Fool Portfolio Report
Friday, November 28, 1997
by Jeff Fischer (

ALEXANDRIA, VA (Nov. 28, 1997) -- It's the busiest shopping day of the year, but certainly not on Wall Street. On what is typically the slowest trading day annually, stocks rose -- granting a small favor to the few Fools here at Fool HQ. That still didn't give our guys on the Fool news team much to write about, though, and I don't have any news to write about either. Instead we'll look at some stock valuations and try to learn some Foolish lessons about buying certain kinds of stocks.

First, the S&P gained 0.40% on Friday and the Nasdaq added 0.38%, while the Fool was no turkey, rising 0.90%. For the week, the Fool and the S&P both lost about 0.80%, while the Nasdaq lost 1.25%. The Foolish Four had a strong week, thanks in part to AT&T which made new highs.

The stock of AT&T (NYSE: T) has been a clear example of the irrationality of Wall Street and the lack of professionalism (or Foolishness) of the so-called "professionals." While the stock was falling, it was hard to find an analyst in support of the leading long-distance company. The stock was downgraded relentlessly as it dropped into the low $30s. Ma Bell has since risen 70% from its April low, but most of the analyst upgrades have been made long after most of the gain. On Wednesday yet another firm initiated coverage and rated the stock a "strong buy."

But why?

With everyone now singing the praises of AT&T, the stock has probably already seen its meaningful price appreciation for quite a while. Over the past ten years, AT&T has had a price-to-earnings multiple ranging from 8 to 14. It now trades at over 18 times trailing earnings and at 19 times earnings estimates for 1998. Over the last five years the company hasn't seen earnings per share growth (or stock growth), and hiring a single man, Mr. Armstrong, doesn't change the dynamics of the industry. That's what I find so Wise about the AT&T story: The core fundamentals of the business never changed, and yet Wall Street's mood on AT&T changed wholeheartedly (twice), and this time in large part due to the hire of one man. Is Wall Street fickle?

Sure is. So it's crazy to think that you can guess what any stock will do next.

At $33, an analyst could have eyeballed AT&T's stock and seen that it was probably priced below its intrinsic value. We didn't hear any analysts making that call, though. Fools don't need to worry much about such things, especially as AT&T is part of the Foolish Four approach, but we do like to point out that, hey, a lot of these analysts seem to be on constant holiday -- always lagging behind the curve that a little homework would provide.

KLA-Tencor (Nasdaq: KLAC) and Innovex (Nasdaq: INVX) have in short order become two good examples of cyclical stocks and the quirks involved. The semiconductor equipment industry and the disk drive industry both move in cycles, and at the bottom of the cycle you see some spanking low multiples on the stocks. That's not to say that we're at the bottom of the cycles here, but we can at least hope that to be the case. In over two years now, the KLAC monster hasn't done anything for the Fool.

This is a good reminder that Fools should focus on companies that are building their own industries and that are not at the whim of cyclical growth. We don't suddenly dislike KLAC and Innovex, though. Both are industry leaders and luckily we bought Innovex when the disk drive industry was already beaten up, but perhaps investments in industry-building leaders (Yahoo! or even Rainforest Cafe, for example) would have served us much better.

There are many moving parts in investing, and one is mitigating risk. When you really consider the potential risks before buying a stock (as you always should), you're much more likely to buy a stock when it's at the lower-end of the risk spectrum and at the higher end of the reward spectrum, respectively. Weighing the risks holds the most merit, perhaps, with cyclical industries like semiconductors or disk drives, where you might be buying at the top and sitting on a market losing investment for several years.

When buying industry creators like AOL and (or Yahoo!), the risks are entirely different. You need to weigh those risks, but there are so many of them that they may cause you to hesitate from buying -- which would have been a big mistake on AOL over the past three years. A Fool should know what are true risks and what are part of any new business's risks. AOL's true risks in the early years weren't its exorbitant marketing costs. A risk was that it wouldn't market enough and reach critical mass and capture mind share before the competition.

Innovex trades at 8.7 times earnings estimates for the year ending next September -- so it trades at the low end of its historical P/E range. It's hard to see much more downside risk unless earnings per share momentum continues downward. The company recently stated that orders are steady, though. As fickle as the market was with AT&T it has been with disk drive stocks in the past, and when the mood finally changes it changes quickly. We saw that happen with KLA-Tencor this year, yet again.

KLA-Tencor has traded at between 9 and 50 times earnings over the past ten years. It was bought at the high end of the range and now trades at 16 times estimates for the year ending in June. In 1996 over 50% of the company's sales were to Japan and Asia, so, in part, the turmoil overseas has impacted how investors value the stock. Just as was the case in 1995, the stock went very quickly from making bold new highs to rattle all the way down near the 52-week low. KLAC trades at $38. The 52-week low is $33 and the recent high was $76. How's that for going from hero to goat in short order?

The company has yet to announce an earnings disappointment, or hint that one was looming in the near future.

Elsewhere in Fooldom, 3Com (Nasdaq: COMS) enjoyed a bounce to end the week. Last week Hambrect & Quist analyst Farrokh Billimoria lowered his fiscal '98 earnings estimate from $2.29 per share all the way down to $1.79 per share, citing high inventory levels and a slowdown in Asia. The mean earnings estimate still stands at $2.28 per share, and the stock trades at 15.7 times that estimate. It trades at 20 times the much lower estimate of the Hambrecht & Quist analyst. The stock is now at $36, up from $30 two weeks ago. At $30 the stock had a market value of $9.7 billion when you subtracted out the company's cash, putting it at 2.4 times trailing sales of $4.03 billion. Put another way: it wasn't expensive. In fact, a large company interested in getting into the networking business in a big way would probably see that price as interesting.

Here's to a wonderful Holiday weekend, hopefully spent with family and friends. If your loved ones aren't familiar with the Fool, wouldn't they like to be? Gather around the computer and give them a quick tour. Or catch David and Tom this weekend on the radio. The Gardner Brothers will be hosting the popular "MoneyTalk" show for Bob Brinker. You can hear them on the radio and give a phone call to Tom and David on both Saturday and Sunday, from 4 p.m. to 7 p.m. EST. The show airs on over 200 radio stations across the country (local radio station call numbers are listed behind the link above). This weekend the nation will truly be Foolish, not only on computer networks, but over the airwaves as well. Give a listen and phone in!

Be Foolish!

--Jeff Fischer

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Stock Change Bid ---------------- AMZN -1 5/8 49.50 AOL +2 75.00 T --- 55.88 CHV + 3/8 80.19 DJT --- 8.69 GM + 13/16 60.94 INVX - 1/16 23.00 IOM + 5/8 33.00 KLAC - 1/16 38.63 LU - 15/16 80.13 MMM + 3/16 97.44 COMS +1 9/16 36.19
Day Month Year History FOOL +0.90% -0.01% 24.08% 231.14% S&P: +0.40% 4.46% 28.98% 108.42% NASDAQ: +0.38% 0.44% 23.97% 122.24% Rec'd # Security In At Now Change 5/17/95 980 Iomega Cor 2.52 33.00 1209.52% 8/5/94 355 AmOnline 7.27 75.00 931.23% 10/1/96 42 LucentTech 47.62 80.13 68.27% 8/11/95 125 Chevron 50.28 80.19 59.47% 8/12/96 110 Minn M&M 65.68 97.44 48.36% 8/12/96 130 AT&T 39.58 55.88 41.18% 9/9/97 290 38.22 49.50 29.51% 8/12/96 280 Gen'l Moto 51.97 60.94 17.25% 4/30/97 -1170 *Trump* 8.47 8.69 -2.58% 8/24/95 130 KLA-Tencor 44.71 38.63 -13.61% 6/26/97 325 Innovex 27.71 23.00 -17.00% 8/13/96 250 3Com Corp. 46.86 36.19 -22.78% Rec'd # Security In At Value Change 5/17/95 980 Iomega Cor 2509.60 32340.00 $29830.40 8/5/94 355 AmOnline 2581.87 26625.00 $24043.13 8/11/95 125 Chevron 6285.61 10023.44 $3737.83 8/12/96 110 Minn M&M 7224.44 10718.13 $3493.69 9/9/97 290 11084.24 14355.00 $3270.76 8/12/96 280 Gen'l Moto 14552.49 17062.50 $2510.01 8/12/96 130 AT&T 5145.11 7263.75 $2118.64 10/1/96 42 LucentTech 1999.88 3365.25 $1365.37 4/30/97 -1170*Trump* -9908.50 -10164.38 -$255.88 8/24/95 130 KLA-Tencor 5812.49 5021.25 -$791.24 6/26/97 325 Innovex 9005.62 7475.00 -$1530.62 8/13/96 250 3Com Corp. 11714.99 9046.88 -$2668.12 CASH $32438.81 TOTAL $165570.62