of the biggest Wall Street firms were touting their years of service to their customers, including their superior research. Levitt's barbs didn't even make them blush. Unfortunately, until individual investors get the courage of their convictions and learn to question the validity of analysis -- both that which supports our positions and that which attacks it -- we will continue to cede incredible power to Wall Street analysts.

And Another Word About

I received a few notes the other day in response to my Fool on the Hill article demonstrating some ways for investors to analyze companies without profits. Several correspondents took me to task over my statements on (Nasdaq: BYND). I used as an example of a company that was failing miserably on one of the tests I use in evaluating companies that are not yet profitable. I have since been told that a) has changed its business plan to a "B2B" focus, and b) the numbers I used were not the most recent. (While the year-end results were available in a press release, I used the 3rd Quarter 1999 10-Q, released on January 14, 2000, the most recent available from the SEC.) My initial response is that I used as an example of fact, that by doing so I wasn't performing a comprehensive analysis. Rather, I was just looking at the numbers as they related to this specific issue.

That said -- I can in fact offer some analysis on the company and its business plan, since these correspondents demanded it. First, I reject any company that cannot resist the institutional imperative. The term "B2B" is the current buzzword to be adopted by a multitude of companies seeking to prop up their share prices. B2B means absolutely nothing, and is in no way a new concept. So is now focusing on business and government sales? I'd be much more inclined to take them seriously if they went to some lengths to differentiate themselves, rather than jumping on the B2B train. Dell (Nasdaq: DELL), for example, has mastered the direct business and government sales models for years, and hasn't required the hot, descriptive word du jour to achieve either business or market success.

Let's look at the three measures I described on Wednesday in regard to

1. Growth in Gross Sales Sufficient to Discount Current Operating Losses

For the fiscal year 1999,'s gross revenues increased 220% over the year previous, up to $117 million from $36 million. So, on a top-line basis, is growing at a suitably high level that an investor can hold some hope that it will eventually show bottom-line profitability. Again, although the reciprocal is not necessarily true, unprofitable companies that show slow top-line growth are unlikely to ever make the transition into profitability.

2. Gross Profits Compared to Sales and Marketing Expenditures's Q3 1999 numbers were analyzed here on Wednesday. For the year 1999, spent $81.3 million in sales and marketing and achieved gross profits of $16 million. This compares to $4.8 million gross profits and $20 million marketing expenditures in 1998. We're not measuring percentages here, we're looking at absolute numbers, and's marketing expenses have ballooned horrendously compared with the benefit derived. And, as is transitioning to a business focus, it is essentially writing off much of its consumer branding expenditures. Bad. Very bad.

3. Cost vs. Benefit for Each New Customer Acquired

This measures the amount of time it takes for a company to earn back its marketing expenses per customer. For, the company has spent $110 million in marketing in its existence, and has a total of 2 million customers, for a total of $55 spent per customer. Given the annualized amount of their Q4 1999 net revenues (or $35 million X 4), the company is earning $70 per customer per year. This means that needs 9.5 months to recoup each one of its invested marketing dollars, a fairly long lag period.

All in all, flunks two out of the three example measures that I would use to evaluate companies that have no operating profit. Throw in the fact that the lack of security surrounding the company's reorganization and shift in business focus, and I would have to see significant turnaround before considering it as an investment.

Fool on!

Bill Mann, TMF Otter on the boards

Related Links:

  • Full Text of Levitt Speech, 1/12/00
  • Q4 1999 Earnings Press Release