Taking Inventory of Earnings
Friday, June 5, 1998
by Paul Larson
(TMFParlay@aol.com)

CHICAGO, IL (June 5, 1998) -- While the markets were rather hot this pre-summer afternoon, the Fool Portfolio was absolutely smoking. Our basket of stocks rose 2.15% versus the S&P 500's jump of "only" 1.74%. This outstanding day is thanks to half the stocks in the portfolio posting gains of over a buck. Additionally, two of our larger positions, America Online (NYSE: AOL) and DuPont (NYSE: DD), had gains of over two bucks. An excellent way to end a volatile week and start the weekend I must say.

On this June Friday, let's continue on the thread started yesterday by Jeff. In Thursday's recap Jeff took a snapshot of the book value of a handful of the companies the portfolio holds and gave a good explanation of how to calculate it. Today, let's look at a different metric of valuing companies -- earnings multiples. Let's quickly take inventory of exactly what the earnings picture looks like for the stocks in the portfolio.

First, here is what the trailing earnings look like using today's closing prices.

 
 Ticker      Price  Trailing Earnings  PE Ratio 
 AMZN       $44.25      $(1.51)             NA 
 AOL        $83.25       $0.32           260.16  
 COMS       $27.19       $0.13           209.13  
 DD         $79.63       $1.98            40.21  
 DJT (short) $8.56      $(2.04)              NA 
 INVX       $17.75       $1.98             8.96  
 IOM         $5.88       $0.26            22.60  
 IP         $47.44      $(0.36)              NA 
 KLAC       $27.63       $1.42            19.45  
 LU         $73.00       $0.33           221.21  
 T          $61.88       $2.91            21.26  
 TDFX       $19.75       $0.46            42.93  
 XON        $71.81       $3.27            21.96 
Just as there are a hundred ways to skin a cat, there are numerous different ways to look at trailing earnings. For simplicity's sake, the numbers cited here are all provided by Hoover's on the Fool's homepage. Many of these numbers include one-time charges to earnings, such as the merger charge 3Com (Nasdaq: COMS) took in its first fiscal quarter.

Looking at trailing earnings alone, one might get the impression that a great number of stocks in the portfolio are greatly overvalued. With two of the companies held long, Amazon.com (Nasdaq: AMZN) and International Paper (NYSE: IP), showing red ink and three others, America Online, Lucent (NYSE: LU), and 3Com, all sporting PE ratios above 200, many of the stocks here can hardly be called cheap when looking at multiples of trailing earnings.

However, look into the future and the stocks in the portfolio don't look nearly so expensive...

 
 Ticker        Date  Forward Earnings  FPE 
 AMZN        Dec-99      $(0.72)        NA 
 AOL         Jun-99       $0.90      92.50  
 COMS        Jun-99       $1.45      18.75  
 DD          Dec-99       $4.14      19.23  
 DJT (short) Dec-99      $(1.94)        NA 
 INVX        Sep-99       $2.34       7.59  
 IOM         Dec-99       $0.44      13.35  
 IP          Dec-99       $3.28      14.46  
 KLAC        Jun-99       $1.80      15.35  
 LU          Sep-99       $1.93      37.82  
 T           Sep-99       $3.84      16.11  
 TDFX        Dec-99       $2.03       9.73  
 XON         Dec-99       $3.20      22.44
(Source: First Call)

Notice that when using the future earnings estimates the average multiple our stocks trade at precipitously drops. Eight of the twelve long positions in the portfolio trade at less than 20x earnings estimates while two of them, Innovex (Nasdaq: INVX) and 3DFX (Nasdaq: TDFX), are trading at less than 10x forward earnings. Furthermore, only two companies are expected to show a loss in 1999, and one of those, Trump (NYSE: DJT), we hold short.

The lesson here is that our particular brand of investing discipline puts a much greater weight on future results than on what is logged in the history books. We wouldn't have it any other way. While looking and learning at the past performance can be insightful, looking forward to the future is a more useful and profitable way of valuing companies. At least that's what we have personally found.

I'm sure we'll get e-mail over the weekend from some folks who disagree and have made money in the market by giving greater consideration to past performance. That's wonderful. Another lesson that can't be repeated enough here is what we decide to do here is our own personal investing decision. You need to decide for yourself what style of investing you are most comfortable with. If you have found a different method of investing that has worked for you and maximized returns while minimizing risks, congratulations! That's excellent. Because if you're investing on your own and beating the market over the long-term, you've found Foolishness in at least one form. (It's good in all forms.)

There are literally thousands of way to value stocks and thousands of other disciplines for buying and selling using those valuations. Heck, just in the Hall of Portfolios alone we have the Boring and Cash-King portfolios that are both run by different people, and both of them have distinctly unique ways of looking at companies. We also have the Drip Portfolio, which offers its own strategies as well.

We're not professing here in the FoolFolio that our valuation techniques and disciplines are the end-all, ultimate way to choose stocks. Far from it. Maybe if we could only get our techies at Fool HQ to get that Foolish Crystal Ball ™ out of beta-testing...

The points to take home this weekend are this: We usually look much more closely at expected future results than at past performance. This is what we have found to work for us in the past (with AOL, Iomega, Medicis, Amazon so far, etc.), and we expect it to work for us in the future. We may be wrong and crazy about this, but it is our discipline. Our growth-investing bent may be different than yours, but that's fine since there are different strokes for different folks.

Have a great weekend!

-- Paul Larson

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN + 3/8 44.00 AOL +2 83.25 T +1 61.88 DD +2 7/8 79.63 DJT --- 8.56 XON +1 1/2 71.81 INVX + 3/4 17.63 IP - 3/16 47.44 IOM + 1/8 5.88 KLAC - 9/16 27.50 LU +1 1/8 73.00 COMS + 9/16 27.06 TDFX +1 5/16 19.50 SPY +2 111.88
Day Month Year History FOOL +2.15% 0.03% 15.24% 286.74% S&P: +1.74% 2.11% 14.78% 142.99% NASDAQ: +0.73% 0.23% 13.54% 147.57% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 83.25 2189.33% 5/17/95 1960 Iomega Cor 1.28 5.88 358.84% 10/1/96 84 LucentTech 23.81 73.00 206.62% 9/9/97 580 Amazon.com 19.11 44.00 130.24% 8/12/96 130 AT&T 39.58 61.88 56.34% 2/20/98 215 DuPont 59.83 79.63 33.08% 1/8/98 115 S&P Depos. 95.91 111.88 16.65% 2/20/98 200 Exxon 64.09 71.81 12.05% 2/20/98 270 Int'l Pape 47.69 47.44 -0.53% 4/30/97 -1170*Trump* 8.47 8.56 -1.11% 1/8/98 425 3Dfx 25.67 19.50 -24.03% 6/26/97 325 Innovex 27.71 17.63 -36.39% 8/24/95 130 KLA-Tencor 44.71 27.50 -38.49% 8/13/96 250 3Com Corp. 46.86 27.06 -42.25% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 59107.50 $56525.63 9/9/97 580 Amazon.com 11084.24 25520.00 $14435.76 5/17/95 1960 Iomega Cor 2509.60 11515.00 $9005.40 2/20/98 215 DuPont 12864.25 17119.38 $4255.13 10/1/96 84 LucentTech 1999.88 6132.00 $4132.12 8/12/96 130 AT&T 5145.11 8043.75 $2898.64 1/8/98 115 S&P Depos. 11029.25 12865.63 $1836.38 2/20/98 200 Exxon 12818.00 14362.50 $1544.50 2/20/98 270 Int'l Pape 12876.75 12808.13 -$68.63 4/30/97 -1170*Trump* -9908.50 -10018.13 -$109.63 8/24/95 130 KLA-Tencor 5812.49 3575.00 -$2237.49 1/8/98 425 3Dfx 10908.63 8287.50 -$2621.13 6/26/97 325 Innovex 9005.62 5728.13 -$3277.50 8/13/96 250 3Com Corp. 11715.99 6765.63 -$4950.37 CASH $11558.06 TOTAL $193370.06

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