Fool Sells BSTN
July 11, 1995

Tuesday, July 11 we're closing out our holding of. . .

Boston Technology
TYPE: Darling/Highflyer
Phone: (800) 426-5523
Closing prices, July 10th, 1994: Bid $19 5/8, Ask $19 7/8

Trailing 12-month revenues: $96.8 million
Trailing 12-month EPS: $0.54
Last quarter reported: April, 1995 (1Q 1996)
Next quarter report date: About August 17th
Consensus EPS estimate for quarter: $0.15e vs. $0.13

FOOL ratio: 1.01

-------> TRADE: Selling our 380 shares

We're parting ways on Tuesday with our 380 shares of Boston Technology. The parting of ways is somewhat sad for us, since we've held these shares affectionately for almost a year and reaped a 50% gain on the investment. In fact, the very same day that the Fool Portfolio crossed the overall return mark of 50%, we're announcing our cashout of our 50% Boston Tech gain. The irony of life. . . .

Boston Technology, based in Wakefield (not Boston), Massachusetts, is a telecommunications technology leader in network-based enhanced services systems. The company's systems enable Baby Bells and international phone services to run and handle huge voice-mail systems, messaging, and fax services. . . and increasingly, as time elapses, video feeds et al.

We purchased our 380 shares on September 2nd, 1994, at a price (which includes commission) of $13.08. Today, Boston Tech closed at a bid of $19 5/8, where we'll expect to cash it out tomorrow. Below, we examine the rationale behind our decision.

A PORTFOLIO MANAGEMENT DECISION. Our decision to liquidate these shares is primarily a portfolio management decision. That is, we are managing a portfolio, and therefore "Buy" and "Sell" reports from us do not always speak directly to the merit of an individual investment per se, looked at in a vacuum. Instead, as portfolio managers we must make decisions from both the point of view of an individual stock AS WELL AS the portfolio as a whole. In Boston Tech's case, we continue to like the investment over the long term, but have some short-term portfolio needs.

What are our portfolio needs? Well, for one, we want to get a few shorts in the portfolio. The idea is not that we think the market is about to tank tomorrow, next week, next month, or even this year. No. Rather, shorting stocks is a basic foundation of The Fool Portfolio approach, and one that we've neglected since cashing out a couple of shorts in March. In retrospect, we're absolutely delighted that we did NOT have any shorts during April, May, and June. . . the market has gone bonkers. But we do always intend to keep a little of our money on the other side of the table.

To get that money, we need to free some up from our current investments. We have about $4800 of free cash sitting in our account. But that's not even enough, really, for a single stock (we've typically been buying $5000 or more at a pop). By selling our BSTN shares, we'll have over $7000 more to play with, for a grand cash total of somewhere around $12,000. That's enough for two new investments, which we'll aim to make before the end of July.

So in looking over the portfolio from a manager's point of view, we wanted to move some of our money from long to short in keeping with our Eternal Foolish Allocation (cf. the article by that name in The Fool's School area, if you haven't already done so). Below, we'll examine just exactly why we decided to tap Boston Technology as the source of new funds.

A COMPANY WHOSE STOCK IS FULLY VALUED. As we look specifically at Boston Technology stock, we notice first of all that the Fool Ratio has reached full value (1.00---actually, in this case, slightly above that). How do we arrive at that figure? We start with trailing earnings of 54 cents per share. Next, we need to locate our estimated annual growth rate by looking at forward earnings estimates. Our current issue of Zacks shows analysts estimating 69 cents per share for this year (ended 1/96), and 92 cents for fiscal 1997. Thus, you see 54 cents expected to go to 92 cents in 1.75 years. Those who have read our Fool's School articles will know that you just take the total growth from 54 cents to 92 cents (1.7037, or 70.37%) and annualize the figure by taking the 1.75 root of 1.7037. It's a breeze, if you have the right calculator (like even your Windows calculator, turned onto "Scientific"). The figure you arrive at for an annualized growth rate is 35.6%, or (rounded) 36%.

The Fool Ratio then takes that growth rate estimate and compares it to the stock's current P/E ratio. Boston Tech, at $19 5/8 with 54 cents in earnings per share, has a P/E ratio of 36. The idea of investing in small-cap growth stocks, as we have written about many times (and further elaborate in---PLUG! PLUG!---"The Motley Fool Investment Guide," coming from Simon & Schuster in January to a bookstore near you), is that when a stock's P/E matches its earnings growth rate, that stock is fairly and fully valued. That is the very situation we're in.

So we think that BSTN is accurately valued for the near term and therefore see more potential downside than upside. Going forward, as the company begins to meet and hopefully exceed earnings estimates, our target price will rise for these shares. Thus, we still think of BSTN as a good place to hold your money over the next 3-5 years. However, as the stock is now fully valued for the short term, we believe we can find better spots for our seven grand.

A COMPANY THAT HAS NOT SORTED THROUGH ALL ITS PROBLEMS YET. Now, if Boston Tech's balance sheet and earnings statement were clean and flawless, we might not be cashing out at all. We do like to hold the cream of the crop for as long as possible. But BSTN has tripped up now and again over the past few months and still has some stuff to work out.

For one thing, Boston Tech missed hitting its last earnings estimate. Supposed to come in with 14 cents per share, the company reported only 13 cents. While we didn't view that as a particularly horrible sign (and neither did the market), we DO prefer that our stocks outperform analyst expectations, not underperform them. Sometimes negative trends can be hard to get away from. But further, the company is expected to show just 15 cents per share for its second quarter (which ends July 31), vs. 13 cents in the year before. That comparison represents growth of just 15% in quarter-over-quarter and year-over-year comparison. While the second-quarter lull looks to be just that---a temporary lull---we do think this might cause the market to sell the stock off a bit from present levels if the numbers do not come in above 15 cents per share.

Further, cash flow has been negative for several quarters running. This annoys us, and we've written about this annoyance for several months in our Daily Recaps and on the boards. We want our companies to be generating cash, not eating it. But mainly because of a bloated accounts receivable, BSTN has reported negative cash flows from operating activities of $3 million for 1995, and a similar figure for the first quarter of 1996. In 1995, revenues grew 26.7%; 1995 accounts receivable, on the other hand, rose 99.2%. For the first quarter of this year, revenues grew 42.3%; accounts receivable rose 44.1%. That ratio is a little better, but not good enough.

The company needs to go cash-flow positive before we'll look at these shares again. Of course, with all the potential contracts this company could sign in the next 12 months, we may see BSTN start generating positive cash very quickly. Meantime, we're happy with our 50% profit.

WHY WE WON'T CRY IF THE STOCK KEEPS GOING UP. We have NO sense of impending doom either for the market in general, NASDAQ tech stocks, or Boston Technology in particular. BSTN may very well reach the mid-$20's in the next few weeks, and we will have sold out at $19. But that's OK with us. You can make a lot of money investing by selling out before the top. The trick is where you reinvest money after you've made a profit in it.

NO HURRY. We have no idea whether this trade announcement will noticeably affect the market price for these shares tomorrow or not. We know one thing: it shouldn't. That is, no shareholder should be in any hurry to dispense with these shares. The market is doing well overall, and Boston Technology has been very strong. No bad news is on the horizon. . . in fact, no news appears to be on the horizon at all, except for maybe some new contract announcements. We are cashing out for the reasons stated above---mainly to redeploy the funds. If the market drops tomorrow morning on this announcement, and you own these shares, you'll probably do well just to sit tight for a little while and let the stock come back. As is always the case with Foolish investing, you make your own decisions. That's the only way to learn and derive true gratification from investing.

Our cashout tomorrow may well cause barely a blip on the investment screens. We just wrote the above paragraph in the unlikely event that our recommendation in some way tilts the market.

Be Foolish.

---David Gardner, July 10th, 1995