Fool Portfolio Report
Wednesday, January 22, 1997
by David Gardner
ALEXANDRIA, VA., January 22, 1997 -- The Fool Portfolio registered a mildly positive day, though our 0.42% Wednesday return couldn't keep pace with the market. The Nasdaq led the way up 0.80%, while the Standard & Poor's 500 index showed a 0.44% gain. Fortunately, however, our Wednesday gain (led by Iomega's $1/2 gain and a new high for Lucent) was enough to keep Foolishness reigning supreme in 1997, up in excess of 8% so far this January.
One stock that has not contributed to Foolish prosperity is beleaguered ATC Communications, the focus of today's report. Today marks the 3-month anniversary since our October purchase, and the company stock is down 45.5% over that period. Let's talk about it.
ATC Communications is a successful company in a dynamically growing industry, one of the primary reasons we own the stock. At the time of purchase, ATC was trading at 92 times trailing earnings. That may sound high (and as it turned out it was!), but several of its industry peers (including APAC Teleservices, Sykes Enterprises, and Sitel Communications) were trading at higher valuations. The main question was how had it gotten there, to a stock price 92 times its existing earnings per share? The answer was that it had demonstrated very strong three-digit growth, growth that was expected to continue.
You take a risk whenever you buy a stock. You take more risk when you pay more than, say, 30 times earnings for a stock. You take more risk than that when you purchase a richly-valued highflier that's up more than 10 times over the previous year, has high expectations, and high-growth numbers to boot. Those are risks that we are willing to take with a portion of our Foolish Portfolio, however. They can work to your benefit (as they did for our Foolish purchases of Medicis, Iomega, America Online) as much as to your demise (ATC, KLA Instruments, and Sonic Solutions).
The short story, well told by now, is that ATC didn't live up to expectations. Posting its first quarter earnings for fiscal 1997 (ended 9/96) on Halloween day, ATC failed to beat analysts' estimates, failed to perform to our more aggressive expectations, and dropped five bucks. As the momentum money pulled out of this small cap, ATCT stock dropped from the low $20's to the low teens in a matter of a few trading sessions. The stock has simply not rebounded in any meaningful way since.
That's the past, which can't be changed. Looking to the present and the future, we continue to own this stock for much the same reason we continue to hold a stock like KLA Instruments. Unless we see a fundamental change in the company's business, its industry prospects, or its competitive position within its industry, we'll hold past short-term market whims. We are investors, not speculators. We don't allow ourselves to be scared by -- or get too euphoric about -- market sentiment. We prefer to keep our eyes on the business overall.
On February 4 (according to Zack's), ATC Communications is due to report its December quarter (2Q '97) earnings. Two analysts following the company both show expectations of 10 cents for earnings per share (EPS). The significant weakness in the stock during a strong quarter for equities suggests a collective pessimism regarding the company's second quarter. Certainly, very little news issued from Dallas (ATC's HQ), except for one contract announcement with AOL, Bell South, and Visa. But the company allowed that the contract itself was not for a large sum of money; it mainly represented some potential new opportunities to develop the business further. So it's my own fear and supposition that the company may not even match estimates. That said, I think the stock's decline has already fully factored in that possibility, unless we see a total disaster. I do not expect any such thing at all.
We'll continue to hold the stock. Why? Again, no material change yet visible in the company, in its industry, or in its competitive position within the industry. It's been a very quiet quarter, which makes sitting on a 46% loss especially difficult. It's hard to know where to go from here! But ATC is still successful, growing, and cash-flow positive. And we still expect American business to continue to outsource in general, and to this industry in particular.
I well remember the posts to our KLA Instruments message folder when that stock hit bottom at $17. Depression, lack of interest, "get out of this dog now." Our ATCT folder, as our AOL users know, looks increasingly similar. (The best posts I see in there these days are from a fellow named Artbros, who's exceptionally Foolish.) As one fellow, FRESSERS, wrote, "From my 30+ years on the Street, the gloomier it gets the closer you are to a bottom."
If our company can continue to operate a profitable business growing at a healthy clip, we may one day cross back over our cost basis and move into the black... what we're so near doing in KLAC, which was down worse than ATCT has ever been. It's a thought.
Our own Jeff Fischer (MF BudFox) did a fine valuation piece on ATCT on December 20th. Given the dearth of news, little has since changed. Jeff's work with the Fool Ratio is still applicable, and still suggests that the company is no longer overvalued, but also not significantly undervalued at present prices... unless we see a strong sudden gain in earnings and cash flow. We shall see how that plays out. The present Fool Ratio is 0.86, so we wouldn't be adding new money (we never throw money at our losers), while at the same time we ain't going to sell. And new investors looking at this stock might find some good bottom-fishing here.
That valuation? It's reached by comparing ATCT's current price-to-earnings ratio ($12 1/2 share price divided by 30 cents EPS), which is 41.6, by the forward growth rate. You get the growth rate by annualizing EPS growth from today's 30 cents to the 60 cents expected seven quarters hence. The growth rate comes to 48.6%. The Fool Ratio, 41.6 divided by 48.6, is 0.86... pretty fairly valued at present. While this has been one of our poorer investments to date, it doesn't look much threatened at these prices at just two times sales ($210 million market cap and $100 million sales); industry peers go as high as 10 times sales. We watch and learn with interest.
ATC's largest customer is AT&T, another Fool Portfolio holding. Ma Bell reported fourth-quarter earnings today, and its quarterly profits from continuing operations rose 12% to 76 cents per share. For 1996 as a whole, earnings per share were $3.47, a 6% increase over 1995.
I'm not sure these numbers are terribly meaningful. The market tends to look ahead, not behind, and it's really hard to figure out where AT&T is going. Obviously, long distance will remain the core business, and the company will aim to get into local markets. It'll also be more focused, following a furious restructuring in '96 that saw Fools like us get shares of Lucent and NCR -- both in the black for the Fool Port... whaddaya know?
Come heck or high water, the Fool Portfolio will hold these shares until the appointed day that we reevaluate, August 13, 1997. That's the beauty of our Foolish Four approach: you don't have to sweat the decisionmaking. And the thing continues to work like a charm, even though it's flat this year versus a Dow up 6%. (That's even after IBM dropped $10 today!)
One of the things I find pleasing about the Foolish approach is that it mixes mind (picking growth stocks, whether Iomega or ATC Comm) with mindlessness (the Dow Dividend Approach). In the end, we'll hope to continue beating the market both ways. But it's important to stay diversified between the two -- and just in general -- because over any short period, or with any single stock, some parts of your portfolio can and almost always WILL go against you.
Please remember, since so many unFoolish people have such a difficult time doing so:
It's the final score, not the score by period or by stock, that matters.
-- David Gardner, January 22, 1997
Stock Change Bid -------------------- AOL + 1/8 39.88 T - 1/2 38.88 ATCT + 1/8 12.50 CHV - 1/2 67.13 GM - 1/8 61.88 IOM + 1/2 19.13 KLAC - 5/8 42.38 LU +1 3/8 55.00 MMM -1 84.00 NCR +1 1/8 39.88 COMS -1 1/8 73.63
Day Month Year History FOOL +0.42% 8.07% 8.07% 188.42% S&P: +0.44% 6.14% 6.14% 71.52% NASDAQ: +0.80% 7.52% 7.52% 92.74% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 19.13 659.24% 8/5/94 680 AmOnline 7.27 39.88 448.27% 8/13/96 250 3Com Corp. 46.86 73.63 57.12% 8/11/95 125 Chevron 50.28 67.13 33.49% 8/12/96 110 Minn M&M 65.68 84.00 27.90% 8/12/96 280 Gen'l Moto 51.97 61.88 19.05% 1/2/97 8 NCR 33.63 39.88 18.59% 10/1/96 42 LucentTech 47.62 55.00 15.51% 8/12/96 130 AT&T 39.58 38.88 -1.78% 8/24/95 130 KLA Instrm 44.71 42.38 -5.23% 10/22/96 600 ATC Comm. 22.94 12.50 -45.50% Rec'd # Security In At Value Change 5/17/95 2010 Iomega Cor 5063.13 38441.25 $33378.12 8/5/94 680 AmOnline 4945.56 27115.00 $22169.44 8/13/96 250 3Com Corp. 11714.99 18406.25 $6691.26 8/12/96 280 Gen'l Moto 14552.49 17325.00 $2772.51 8/11/95 125 Chevron 6285.61 8390.63 $2105.02 8/12/96 110 Minn M&M 7224.44 9240.00 $2015.56 10/1/96 42 LucentTech 1999.88 2310.00 $310.12 1/2/97 8 NCR 269.00 319.00 $50.00 8/12/96 130 AT&T 5145.11 5053.75 -$91.36 8/24/95 130 KLA Instrm 5812.49 5508.75 -$303.74 10/22/96 600 ATC Comm. 13761.50 7500.00 -$6261.50 CASH $4600.04 TOTAL $144209.67
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