Fool Portfolio Report
Monday, February 10, 1997
by Randy Befumo (MF Templar)
ALEXANDRIA, VA., Feb. 10, 1997 -- THERE HAVE BEEN BETTER DAYS. Today was a very busy day for the Fool Portfolio. The 4.53% beating the portfolio took today is even more ugly given that Tom, David and the irascible Jeff Fischer (MF BudFox) have stolen away to a mountain retreat to begin work on the Fool's second book, code-named "Missoula" in the spirit of Microsoft's "Chicago" and America Online's "Casablanca." The unenviable task of dissecting today's performance, as well as bringing some greater clarity to the fall of the Fool Portfolio over the past two trading days, falls squarely upon my shoulders.
For those of you who are completely unfamiliar with me, let me do a quick introduction and then outline where I want to go with today's portfolio report. As employee number two of the Motley Fool, I have been here for quite some time. Initially hired to pen the Daily News (since split into the Evening and Lunchtime News) and help with research for the Fool Portfolio, I currently focus on the emerging News and Research content. I currently write two columns a day, which appear in the Evening and the Lunchtime News, as well as a weekly piece that appears on EE Times Web site. Today I want to discuss the purpose of the Fool Portfolio, the fall of 3Com and current valuation, the fall of ATC Communications and current valuation and finally touch on America Online's recent earnings report and subsequent drop.
THERE IS A REASON WE SAY WE DO NOT MANAGE YOUR MONEY. The Fool has enjoyed quite a bit of success over the past two and a half years. The real-money portfolio begun on August 4th, 1994 has more than doubled the S&P 500 and has come close to doubling the Nasdaq Composite in its relatively intermediate lifespan. The faces of Tom and David Gardner have regularly graced magazines and televisions across the country, both as digital glitterati of the investment world and co-writers of Business Week's number three best-seller in 1996, the Motley Fool Investment Guide. Despite the wildly unsuccessful project we aired in 1995 called Running With the Market, a real-money portfolio that finished down more than 60% after less than six months, the company's reputation as a hip company run by savvy investors has not changed.
Let's face it -- if we had wanted to start the Fool fund, we would have had to hire a staff of thirty to deal with the incoming calls from investors who wanted to put their money with the Fools. There is a reason that we have not done this, and it ain't because we don't have the dough to hire thirty people. To paraphrase both Tom and David Gardner at various points over the past two and a half years, "We are not this good." The statistical likelihood is that despite the fact that we are pure of heart and downright Foolish, we will underperform the market for a substantial period of time. Like a few years, maybe. The simple fact is that our goal is to outperform the market over 20 year periods -- not two years, not two days, and certainly not ten minutes.
So why do we have this stupid portfolio if we do not think highly enough of our stock-picking ability to make a ton of cash investing other people's money? For its educational value. There is more to learn from this little portfolio and how it is managed, co-managed, passively-managed and occasionally pretty mis-managed than all the mutual funds in the world have to teach you. Every market day, rain or shine, someone shows up to explain our performance. Some days, this person is very happy and whoops up a short-term performance that in the end is an insignificant statistical speck. Some days, this person talks about the long-term because the short-term performance was, in a word, abysmal. However, you get to see the daily ups and downs and second-guess every decision before the trade is complete. In hindsight, you can see where the right call was made and where someone was obviously IUI -- investing under the influence.
If you have been blindly following every Fool trade, stop. No good can come of this. Even if the investments are successful, you will be left forever in the dark, never really understanding the mechanics of each decision and never knowing when you are parachuting down with us into Dien Bien Phu to get slaughtered by the Viet Minh. Certainly, if a Fool idea sparks the fire of investing inspiration, go nuts. But if you are recently arriving and have decided that you do not have to learn to think for yourself and need only blindly do whatever the Fool does, you are going to probably lose a lot of money. We are not that good. In fact, sometimes we can be quite dumb. We will probably underperform the market for a substantial period of time.
The Fool Portfolio is run by two very busy brothers and an incredibly diligent helper, Jeff Fischer, with some input from a few people around the office. Given that the Motley Fool is a business growing at double digits on a monthly basis and that Tom and Dave have a growing responsibility to deal with the press and the public to benefit the entire company, I would estimate that about ten to fifteen hours each week, between everyone, is spent doing research for the Fool Portfolio. This is essentially the same amount of time almost anyone could spend if they dedicated one weeknight and one weekend afternoon to the pursuit of investing. You are not getting some kind of incredible, intensive, institutional quality research for free. You are getting a Foolish educational product that is designed to help you help yourself become a better investor. Our goal is to teach people how to catch fish, not to run a tuna trawler.
3COM BLUFF. Foolish paratroopers charged a well-defended hill today called 3Com Bluff and were completely routed. 3Com plunged to a bid of $37 1/4, down $13 3/8 on the day. In a mere eight hours, our previously profitable 3Com investment became decidedly unprofitable, down 20.51% for us since we bought 250 shares on August 13th. Worse yet, 3Com has fallen from a high of $77 on January 21st to its current perch, down more than 50% in less than fifteen trading sessions. Where once we looked omniscient, we are merely Foolish again. We have lost more than $2400 on 3Com, a little less than 10% of our current profit on Iomega.
My daily column in the Evening News called "Fool on the Hill" detailed the specific reasons for 3Com's descent. The short version follows. On January 23rd, CASCADE COMMUNICATIONS (Nasdaq: CSCC) released an unfavorable earnings report. On January 28th, 3Com's Chief Executive said sales for December were a little slow. Last week, INTEL CORP. (Nasdaq: INTC) cut prices on Fast Ethernet network interface cards (NICs). Today, 3Com announced similar price cuts on its Fast Ethernet NICs as well as low-end hubs and routers, causing everyone who owned the stock to try to sell it in one gigantic trading session.
The news is pretty grim, short-term, for 3Com. The only historic parallels I could find this morning, captured in the Lunchtime News, were 3Com's August 1990 and May 1993 one-day drops of similar magnitude. In 1990, the company said some stuff in a conference call about how the recession was killing them. In 1993, the company pre-announced a bad quarter due to a product transition. Both times, if you had bought 3Com at the low, you would have looked like a genius. Will history repeat? Everyone is currently hand-wringing about a fundamental change in the network-adapter card market. 3Com will enjoy lower prices and higher costs as it slashes the sticker price on its NICs to keep up with Intel, offering more software as a way to add value to the product.
The numbers are in a word, uninspiring. The company will only make between $0.45 EPS and $0.53 EPS in the next quarter, well below the $0.60ish EPS that analysts were looking for and well below last quarter's $0.62 EPS. The next quarter does not look that much better, meaning estimates of $2.40 EPS for the year will probably come down to around $2.00 EPS, only up 25.7% from last year. The good news is that 3Com will still probably grow earnings this year, although these preliminary estimates the company is giving out could be high. You see, right now its 10/100 megabit cards are selling at the same price as its 10 megabit cards, a situation that probably will not remain static.
3Com currently trades with a price/sales ratio of 2.34 and an enterprise value-to-sales ratio of 2.26. Although I have not done any historical comparisons, I would bet dollars-to-doughnuts that this is about as cheap as 3Com has been since 1993. By way of comparison, sticking strictly to price/sales ratios, CISCO SYSTEMS (Nasdaq: CSCO) has a 7.41, CABLETRON (NYSE: CS) has a 3.44, ASCEND COMMUNICATIONS (Nasdaq: ASND) has a 13.44 and FORE SYSTEMS (Nasdaq: FORE) has a 6.69. The only networking company with more than $500 million in trailing sales that is cheaper is BAY NETWORKS (NYSE: BAY), and that is basically because the Wellfleet-SynOptics merger has been a disaster from day one. Folks, don't go out lemming-like to your broker and buy, but the stock is looking cheap.
ATC COMMUNICATIONS CONTINUES TO FALL. For long-time Fool Portfolio followers, there are four really dumb investments the Fool has beaten itself up over: buying SONIC SOLUTIONS (Nasdaq: SNIC), shorting PAYCHEX (Nasdaq: PAYX), buying APPLIED MATERIALS (Nasdaq: AMAT) at the top of the semiconductor rage and buying KLA INSTRUMENTS (Nasdaq: KLAC) at the same time. Sonic was just a matter of watching the company fall apart and not doing a thing. Paychex was an issue of never realizing that some companies may not deserve to trade at a 1.0 PEG. Applied and KLA were the product of very early excitement about Investing For Growth, the screen these two were cherry-picked from. In our time we have learned (1) small caps can fall apart so be careful, (2) some companies deserve to trade at premiums and (3) never trust a screen alone.
These dumb investments have been joined by a mysterious fourth horseman, known as Peer Valuation. For those who read David and Jeff's excellent write-up, one thing may have struck you as odd. Consistently, throughout the peice, David stressed that ATC Communications was cheap relative to APAC TELESERVICES (Nasdaq: APAC). Even after its first quarter report while in the Fool Portfolio, when the company showed no sequential growth and missed estimates by a penny, David still kept comparing that valuation to APAC Teleservices. I think at this point with the stock down around $6 and change, it is clear we ain't got another APAC Teleservices on our hands. In fact, ATC is the single-largest nominal loss in Fool Portfolio history. Lesson: relative valuation and speculation about another earnings surprise are not sufficient reasons to buy a company in a hot sector.
For those who actually own the stock with the Fool Portfolio, folks, it cannot get much worse. Okay, it can get a little worse. The company currently trades with a price/sales ratio of around 1.0. Earnings over the next two quarters will be flat versus last year. Everyone who owned the stock as a momentum play has completely abandoned it. The commodity-nature of teleservices is becoming more widely known, as names like WEST TELESERVICES (Nasdaq: WTSC) begin to nosedive as well. The industry will continue to grow -- the question is whether ATC's management can capture any of this growth. Certainly the fact that ATC switched horses this quarter affected their business. However, many suspect there is a lot more going on with ol' ATC and the price shows it. Will it get much cheaper? With expectations of a flat quarter built in, the only thing that will move this guy lower is the announcement it has lost a customer. Perhaps the silence of ATC's management on the PR front is actually a blessing in disguise. If you still own the shares, there really is no reason to sell them at this price given the company is worth around $8 or $9 a share given the current numbers. Check out the synopsis of the call in Earnings Central, courtesy of Debbie Tidwell (MF Debit).
A SHORT NOTE ON AMERICA ONLINE. Much has been made of the lack of coverage of America Online's recent earnings announcement. Let me be the first to say as the long-time America Online bull that you are all paranoid. The truth behind the lack of a Feature on the earnings is that Keith Pelczarski (MF Czar) and I are majorly overwhelmed. The Fool is quickly hiring people to help get our Feature machine rolling again, but in the last few weeks we have dropped a lot of balls -- America Online is certainly not the least of them. However, ace-call coverer Debbie Tidwell has had a synopsis of the call up since Saturday. As for having no replay number, folks -- AOL won't let us print one for wide distribution. You have to call and ask. Their policy is to put transcripts up in Full Disclosure, where one currently resides on the Corporate Transcripts page. The reason for this is because 800-number replays are very expensive. As for a more in-depth review of the call and some due diligence on why my favorite analyst, Morgan Stanley's Mary Meeker, went to outperform afterwards, I will have to defer until another day.
NEW FOOLISH FEATURE: The Fool introduces a new feature today -- the Daily Double. It provides a description and valuation of a company whose stock has more than doubled over the last six months. Each day, the Fool will review the business, talk about the cause of its doubling in value, and broadly consider valuation.
Our aim is two-pronged. We hope that by concentrating attention on spectacular recent performance, together we'll come to a more thoroughgoing understanding of how and why certain businesses rapidly double in value. But just finding and focusing on the doubles isn't fulfilling. Additional to that task, we'll venture out in search of a fair value for the business.
(c) Copyright 1997, 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.
Stock Change Bid -------------------- AOL -1 1/4 34.63 T + 3/4 39.00 ATCT - 7/8 6.50 CHV - 1/2 65.25 GM - 1/4 56.50 IOM - 3/8 16.50 KLAC -1 1/4 39.38 LU +1 55.88 MMM - 7/8 83.50 NCR + 3/8 36.25 COMS -13 3/8 37.25
Day Month Year History FOOL: -4.53% -11.39% -9.66% 141.10% S&P: -0.52% -0.09% 6.03% 71.34% NASDAQ: -1.65% -3.23% 3.43% 85.42% Rec'd # Security In At Now Change 5/17/95 2010 Iomega Cor 2.52 16.50 555.03% 8/5/94 680 AmOnline 7.27 34.63 376.08% 8/11/95 125 Chevron 50.28 65.25 29.76% 8/12/96 110 Minn M&M 65.68 83.50 27.14% 10/1/96 42 LucentTech 47.62 55.88 17.34% 8/12/96 280 Gen'l Moto 51.97 56.50 8.71% 1/2/97 8 NCR 33.63 36.25 7.81% 8/12/96 130 AT&T 39.58 39.00 -1.46% 8/24/95 130 KLA Instrm 44.71 39.38 -11.94% 8/13/96 250 3Com Corp. 46.86 37.25 -20.51% 10/22/96 600 ATC Comm. 22.94 6.50 -71.66% Rec'd # Security In At Value Change 5/17/95 2010 Iomega Cor 5063.13 33165.00 $28101.87 8/5/94 680 AmOnline 4945.56 23545.00 $18599.44 8/12/96 110 Minn M&M 7224.44 9185.00 $1960.56 8/11/95 125 Chevron 6285.61 8156.25 $1870.64 8/12/96 280 Gen'l Moto 14552.49 15820.00 $1267.51 10/1/96 42 LucentTech 1999.88 2346.75 $346.87 1/2/97 8 NCR 269.00 290.00 $21.00 8/12/96 130 AT&T 5145.11 5070.00 -$75.11 8/24/95 130 KLA Instrm 5812.49 5118.75 -$693.74 8/13/96 250 3Com Corp. 11714.99 9312.50 -$2402.49 10/22/96 600 ATC Comm. 13761.50 3900.00 -$9861.50 CASH $4639.01 TOTAL $120548.26