Fool Portfolio Report
Thursday, January 22, 1998
by Jeff Fischer (JeffF@fool.com)

ALEXANDRIA, VA (Jan. 22, 1998) -- Bittersweet results after the market closed. Amazon reported eye-popping fourth quarter sales of $66 million, selling 1,200% more than what Barnes & Noble sold online for the same quarter. Meanwhile, Iomega reported results that were one cent below expectations of $0.15 per share, but two cents below expectations on a fully diluted basis. Though the business grew very respectably (sales were up 27% sequentially from the third quarter, to $547 million), expenses increased and operating and net margins dropped from the third quarter.

A company can report strong or decent earnings but the stock will get punished if management even hints at any weakness going forward, because the immediate fear then -- especially if the company misses the current quarter's estimate -- is that earnings are growing at a rate slower than anticipated and future earnings estimates will be lowered. This demands a reassessment of the stock valuation, regardless of the current quarter. Stocks always trade based on expectations going forward, and today lower expectations for Iomega in Asia and in the ramp up of new products -- alongside concerns that margins may have peaked for now -- are sending the stock down.

Iomega (NYSE: IOM) reported record sales of $547 million, a 38% climb from the fourth quarter results of 1996, and net income of $36 million, up nearly 80% from last year. Looking at the earnings report we see that gross margins climbed to 33% from 29% last year, same quarter, but selling, general and administrative expenses rose to 19% of sales, compared to 17.2% last year. Research and development expenses rose, too, but we can't summarily consider this negative. R&D is an investment in the future that hopefully produces a positive return.

Year-over-year all of the company's margins improved considerably (having dissed its Utah production workers to move operations to Asia in 1996), as operating margins grew to 10.2% from 8.2%. But the decline in the most recent quarter (the strongest quarter of Iomega's year) is all that matters to investors.

This and the fact that the press release stated that demand in Asia slowed (though sales in the Pacific Rim accounted for less than 1/11th of revenue for the quarter anyway), and the company postponed some shipments of new products until the first quarter (meaning: increased inventory, which is actually up 31% from the third quarter -- not something that we like to see). And, finally, the company stated that the volume production increase of other new products was slower than planned.

Words like "delay," "slower," and "postponed" can terrify some shorter-term thinkers and too often are accompanied by lower earnings estimates in the days ahead. But does the stock deserve the 31% slam that it took after the earnings report? (The stock is now slightly below the Fool's sell price on 4/17/97, when the portfolio lightened up on the position.)

In the stock market everything is based on capital, which is why I find stocks sometimes repulsively amazing -- everything regarding a stock price, in the end, is based on money, and the valuations granted are for the most part based on reported financial numbers, expected numbers, and the perceived intrinsic value of the business (which changes whenever the numbers change one way or another). If things are improving, all existing valuation perceptions (by the numbers and also the intrinsic value) improve and the valuation granted can expand. If things falter, all perceptions decline, and the stock with it. The degree to which an expansion or decline in price is merited is where inefficiencies are created, because the opinions of investors differ considerably, and they can't all be right.

With $1.7 billion in 1997 sales, at $9 per share the company is capitalized at $2.5 billion (on 282 million shares outstanding, assuming dilution). So the stock trades at just 1.4 times sales, but at 14 times operating income of $177 million. On the more common earnings per share front, with fully diluted earnings of $0.42 per share for 1997, the stock now trades at 21.4 times trailing earnings, as low as it has been in a long time. Prior to today analysts expected at 39% increase in earnings per share for fiscal 1998, putting the stock at 14.75 times the current estimates of $0.61 per share for the year ended in December.

Nipping 10% from those estimates, to $0.54 per share, the stock is valued at 16.6 times forward estimates. Nipping a full 20% off the estimate, to $0.48 per share, we have a stock trading at 18.75 forward estimates (though on implied flat earnings growth from 1997). The conclusion on this quick, deadline hastened writing: it appears, depending on the valuation that the market is willing to grant this company with nearly 7% profit margins, that much of the downside risk was taken out of the stock today. (It's a bit late for those already holding the stock, though, eh?!) But the next question Fools need to face on their own is whether or not to continue holding the stock if the story has substantially changed. (It's hard to say that anything has changed from looking at just one quarter, though).

If you're a long-term investor, selling after the stock's largest single day drop since 1996 might not make much sense, especially as that drop came alongside record revenue and earnings growth for the year. Going forward in the Fool Port we'll closely be watching margins and inventory at the company, as always. For the past three years we've only seen margins rise. Let's hope that trend can continue again, and that any possible slowdown is temporary. (The company should have specified which new products were seeing the general slowdown. Management will probably clarify in the conference call that can be heard for a limited time at 1-800-446-4927 with no password needed.)

All in all, today I'm hesitant to say that the market overreacted to the threat of a slowdown following the lesson learned from networking stocks last year, though on the numbers that's what might likely be concluded -- and comparing industry to industry without context is a large mistake. We'll have more on the Iomega story tomorrow, after we have time to shake through the numbers and facts.

Amazon.com (Nasdaq: AMZN) reported blow-out (in my mind) sales of $66.0 million for the fourth quarter, up 74% from sales of the third quarter and 680% from sales the year before. Individual customer accounts increased to 1.5 million from 940,000 in September. Repeat customers accounted for over 58% of sales. This puts 1997 sales at $147 million. Tomorrow we'll look at the numbers and the new price-to-sales valuations on the stock -- and most importantly how the sales to expenses are shaping up early on at the young company.

A bittersweet day at the Fool Port, and saying that after a 5% loss feels kind of Foolish.

Message board links to Iomega, and to Amazon.com.

--J. Fischer

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN + 7/8 61.63 AOL + 3/16 95.44 T + 5/8 65.75 CHV -1 9/16 75.44 DJT - 1/8 8.63 GM -1 3/16 57.38 INVX - 7/16 20.94 IOM -4 1/16 9.13 KLAC -1 9/16 36.13 LU + 3/8 83.31 MMM -1 5/8 80.75 RTN.A -1 3/16 49.81 COMS - 5/8 31.00 TDFX + 3/8 23.88 SPY - 59/64 96.08
Day Month Year History FOOL -5.15% -5.84% -5.84% 216.01% S&P: -0.80% -0.76% -0.76% 110.09% NASDAQ: -0.72% 0.39% 0.39% 118.90% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 95.44 1212.24% 5/17/95 1960 Iomega Cor 1.28 9.13 612.66% 10/1/96 42 LucentTech 47.62 83.31 74.97% 8/12/96 130 AT&T 39.58 65.75 66.13% 9/9/97 290 Amazon.com 38.22 61.63 61.23% 8/11/95 125 Chevron 50.28 75.44 50.02% 8/12/96 110 Minn M&M 65.68 80.75 22.95% 8/12/96 280 Gen'l Moto 48.74 57.38 17.71% 1/8/98 115 S&P Depos. 95.91 96.08 0.18% 4/30/97 -1170 *Trump* 8.47 8.63 -1.84% 12/19/97 17 Raytheon 53.21 49.81 -6.39% 1/8/98 425 3Dfx 25.67 23.88 -6.98% 8/24/95 130 KLA-Tencor 44.71 36.13 -19.20% 6/26/97 325 Innovex 27.71 20.94 -24.44% 8/13/96 250 3Com Corp. 46.86 31.00 -33.85% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 33880.31 $31298.44 5/17/95 1960 Iomega Cor 2509.60 17885.00 $15375.40 9/9/97 290 Amazon.com 11084.24 17871.25 $6787.01 8/12/96 130 AT&T 5145.11 8547.50 $3402.39 8/11/95 125 Chevron 6285.61 9429.69 $3144.08 8/12/96 280 Gen'l Moto 13647.92 16065.00 $2417.08 8/12/96 110 Minn M&M 7224.44 8882.50 $1658.06 10/1/96 42 LucentTech 1999.88 3499.13 $1499.25 1/8/98 115 S&P Depos. 11029.25 11048.98 $19.73 12/19/97 17 Raytheon 904.57 846.81 -$57.76 4/30/97 -1170*Trump* -9908.50 -10091.25 -$182.75 1/8/98 425 3Dfx 10908.63 10146.88 -$761.75 8/24/95 130 KLA-Tencor 5812.49 4696.25 -$1116.24 6/26/97 325 Innovex 9005.62 6804.69 -$2200.93 8/13/96 250 3Com Corp. 11715.99 7750.00 -$3965.99 CASH $10740.46 TOTAL $158003.19