Motley Fool Evening News
The Evening News (Archive)
Aug 01, 1997
An Investment Opinion by Randy Befumo
Getting the Business, and understanding what you've got
A few days ago in the Lunchtime News "Fool Plate Special" column I
wrote about how some recent positive news from ASCEND
COMMUNICATIONS (Nasdaq:ASND) might impact another
manufacturer of networking equipment, ACT NETWORKS
(Nasdaq:ANET) . Ascend Chief Executive Mory Ejabat had
commented that business for the company's new Cascade
Communications subsidiary had been picking up and should show
sequential growth, particularly for frame-relay. Since ACT Networks
also manufactures frame-relay equipment and was pummeled the next
day for crappy earnings, I though this was a rather interesting
divergence and might warrant some further research.
As I really did not have much to add to the discussion of the
frame-relay business beyond this interesting, but only preliminary,
observation, I wrote: "...those who know more about frame-relay than
the average investor might want to check the company out." To my
surprise, I got quite a bit of mail because of this comment from readers
essentially asking whether or not I really believed that an investor
should understand the basic business a company is in before they put
money into it. If so, these notes queried, how does an investor go
about trying to understand a company's basic business well enough to
consider investing? What tools are out there that they can use?
In an attempt to elucidate this important point, I thought it might be
useful to take readers through a preliminary examination of a company
that caught my eye today, ORBIT FR (Nasdaq:ORFR) . Orbit rose $2
5/8 to $14 1/4 today after the company reported quarterly earnings of
$0.20 per share, four cents above the estimate from the lone analyst
who tracks the company on a quarterly basis according to First Call.
Glancing at the company's press release this morning to decide
whether or not it might make fodder for the Lunchtime News column,
I noticed that the company had increased revenues by 194% and
profits by a whopping 20,000% by looking at the "Consolidated
Statements of Operations."
When a small, recently public company can report impressive earnings
growth on very strong sales growth, I normally make a mental note of
the company and go back to check on it later. After writing my
Lunchtime News column on the interesting earnings growth posted by
cereal vendor Kellogg Co., I went back to Orbit's financials to look at them a little bit closer. A quick assessment of operating margins
showed that Orbit had increased them to 24.3% from 4.3% the year
earlier. Operating margins, the percentage of money a company gets to
keep after paying all manufacturing and operating expenses, is an
excellent guide to the underlying profitability of the business without being obscured by interest income, interest expense, tax expense, or contributions to net income from "other" sources. With a 24.3% operating margin on only $5.3 million in revenues, Orbit struck me as a very profitable business.
Orbit gained most of its operating margin increase by only growing
"General & Administrative" and "Sales & Marketing" expenses by
about 45% year over year, although "Research & Development" also
grew much slower than revenues, and gross margins increased a few
percent. A newly public company controlling operating expenses to the
point where it is already surprising the analysts who helped to bring the
company public is always very interesting. It was time to figure out
what the heck Orbit FR did and whether or not there was any
reasonable way that I could learn enough about its business to
understand what was happening at the company.
The blurb at the bottom of the press release stated that Orbit made
microwave test and measurement equipment for a variety of
applications, mainly telecommunications and satellite communications.
Although helpful, this was not necessarily what I was looking for.
Because I knew from the press release that Orbit only came public on
August 1st, I knew that the company's S-1 filing would be available on
EDGAR, giving me a wonderful opportunity to read all about the
company courtesy of the underwriters. Although 10-Qs and 10-Ks are
great and everything, there is nothing more comprehensive than an S-1
filing -- the filing a company makes before it comes public. The S-1
details the business in a way that is not required in the 10-Qs or 10-Ks, and therefore makes this little document a great source for information about the industry. |
