Fool Portfolio Report
Monday, July 22, 1996
Monday, July 22, 1996 (FOOL GLOBAL WIRE)
by Tom Gardner
Another rough day for Foolish investors looking to outperform the S&P 500. The Fool Portfolio fell another 6.47% versus the S&P's loss of 0.77%. The conversation over market direction continues. With inflation peeking in from the periphery, hints at a hike in short-term interest rates, and a mixed bag of 2nd quarter corporate earnings, investor confidence has no doubt been shaken.
After all, if there is too much money in the marketplace, how come it isn't translating into stellar numbers across the board? How is it that technology leader, Hewlett-Packard, would suffer a soft quarter in inflationary environs? The stock is 25% off its high for 1996. Apparently Street expectations, broadly defined, ran too high. The second tier has fallen short or barely met projections. The third tier is in disarray. And with Hewlett-Packard restructuring, the weakness has even crept up to the torchbearers.
Think about how different a market this is than when The Motley Fool bid adieu to traditional publishing and distribution, began a national conversation, tossed open the doors on the most comprehensive financial library ever fashioned, and started The Motley Fool Portfolio. Think back with us.
Do you remember late in 1994 when Cisco Systems missed estimates by a couple cents and the stock rose 10% in after-hours trading? From one underperforming quarter into a second mediocre quarter, Cisco's stock slammed forward 50%. So why is that over in the Boring portfolio, when Cisco recently beat quarterly projections, its stock fell 7.5% in after-hours trading?
Well, there are thresholds. In down markets, bad earnings resting atop financial stablility are rewarded. In up markets, strong earnings with any sign of slowdown or financial uncertainty are hammered. After 45% gains in the S&P 500 over an eighteen month period---or 28% annual growth---we have been in an up market phase. And when cash is pouring into the marketplace, moderate strength is weakness.
Talk to the shareholders of Hewlett-Packard, who are owners of a business with an extraordinary long-term record of superior performance. The Company has $3.5 billion in cash, over $5 billion in working capital, and has posted strong sales and margin growth over the past five years. A soft quarter, to be announced in early August, and the $150 million write-off of their profitless disk-drive business shouldn't be boxing HP to the tune of a 25% loss in the value of the business. But uncertainty and moderate strength in a drawn-out upswing is weakness.
In that context, consider Iomega's second-quarter earnings announcement. $284 million in sales, 5% profit margins, 11 cents in earnings, and a warning that with weakness in Europe and the ongoing effort to ramp-up for Jaz disk and drive production and delivery, the third quarter might be flattish. What this amounts to is the subject of a great debate here online and elsewhere.
I'll start by clarifying again that we consider business performance of greater consequence than stock performance when investing. That's contrary. And it certainly isn't the only way to make money in equities. But it's important that folks are aware of this position or principle because it reveals a lot about what to expect from our portfolio in performance and in structure.
Over the past few days, I've received a load of emails questioning our decision to hold onto Iomega stock, offering that had we gotten out at $50, we'd have X dollars in our account now, rather than X minus many dollars. I agree. This is true. If we had sold higher, we'd have more money. And given that we said on more than one occasion here in The Fool Portfolio and on CNBC that we thought the stock was fairly priced in the $45-$50 range, and given that reasonable multiples off sales and earnings growth pinpointed value there, we could have. No argument there. We would have more money now had we than hadn't we.
But we come at the market a little differently. And I want to say again that we don't propose this the only way to invest, the best way to invest, but it is the way that we do invest. And that is that we look at the company, its management, its lines of product or service, and its competitive positioning. Focusing on these, we're absolutely going to miss the best prices the market has to offer. Our fascination with businesses will occasionally draw our eyes away from price fluctuations. Calling the highs and lows will never be our game. It's so far removed from our core competency as investors and from what we believe will lead to enduring market outperformance that we don't nor will we ever stake claims to being price-target aficionados or experts.
In the case of Hewlett-Packard, some people believe that the stock will trade up into the mid-$50s come New Years, 1997. I see their reasoning. I casually agree with them. But the question we ask ourselves is. . . is that a business that we want to be involved with as owners in the decade ahead? We may sell out long before then. When Boston Technology's accounts receivables rose---and a higher-level business concern came to the fore---we sold out our position. But we asked ourselves, and will always: Is this a company whose mission we believe in, for whom we are willing to sit through pricing volatility on the high and low side barring higher-level business concerns?
Knowing that we selected Iomega thus, you can begin to understand why we didn't sell out at $50 a share. There were no business concerns. The Company had just inked an OEM deal with IBM. And the business looked fundamentally strong. The question now is: Is this business still sturdy? Is the product still in demand? Is the Company reasonably able to meet that demand? And are marketing plans in place to inspire demand for product upgrades?
If I were to just target price Iomega after this quarter, I would lower sales expectations for 1996 to $1.3 billion. With an attractive consumer-technology product heading into Christmas and margins rising, I continue to believe that 4x sales at year-end is appropriate. That's a $5.2 billion capitalization off $1.3 billion in sales. With projections for 140 million shares outstanding, Iomega looks fairly priced in the $35-$40 range after this quarter. That's a double from here.
But the broader, more meaningful question is: Is this a business that you feel comfortable owning today? And would it be one for whom you would be willing to sit through pricing volatility and occasionally kooky misinformation to own? For me, the answer is yes. I believe storage demands are going to increase substantially in the decade ahead, and I think Iomega is singularly in position to meet those demands. In my estimation, the second quarter was a healthy one with a higher-level business disappointment in Europe that they're aiming to solve.
As this stock bounds back up toward a reasonable valuation off sales, profits, brand-value and managerial strength---and I firmly believe it will---we will continue to ask ourselves if this is a business we want to be involved in. I think that's the same question most individual investors should be addressing themselves with when they look down over their investments in Microsoft, Intel, The Gap, Hewlett-Packard, Gillette, US Robotics, Johnson & Johnson, Merck, Ascend, America Online, and any of the other 8900 stocks on the US markets. Because in up-periods and down-periods, stocks are going to move contrarily---up on moderately bad earnings and down on moderately good ones. But for Fools, it's the companies that we own.
That's the way we go at it. We suggest you consider doing so yourself. But hey, it's only a suggestion.
Day Month Year History FOOL -6.47% -20.60% 27.62% 138.31% S&P 500 -0.77% -5.50% 2.90% 38.26% NASDAQ -1.49% -8.75% 2.77% 50.14% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 19.75 684.05% 8/5/94 680 AmOnline 7.27 29.38 303.90% 4/20/95 310 The Gap 16.28 30.00 84.33% 8/5/94 165 Sears 28.93 42.63 47.36% 1/29/96 250 Medicis Ph 27.86 40.63 45.82% 8/11/95 95 GenElec 57.91 80.88 39.65% 8/11/95 110 Chevron 49.00 57.63 17.60% 8/24/95 130 KLA Instrm 44.71 19.50 -56.39% Rec'd # Security Cost Value Change 5/17/95 2010 Iomega Cor 5063.13 39697.50 $34634.37 8/5/94 680 AmOnline 4945.56 19975.00 $15029.44 4/20/95 310 The Gap 5045.25 9300.00 $4254.75 1/29/96 250 Medicis Ph 6964.99 10156.25 $3191.26 8/5/94 165 Sears 4772.65 7033.13 $2260.48 8/11/95 95 GenElec 5501.87 7683.13 $2181.26 8/11/95 110 Chevron 5389.99 6338.75 $948.76 8/24/95 130 KLA Instrm 5812.49 2535.00 -$3277.49 CASH $16434.53 TOTAL $119153.28 Transmitted: 7/22/96