Blue Light Specials?
...considering AOL, Innovex, 3Dfx and IOM
by Jeff Fischer
ALEXANDRIA, VA (Sept. 2, 1998) -- After four days of declining and one day of a large bounce (yesterday), today the confused stock market split in two. The S&P declined slightly and the Nasdaq rose 1.1%. The Fool left both behind and gained 3.3%, up 20% for the year against a 2% gain for the S&P.
Here's how the past few weeks have felt to some:
Imagine a speedboat racing over the ocean water. It leaves a wake behind it -- churning, choppy, and violent. Now imagine that you're tied to a rope that's connected to the end of this boat. In fact, you're in the water behind the boat, toppling through the wake. At some moments you're able to right yourself and get a good breath of air, at others you're underwater. Every moment is a new and different experience -- one moment provides hope, the next uncertainty or simply darkness (underwater).
Now consider the daily volatility of the stock market, while you -- being constant in your beliefs -- always possess the same Foolish approach to investing. Imagine trying to explain this Foolish approach while being blasted by mouthfuls of water and twisting on the end of a rope, your words dangling in the daily noise of the world like a wind-threatened spider web. With the recent stock market volatility, some peoples' minds are racing with fear or uncertainty, so the Foolish message needs to be reiterated at even higher volume. We all need to shout over the waves and over the roar of the speeding boat -- whether in this column or whether you're posting on the message boards to calm other Fools.
Simply said, given the market's propensity to rise over history, investing more money on large dips has always been more attractive than selling. If that's the only life vest thrown to you, be secure in grabbing it and holding onto it for the many years ahead.
Meanwhile, daily volatility will continue, but the Fool Port will -- as always -- favor writing about its companies rather than the stock market. Today we'll specifically consider the valuations of AOL, Innovex, 3Dfx and Iomega. But first, tomorrow the Fool is interviewing Mr. Howard Schultz, CEO of Starbucks (Nasdaq: SBUX). If you have any questions for the company, please post them in the Starbucks message board.
Now, roll up your sleeves, grab a pencil (a red one?) and let's take a look at some stocks...
Hambrecht & Quist upgraded America Online (NYSE: AOL) from "buy" to "strong buy" today, a move that makes sense given the online leader's steep decline in price with no deterioration of the underlying business. The stock rose $3 to $88 after touching $94. Applying basic valuation principles to the company goes a long way to support the "strong buy" rating.
On a subscriber-based valuation, AOL's stock is shown to be worth $76 per share based on its members alone. Each member is valued at $1,300 (a 25% discount to the valuation given cable subscribers). This number, multiplied by 13 million members, gives us $16.9 billion in value, or about $76 per share. If AOL grows to an estimated 15 million members by the end of fiscal 1999, this number climbs closer to $88 per share.
Now we need to determine the worth of advertising and commerce revenue and add it to the company's overall valuation. America Online earned over $400 million in ad and related revenue in fiscal 1998, and the company is expected to earn about $690 million more in the current fiscal 1999.
A 20 times multiple is commonly given to this type of high-margin revenue in equivalent new companies. We'll be conservative (especially considering AOL's new two-year $100 million deal with discount brokers, and its current record-high backlog of $510 million in ad revenue) and say that the company earns $600 million in ad revenue next year. When valued at a revenue multiple of 20, that adds another $12 billion in value to the stock, or an additional $54 per share.
These numbers might seem aggressive, but even permitting plenty of leeway (say, valuations 30% below these), you can still see how the value adds up and the current share price might be attractive. We have an implied 1999 stock value of $142, and that's before we add the value of the network and the company's cash and investments to the numbers. Adding it all up, Foolanalysts (and other analysts) perceive a fair value for AOL of about $150 per share in fiscal 1999, or 70% above the current price. AOL is expected to earn $1.00 per share next year, while cash flow -- already strong and growing -- can be cranked up with a simple discretionary drop in marketing expenses.
A few other Fool stocks in the Fool Port have interesting and Foolish valuations to this Fool's Foolish eye. (I was going for maximum use of a certain word there.) These stocks are so weatherworn that book value is now the barometer worth using when proposing that, hey, there might be some value here! Book value per share is simply a company's shareholders' equity (found on a balance sheet and representing a firm's "worth" based on assets) divided by the shares outstanding.
Innovex (Nasdaq: INVX) has a book value of $6.70 per share and trades at $10.50, while paying a dividend yield of 1.30%. The uncertainty of its business is playing a tremendous factor in this valuation, but management has known how to grow value over the past two decades and can very likely do so again in the coming years. To learn how it might do so, please read the past Innovex conference call summaries from the Fool.
The company has consistently grown its book value since 1988, when its book value was $1.18 per share. The stock has traded at anywhere from 1 to 6 times "book." Innovex now trades at 1.5 times book value (this at a company with 20% trailing profit margins), and it is still growing its book value even during a difficult time. We're leery to sell Innovex at such a valuation.
3Dfx (Nasdaq: TDFX) has a book value of $7.52 per share and trades at $10 3/8, or 1.37 times book. The company is valued at 8 times trailing earnings and 5.5 times 1998 earnings estimates of $1.88 per share. When it comes to semiconductor-related stocks, book value coupled with earnings growth are often the two safest measures when figuring valuation. KLA-Tencor (Nasdaq: KLAC) has a book value of $13.50 per share and has usually bounced sharply whenever it comes close to that price. Its lows of the past years have been $17 and $20 (hitting $20 this week). It's notable that this company, compared with 3Dfx, is not growing earnings.
3Dfx is growing earnings at breakneck speed, which usually grants even a semiconductor stock a higher multiple to earnings and book value. What's wrong? The thing is a small-cap and it's in a shunned industry. Small-caps have performed horribly this year and semiconductor stocks just as poorly.
Iomega (NYSE: IOM) has fared no better. Trading at $3 3/4, Iomega has a book value of $1.52 per share. The problem here is that its book value has been shrinking rather than growing, unlike Innovex or 3Dfx. It's hard to base an argument on book value when the company's book value is threatened. Iomega actually becoming profitable again might do wonders for the stock, one would think. The fourth quarter "trial by fire" is fast approaching. Iomega is expected to earn $0.07 per share that quarter, and $0.31 per share next year, putting it at 12 times 1999 estimates.
Tonight Tom Gardner's Cash-King column addresses long-term investing -- the Foolish way. The Drip Port, meanwhile, has narrowed its six-month banking study to two companies for potential purchase, Mellon and Norwest/Wells Fargo. Tonight's column is about Wells Fargo.
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Day Month Year History Annualized FOOL +3.34% 5.11% 20.99% 306.05% 41.02% S&P: -0.37% 3.45% 2.07% 116.08% 20.80% NASDAQ: +1.13% 6.24% 1.43% 121.17% 21.50% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 88.38 2330.26% 9/9/97 580 Amazon.com 19.11 87.88 359.82% 10/1/96 84 LucentTech 23.81 79.13 232.34% 5/17/95 1960 Iomega Cor 1.28 3.69 187.99% 4/30/97 -1170*Trump* 8.47 3.38 60.15% 8/12/96 130 AT&T 39.58 52.13 31.70% 2/20/98 200 Exxon 64.09 64.13 0.05% 2/20/98 215 DuPont 59.83 56.94 -4.84% 2/20/98 270 Int'l Pape 47.69 38.25 -19.80% 7/2/98 235 Starbucks 55.91 32.88 -41.20% 8/24/95 130 KLA-Tencor 44.71 25.38 -43.25% 8/13/96 250 3Com Corp. 46.86 25.94 -44.65% 1/8/98 425 3Dfx 25.67 10.38 -59.58% 6/26/97 325 Innovex 27.71 10.53 -61.99% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 62746.25 $60164.38 9/9/97 580 Amazon.com 11084.24 50967.50 $39883.26 4/30/97 -1170*Trump* -9908.50 -3948.75 $5959.75 5/17/95 1960 Iomega Cor 2509.60 7227.50 $4717.90 10/1/96 84 LucentTech 1999.88 6646.50 $4646.62 8/12/96 130 AT&T 5145.11 6776.25 $1631.14 2/20/98 200 Exxon 12818.00 12825.00 $7.00 2/20/98 215 DuPont 12864.25 12241.56 -$622.69 8/24/95 130 KLA-Tencor 5812.49 3298.75 -$2513.74 2/20/98 270 Int'l Pape 12876.75 10327.50 -$2549.25 8/13/96 250 3Com Corp. 11715.99 6484.38 -$5231.62 7/2/98 235 Starbucks 13138.63 7725.63 -$5413.00 6/26/97 325 Innovex 9005.62 3422.66 -$5582.96 1/8/98 425 3Dfx 10908.63 4409.38 -$6499.25 CASH $11876.47 TOTAL $203026.56