Fool Portfolio Report
Thursday, June 27, 1996
Thursday, June 27, 1996 (FOOL GLOBAL WIRE)
by Tom Gardner
ALEXANDRIA, VA, June 27, 1996 --Ricochet. The Motley Fool bounced back today. And I'll report on the portfolio's 11% growth today, after working through some of our small-cap valuations.
We'll continue to work down the capitalization chain---from America Online to Iomega to KLA Instruments to Medicis.
America Online (NASDAQ:AMER), with 111 million shares outstanding and the stock at $44, is capitalized at $4.9 billion. The company has trailing twelve-month sales of $895 million. So presently, AMER is trading at 5.5x sales. Wall Street is tagging America Online at a per-subscriber value of $817, assuming that you tie all revenues to their subscriber base, which I think is fair.
AOL's third quarter numbers surpassed Street expectations, with sales at $285 million, earnings of $15 million, profit margins of 5.3%, and earnings per share figures of $0.14. On the down side, the Company's deferred subscriber acquisition costs ranged up to $277 million, cash on hand continued its pace a half-step behind accounts payable, and in their third-quarter conference call, management announced plans to scale back investments in the acquisition of new subscribers.
I'll talk more about the business next week. How about the numbers? Well, as you might expect, it's exceedingly difficult to separate away the business story from the numbers. On the one hand, at 5.5x sales, with 5% profit margins, America Online is overpriced relative to other technology concerns. On t'other, AOL is growing sales at a furious pace. With subscriber acquisition on hold, the Company can focus on profitability, where it lies and why. And with 6 million subscribers valued at far less than those of your average cable company, perhaps these shares are cheap.
Morgan Stanley analyst Mary Meeker upped AOL to a Strong Buy this week, targeting a fair price between $55 and $60. That seems entirely reasonable. AOL continues to be the runaway leader in online communications. The next six months will tell us how improved AOL's service is, how broad their profit margins can run, and how involved in the development of the World Wide Web they will be.
Iomega Corporation (NASDAQ:IOMG) rallied on a "Buy" report from JP Morgan this morning. The stock closed up $6 1/2, or 31%. The Wise would have investors believe that while there is nothing inappropriate about this sort of pricing reaction driven, as it was, by "offline" information, the same is not true for "online" information, which our Sage sherpa have labeled "chatter."
Iomega has been a fascinating investment. I still believe that the greatest value accrued to The Fool has been an educational, not monetary, one. We have seen options players shriek strange tales from one equity-expiration stop to the next. We've followed the financial media's bumbling trek through imprecision toward some hazy familiarity with the products being delivered out of Roy, Utah. We've learned much from technology publications and conferences. And we've heard harrowing stories from shorters who knew not what they borrowed and sold as well as from buyers whose hearts overrode their minds, whose narrow allocation nearly sunk them.
I'm biased. Profoundly so. But I can't see a less stressful, more consistently profitable and educational way to have invested in Iomega than to have simply purchased shares, followed the business announcements, studied the quarterly earnings announcements, and listened to the brightest minds in the Iomega folder here. MF Ben just noted there that consumer demand and the company's ability to meet that demand, profitably, IS the story. Welcome all the discussion but remember that the game is plays out numerically. Iomega earnings are due around July 15th. We'll be looking in.
As for a valuation, after today's move, Iomega is capitalized at $3.5 billion, or 2.2x projected year-end sales ($1.6 billion). JP Morgan stamped IOMG with estimates of $0.52 for fiscal 1996. Priced at $27 3/8, that gives us a year-end P/E multiple of 52x earnings off JP Morgan's projections.
Why work off year-end numbers. . . why not stick to the here-and-now? Well, Iomega is growing their business with such rapidity that holding it still to value it does not work. It hasn't worked for the past fourteen months, during which we've seen price appreciation of 1000%. Holding it still, pressing a P/E multiple on it, ignoring past, present and projected growth rates, and naming it badly overvalued seems to me to be oversimple---particularly since that valuation approach has oft partnered up with an illiteracy regarding storage techology products and demand.
We still stand by our valuation of Iomega, reported in this column over the past month. We proposed that 4x year-end sales was more apropos for a company manufacturing and marketing consumer-brand technology into substantial demand---as well as racing headlong into greater profitability as disk sales grabbed the baton from disk-drive sales.
Too many on Wall Street have been obsessed with the multiples assigned to supposedly comparable businesses. I don't see a reasonable comparison between Iomega and Quantum---whose multiple off sales is miniscule---or Conner---whose multiple off sales is miniscule. But they're all disk-drive manufacturers. . . why not compare them?
The key difference is that Iomega has designed a product that people are driving out to computer stores to purchase. They stand on line; they sit on waiting lists; and they appear to love the product. The technology media has championed Iomega products since they first hit shelves and were stripped off shelves. And the Company has created what I believe is one of the most advanced and spirited marketing campaigns in all of technology today. In those words of Intel's Andrew Grove, they have "created a lust for their product." This is not true of other drive makers. . . but it is true of companies like US Robotics, Microsoft, Intel, America Online---all of which trade at greater than 5x sales.
At 4x projected sales of $1.6 billion, Iomega would be capitalized at $6.4 billion. Off a loose projection of 135 million shares outstanding (up from 128 million today), IOMG stock is targeted at $47 a share. As OEM sales flow in through fiscal 1997, and if Iomega can meet demand and augment it via marketing an experience with their product, I suggest that at $47 a share, Iomega would still be cheap. But those additional factors sit a bit out on the periphery in my mind. Thus our here-and-now price target of $47.
Now compare what you've just heard to the story of KLA Instruments (NASDAQ:KLAC), which rose $3/4 to $21 3/4 today. KLA is in the business of manufacturing semiconductor equipment used to sharpen the processes of chip-production. They're walled off from the consumer and, by extension, most of Wall Street. If you understand the workings of the semiconductor industry, raise your hand now. I suspect there are very few that do, and I would not number myself among them.
On the business side, however, the industry continues to experience extraordinary growth, even in a soft year. MF Raleigh's interview with the chief economist at Texas Instruments---published this weekend and accessible via our Stock Research Database---perpetuated the notion that chips are flying out of manufacturing plants into PCs, calculators, microwave ovens, television sets, cellular phones, automobiles, and. . . children's sneakers? The overall industry is projected to grow at a phenomenal rate into the next millenium. And equipment makers will certainly benefit from this growth.
What's the PEG on KLA. . .and is it PEGgable? With $2.17 in trailing earnings, and $2.82 projected for fiscal 1997---1.25 years away---we have a rate of growth approaching 24% and a fair price of $50 1/2. With the stock at $21 3/4, your PEG is 0.43. And that sits in Fool buy range. Now many don't believe that semis can or should be PEGged off earnings growth---since that growth is so tightly bound to PC demand today. How pure is growth that is so reliant?
For this reason, it's tough to nail down a fair price for KLA Instruments. But if you look at the financial state of its business, KLA looks vibrant. KLAC has profit margins of 18%, $85 million in cash on hand, working capital of $90 million, and not a lick of long-term debt. We've lost 51% of our monies invested in KLAC. . . but we've been involved with a business that financially looks sturdy through a soft period for the industry. We're holding.
We've run valuations for Medicis Pharmaceuticals (NASDAQ:MDRX), and re-ran them in the wake of the Robertson Stephens report that drove the stock up $13 to $45 two weeks ago. Our fiscal estimates for 1997 are $1.67. Trailing twelve-month earnings are $1.01. The annual growth rate is 49.5%. As outlined in The Motley Fool Investment Guide, we believe in small-cap, pure-and-rapid growth situations, the P/E multiple ought equal the company's earnings-per-share growth rate. Thus, our Foolishly fair price for Medicis in the here-and-now is:
49.5 x $1.01 = $49.95
Robertson Stephens pharmaceuticals analyst, Dr. Donald Ellis, has issued a 12-month price target of $50-$54 a share. The stock closed today up $1/4 to $39 1/2.
As you well know, today was bounceback day for lowly Foolish investors aspiring to beat the market. Our two-ton tidal wave of America Online (up $2), and Iomega (up $6 1/2), floated higher all Foolish boats. And yesterday's 8.5% decline was greeted with a 10.95% rebound today.
To close, I'd like to just briefly respond to a post in our Iomega folder that was critical of The Fool Portfolio this past week. One of our participants felt that I was avoiding a bad day for our smaller-cap stocks this past Tuesday by reporting only on our large-caps. I can understand where this is coming from, but let me assure this Fool that I had no designs on misleading investors into believing that we only have good days and good investments in Fooldom.
Nay. The Fool has invested in dogs. Sonic Solutions. Short of Paychex. Applied Materials. KLA Instruments. Each of these has lost us 50%. My goodness. They're in plain view. Dawgs. Arf. Bow-wooow. Close your eyes. Picture your average Rottweiler, unfed for seventeen days. Then associate that with the ticker symbols: SNIC, KLAC, and AMAT. Grr-rrr.
And you know what, that's just the beginning. Over the next two decades online, I suspect we'll have plenty more. Perhaps at the same rate of four for every 24-month period. Odd as it may seem, we wouldn't have it any other way. Not every stock is going to go our way. But the lesson here is that if Fools discipline themselves to find very purely profitable companies in growing industries and add those to the sturdy foundation of large-capitalization turnaround plays. . . they can expect to beat the market over time.
This is why I reported on the large-caps first. Because I think the investor that goes for growth, first and/or exclusively, is doing far more speculating than investing. GE, Sears, Chevron and The Gap are there for a reason. The offline media might not have their eyes focused on them, but motley eyes do.
Tom Gardner, Fool
(c) Copyright 1996, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.
Day Month Year History
FOOL +10.95% -22.15% 57.19% 193.51%
S&P 500 +0.62% -0.09% 8.54% 45.84%
NASDAQ +1.11% -6.23% 10.82% 61.90%
*Scroll down or expand screen for full portfolio accounting
AMER +2...CHV - 5/8 ...GE + 1/2 ...GPS - 3/8 ...IOMG +6 1/2 ... KLAC + 3/4 ...MDRX + 1/4 ...S + 1/4 ...
Rec'd # Security In At Now Change
5/17/95 2010 Iomega Cor 2.52 27.38 986.75%
8/5/94 680 AmOnline 7.27 44.00 504.99%
4/20/95 310 The Gap 16.28 31.50 93.55%
8/5/94 165 Sears 28.93 48.88 68.97%
8/11/95 95 GenElec 57.91 87.50 51.08%
1/29/96 250 Medicis Ph 27.86 39.50 41.78%
8/11/95 110 Chevron 49.00 59.38 21.17%
8/24/95 130 KLA Instrm 44.71 21.75 -51.35%
Rec'd # Security Cost Value Change
5/17/95 2010 Iomega Cor 5063.13 55023.75 $49960.62
8/5/94 680 AmOnline 4945.56 29920.00 $24974.44
4/20/95 310 The Gap 5045.25 9765.00 $4719.75
8/5/94 165 Sears 4772.65 8064.38 $3291.73
1/29/96 250 Medicis Ph 6964.99 9875.00 $2910.01
8/11/95 95 GenElec 5501.87 8312.50 $2810.63
8/11/95 110 Chevron 5389.99 6531.25 $1141.26
8/24/95 130 KLA Instrm 5812.49 2827.50 -$2984.99