Selling Medicis
September 10, 1996

SELLING
Medicis Pharmaceutical Corporation
NASDAQ: MDRX
Type: Small-Cap Growth
HQ: Phoenix, AZ
Phone: 602-808-8800
Closing prices: $43 bid, $43 1/4 ask

Trailing 12-month sales: $25.3 million
Trailing 12-month earnings per share: $0.84
Last quarter reported: 4Q Fiscal '96 (June)
Next quarter reported: 1Q '97 (September), around October 14th
Consensus EPS for quarter: $0.16
Fool Ratio: 1.41

Trade: SELL 375 shares

OVERVIEW

Less than eight months after our initial purchase of Medicis, we find ourselves riding a gain of more than 120%. But with some new investment ideas to add to the Fool Portfolio, we must free up cash. Medicis looks most fully valued today, so it goes.

Medicis stock has performed up to our every expectation, fulfilling our Foolish aim of doubling our money within 12 months of a small-cap purchase. While a tremendous amount of reader and media attention over the summer have been focused on the successes and recent failures of America Online (Nasdaq:AMER) and Iomega (Nasdaq:IOMG), tiny Medicis has quietly and consistently outperformed the market.

But we have some new investment ideas to add to The Motley Fool Portfolio this month, and we need to free up some dough. As readers of The Motley Fool Investment Guide well know, our sell rule remains, "When you find a better place for your money, put it there." We are evaluating a few new investments with significantly more potential at these prices than we believe Medicis has here. And looking over our portfolio today, we consider Medicis to be the most fully valued stock at present prices. It goes.

This is all completely in spite of this Phoenix-based operation's continued fine execution. Any interested reader does well to review our fourth-quarter conference call summary, brought to you exclusively by Debora Tidwell of The Motley Fool. ... it's a very impressive show.

VALUATION: FULL AND FAIR

The current valuation suggests that we can find some better opportunities elsewhere.

Medicis closed fiscal 1996 with trailing sales of $25.3 million, compared with $19.1 million for 1995... an increase of 33%. Net income rose to $6.0 million (which excludes a fourth-quarter tax credit of $1.9 million) vs. $1.6 million from the year before... an increase of 275%. Trailing earnings per share are $1.09, which includes a fourth-quarter tax benefit. Removing that tax benefit, operational earnings per share for 1996 were $0.84. At today's closing bid of $43, that makes the price-to-earnings ratio 51.2.

So let's do a Fool Ratio (click into our Fool's School if you're new to this). First we need the forward growth rate. First Call shows a current consensus earnings estimate of $1.56 for 1998... exactly two years ahead. Computing an annualized growth rate (again, the way to do this is fully explained in our Fool's School) you reach 36.2%.

To get the Fool Ratio, we compare the company's P/E ratio to its growth rate. Thus we divide the P/E (51.2) by 36.2 (the percentage of the growth rate). That comes to 1.41... which indicates a fully valued stock.

Throw in a dilutive secondary offering occurring later this month, and we think we're getting a good price for Medicis.

HOWEVER, do keep in mind that the company has consistently whacked its earnings estimates. Thus, you should tend to expect MDRX will come in above First Call's numbers, which makes our estimate of the growth rate conservative, and our Fool Ratio unfairly high. This is a main reason we've continued to own Medicis into the high $30's and beyond, even if it started to look pricey by conventional wisdom. You have to credit companies that are putting out numbers well above the market's expectations.

In the end, our biggest reason for selling Medicis is not because of its valuation. It's our desire to put our money to other use. In fact, we can easily picture a continued rosy future for this stock, as the company continues to execute CEO Shacknai's business plan. We just think we might be able to earn a higher return somewhere else.

For those wishing to view the context of the company's past success as a guide to evaluating its future, here is a full accounting of income statement figures from 1994 through the recently closed fiscal 1996:

        SALES (in millions)
        1996     1995    1994
1Q    4.57      3.69     3.58
2Q    6.45      4.73     4.67
3Q    7.02      5.03     4.17
4Q    7.27      5.68     4.59
     25.31    19.13   17.01
  NET INCOME (in millions)
        1996       1995    1994
1Q    0.646      0.026    0.006
2Q    1.404      0.308    0.039
3Q    1.759      0.312    0.120
4Q    2.245+    0.967    0.491
      6.000+    1.613*   0.655

+excludes tax-loss carryforward of $1.9 million
*includes extraordinary charge of .610, due to headquarters relocation

         EARNINGS PER SHARE
        1996    1995    1994
1Q    0.10      0.01    0.00
2Q    0.21      0.07    0.01
3Q    0.24      0.07    0.03
4Q    0.29+    0.22    0.11
      0.84+    0.37*   0.14

+excludes tax-loss carryforward of $0.25 per share
*excluding extraordinary item, company EPS was $0.51

SIGNS AND PRESENTIMENTS

Michael O'Higgins reminds us that media notoriety is a contrary indicator.

Michael O'Higgins in his book Beating the Dow pointed out a favorite hobby of his. Namely, O'Higgins makes a point of clipping newspaper headlines (or other media notices), using them as a contrary indicator. Calling it his "Media Index," O'Higgins notes, "When headlines scream bull or bear or magazine covers picture one or the other, you are well advised to run in the opposite direction." (This is on pages 229-30. Those interested in the book can purchase it directly through FoolMart.)

We like this. We believe in doing this. And this week, a few unrelated bits of notoriety have come Medicis's way, suggesting maybe the Foolish money should move out where the Wise money is coming in.

Reports in our Medicis folder suggest that over the weekend, newsletter writer Louis Navellier ("MPT Review") added this stock to a number of his model portfolios. That may have given the stock a little lift this week.

Further, one of our readers also points out that the just-out issue of Forbes plugs plugging MDRX. We're not subscribers to Forbes so we don't have the issue on our desk yet, but page 212 has money manager Michael Gianturco saying, "I have been accumulating MDRX for customer accounts, and I consider it a buy at 35 or better." The reader went on to say that "the whole page is dedicated to MDRX... generally bullish."

OK, so Navellier is adding it to his well-followed portfolios, and now Forbes has found Medicis.

WORLDBEATER?

We may often sell into strength when we're holding a small cap that's reached fair, full valuation and doesn't look like a "world beater."

You may be wondering why we would sell this stock into strength while retaining a stock like Iomega (which also could've been sold into strength just about anytime from February 1995 to May 1996). The answer is that we do not consider Medicis a "world beater." Companies that have the opportunity to change the way the world works in a very broad brush way earn the term "world beater" from us. Iomega is one such an example: we remain hopeful -- even a bit confident -- that Iomega will create a new portable standard for computer storage with its Zip drive technology. With little competition, and outstanding performance, we believe that Iomega may just "beat the world" on this score. And certainly, the computer industry is already in the midst of what may be a profound change, thanks to IOMG.

Medicis is not a world beater. Neither was Ride Inc. (the snowboard manufacturer we held to a double in 1995), neither was Boston Technology (the small cap telecom equipment company we gained 40% on last year). For companies whose products will not massively transform the way we live, we have a tigher sales rein. When they hit our valuation goals (as Medicis has, and as Ride and Boston Tech did), we look elsewhere for something cheaper.

TRADING THOUGHTS

A thin stock can make for a gap down on sell announcement. If so, we may hold off for a few days.

The final thing to keep in mind is that this stock is thinly traded. The float is about 5.4 million shares, and average daily volume is below 200,000 shares. Even given the recent strength and media attention, this stock could well open lower following our sell announcement. But we think that's silly, and should this occur in any significant way, you can expect us not to sell the first day or two. Our Foolish trading rules indicate that we will make a trade at any point during the five days after a trade announcement. Medicis may be one such case where we hold off a while. This remains a strong stock backed by a strong company.