Smushed Small-Caps
Plus, an contest

by Jeff Fischer (

ALEXANDRIA, VA (Sept. 15, 1998) -- The Fool Port certainly has its share of dogs. Four of fourteen stocks are down 40% or more. Call it the Dog Pound. Or at least call this group of stocks the Pack o' Hounds.

Not surprisingly, all of our downtrodden stocks are small or mid-cap companies. Anything smaller than Burt Reynold's ego has been crushed over the past year, with some small company indices down a whopping 40%. However, this by no means justifies the Fool Port. We probably hold stocks that we should no longer own, regardless of how they perform going forward.

When was the last time that we wrote knowingly about KLA-Tencor (Nasdaq: KLAC)? When was the last time that Iomega (NYSE: IOM) did anything interesting? Iomega is losing money, and while I admit that that's interesting in the face of record sales, it isn't the type of interest we're looking for. Today Iomega gained 15% on the heels of (but not related to) a large block buy from an institution yesterday -- 250,000 shares were bought at $4.

All eyes are on Iomega to be profitable again in the fourth quarter this year and in fiscal 1999. If that turns out to be true, we could see a recovery in the shares. Still, the stock is 40% below its pre-loss announcement price. Iomega trades at 14 times the current guess of $0.31 per share in 1999 earnings.

Now 3Dfx (Nasdaq: TDFX) will post a money-losing quarter. Of course, one quarter alone isn't meaningful. Only years are meaningful. And 3Dfx has been anything but a dog when it comes to its business. It offers the best products in the industry and it has more contracts with game-makers, by far, than any competitor. What is concerning, however, is that in its hey-day the company is about to post a loss.

If a company is losing money during its strongest period of growth (like Iomega and 3Dfx are), what will happen in slow times? Sure, this is a "slow quarter" for 3Dfx, but that alone is puzzling. Management knew that a seasonal slowdown would occur, but they're surprised by its magnitude. That's obviously not good. What would be good news, if true, is that reportedly high inventory at one major customer (3Dfx only has a few, one being Diamond Multimedia) caused much of the current problem. But also, 3Dfx's new Banshee product -- which represents lower margin sales -- is reportedly eating into top-line Voodoo2 sales. That's a problem that was at least partially predicted.

3Dfx is now trading $1.50 above its book value, but impending losses don't stack the cards in book value's favor. Book value could follow in the footsteps of M.C. Hammer -- quick rise, quicker fall. Even though management is claiming that the fourth quarter will be profitable, that's predicated on strong holiday sales and new OEM revenue (OEM, or original equipment manufacturer programs are ramping now, but these, as with Iomega, represent lower margins).

So what's the Fool to do?

The Fool Port's aim is to maximize returns while investing in leading companies that it understands, usually focusing on new, dynamic, and smaller companies. (The portfolio's "large" foundation is the Foolish Four.) A focus on small-cap and new companies will typically produce the results that we're seeing now: for every winner, you'll likely have at least three or four laggards or even all out bombs. This style of investing can still work well, however, because when you do uncover an emerging winner in the world of small-cap investments, it can easily compensate for several losers... and then some. And then some once again.

Picture a back alley in Philadelphia. Sweeping around the corner is a pack of wild dogs, running. What you don't see several miles ahead of the dogs is a rabbit. Some might call it a lucky rabbit. In reality, it's a winning investment such as America Online. It's the type of outcome that you seek out of every handful of small caps that you buy. Small caps are risky, and they tend to either reward an investor several-fold and ten times over, or punish everyone to an extreme that leading large caps rarely do. Small caps are not the type of stocks that you should ever buy on margin.

Also, Fools should never own just one or two small caps and call that a portfolio. The Motley Fool Investment Guide suggests that when a Foolish investor is ready to move beyond an index fund, they should first consider buying the Foolish Four, and even consider basing their entire portfolio on the approach. Later, a Fool should add small caps only if they're willing to do their homework and can handle the risk. (Nasdaq: AMZN) must be busy with traffic. I've placed fifteen separate orders with the company since December and I've noticed that the last three orders have been slower to fill than in the past.

I placed an order on Sunday night. All of the items I requested were available immediately, but since Monday morning my order status has been "shipping soon." On Tuesday night the order still had not been shipped. Rather than complain, it's more fun to note that in some regards my order is to blame for the slowness.

The traffic. Imagine:

A crowded highway filled bumper-to-bumper with cars. This happens every business day in all major American cities. Yet, every day most of the drivers hope that today it won't be so bad.

Each morning they get on the highway ready to roll. As the traffic begins to build -- and then slows to a crawl -- many of the drivers can't help but get upset. "This traffic!" they lament, upset with every car around them. As if they're not in a car themselves, adding to the very same problem for everyone else. Perhaps they should honk at their own car.

At least Amazon provides a fast lane, typically upgrading shipments to "priority mail" without charging for it. A separate order placed on Friday arrived today thanks to this, and I don't plan to shop elsewhere. After all, many things that I buy at Amazon I wouldn't buy at all if it weren't for Amazon.


What about you? (1) Do you buy more books and music due to Amazon? (1a) If the answer is yes, why is that? (2) Are you happy or unhappy with Amazon's service and site? (3) What can the company do better? and (4) Who was the best novelist and/or musician of this century?

Post your thoughts to these questions on the Fool's message board. The most Foolish post wins a $30 e-mail gift certificate to You can post until midnight Eastern Time on Wednesday night. Please title your post "Fool Amazon Contest."

3Com (Nasdaq: COMS) rose on the recurring rumor that Intel (Nasdaq: INTC) might acquire the company. The Cash-King and Drip Portfolios both hold Intel. I don't know about the C-K managers, but, at least initially, I'd rather not see 3Com and its lower margin business acquired by the semiconductor leader. Although over the long term, the possible merger could have serious synergy. 3Com rose 10%. It trades at 22 times the fiscal 1999 earnings estimate of $1.29 per share.

Lucent Technologies (NYSE: LU) has fallen from $108 to $74 during the stock market's decline and the collapse of the Tellabs (Nasdaq: TLAB) and Ciena (NYSE: CIEN) marriage. Under different circumstances, shareholders might see the collapse as good news for Lucent. Today an analyst voiced concerns about 1999's earnings estimate in the industry overall. Despite Lucent's recent 31% slide, the stock trades at 43 times 1998 earnings estimates of $1.69 per share, and 36 times 1999 estimates of $2.02. The company is expected to grow earnings 21% annualized the next five years.

To close, don't miss part two of the Fool's Year 2000 Bug report. Also, don't forget to give the Amazon contest a try. And finally, I read an article today that stated the Internet is spawning new and smarter car buyers -- buyers who are working to get the best deal, and using unconventional measures. Yep, bookmark The Motley Fool's How to Buy a Car area!

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09/15/98 Close

Stock Change Bid ---------------- AMZN - 3/4 72.94 AOL - 3/8 97.50 T - 7/16 57.25 DJT + 1/16 4.31 DD - 5/16 59.19 XON + 13/16 71.31 INVX - 1/2 10.75 IP +1 15/16 44.31 IOM + 5/8 4.63 KLAC + 1/8 22.88 LU -2 1/2 74.50 SBUX --- 31.94 COMS +2 7/8 30.31 TDFX -2 8.81
Day Month Year History Annualized FOOL +0.26% 6.39% 22.47% 311.01% 41.02% S&P: +0.77% 8.37% 6.93% 126.36% 21.98% NASDAQ: +0.74% 11.93% 6.86% 133.02% 22.84% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 97.50 2581.20% 9/9/97 580 19.11 72.94 281.66% 5/17/95 1960 Iomega Cor 1.28 4.63 261.21% 10/1/96 84 LucentTech 23.81 74.50 212.92% 4/30/97 -1170*Trump* 8.47 4.31 49.08% 8/12/96 130 AT&T 39.58 57.25 44.65% 2/20/98 200 Exxon 64.09 71.31 11.27% 2/20/98 215 DuPont 59.83 59.19 -1.08% 2/20/98 270 Int'l Pape 47.69 44.31 -7.09% 8/13/96 250 3Com Corp. 46.86 30.31 -35.32% 7/2/98 235 Starbucks 55.91 31.94 -42.88% 8/24/95 130 KLA-Tencor 44.71 22.88 -48.84% 6/26/97 325 Innovex 27.71 10.75 -61.20% 1/8/98 425 3Dfx 25.67 8.81 -65.67% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 69225.00 $66643.13 9/9/97 580 11084.24 42303.75 $31219.51 5/17/95 1960 Iomega Cor 2509.60 9065.00 $6555.40 4/30/97 -1170*Trump* -9908.50 -5045.63 $4862.88 10/1/96 84 LucentTech 1999.88 6258.00 $4258.12 8/12/96 130 AT&T 5145.11 7442.50 $2297.39 2/20/98 200 Exxon 12818.00 14262.50 $1444.50 2/20/98 215 DuPont 12864.25 12725.31 -$138.94 2/20/98 270 Int'l Pape 12876.75 11964.38 -$912.38 8/24/95 130 KLA-Tencor 5812.49 2973.75 -$2838.74 8/13/96 250 3Com Corp. 11715.99 7578.13 -$4137.87 6/26/97 325 Innovex 9005.62 3493.75 -$5511.87 7/2/98 235 Starbucks 13138.63 7505.31 -$5633.31 1/8/98 425 3Dfx 10908.63 3745.31 -$7163.31 CASH $12005.75 TOTAL $205502.81 CASH $12005.75 TOTAL $204978.13

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