Hands on the Levers
Investors need to get a grip on the difference between those factors that move stock prices and
those that don't.
By Jim Jubak
You know my favorite kind of surprise? The one I've seen coming for days. I hate being
startled when friends jump out of the dark yelling. I dread ripping open that "mystery" gift.
But I love knowing a bit of news before most everyone else and then watching their surprise
when they hear it.
I'm the same with stocks. I love the earnings "surprise" that catches analysts and the
market unprepared. I love sitting there watching a stock that I already safely purchased
for my portfolio climbing from point to point like a mountain goat feeling the first rush of
spring. That doesn't happen anywhere frequently enough to make me happy -- but I can
remember how good it feels.
To capture that feeling -- and the returns that come with it -- you have to anticipate, not
follow a trend. Any kind of trend will do, if it's sizeable enough. It can be a new product set
to drive a company's earnings or a successful program of cost-cutting or a new CEO.
Actually, I've found that identifying the lever that could move a stock isn't the hard part.
Judging the power of that lever to move share prices is far more difficult and far more
important. Putting your cash behind a trend that isn't strong enough to tack dollars onto
the price of a stock is just a waste of time. And in investing, where time is money, every
stock like that cuts into performance.
So how do you find a lever that can move a stock in the first place? And how do you judge if
it's big enough to give you the return you want? Let's go through some examples.
There are a couple of ways to find a lever. You can tear apart a company to see what makes
it tick. Or you can look for macro-trends in the U.S. or global economy, and then try to
predict which companies stand to benefit from them. Both work.
Snapshot
3-year Chart
Snapshot
3-year Chart
The first method can be pretty simple if the economics of the company under the
microscope are straightforward enough. For example, even though it sells high-tech
computer chips, Micron Technology (MU) is a very straightforward company. Since it
concentrates on commodity memory chips, Micron Technology has very little pricing power.
The company's bottom line rises and falls as the forces of supply and demand raise and lower
the price of chips. As one of the lowest-cost producers in its business, the company mints
money when supply is tight and prices high. In 1995, for example, Micron Technology earned
$3.95 a share, and the stock traded as high as $95. In 1997, when chip prices plunged, the
company earned just $1.04 a share and the stock currently trades at just $35.
An internal lever can be pretty simple, even when the company's economics aren't. Vitesse
Semiconductor (VTSS), for example, produces a complicated mix of products that sell into
the military, Internet and Intranet, telecommunications, and equipment testing markets. (I
recommended Vitesse for purchase in Jubak's Picks last summer, and I own shares myself.) I
don't have the data to trace the pricing trends and costs in each of those segments. But
fortunately, right now, I don't have to.
I think another factor will be responsible for pushing the stock price up. In recent quarters
the company simply hasn't had enough factory space to handle all the business coming its
way. That's led to a backlog of orders -- $71 million as of the end of 1997, which is equal to
about two quarters of sales -- and, I'd assume, some loss of business as customers who
couldn't wait went elsewhere. A new factory will start turning out chips this year in time to
add as much as $8 million in sales in the June quarter. That's a 25% increase, and in dollar
terms about double what the company added to sales in the most recent quarter.
Snapshot
3-year Chart
Snapshot
3-year Chart
Snapshot
3-year Chart
Earnings Estimates
Sometimes, an internal lever can be poised to work against a stock, too. In its last quarter,
Iomega (IOM) showed rising inventory levels -- a signal of potential sales problems -- and a
costly rise in sales through original-equipment makers such as Compaq (CPQ). Iomega makes
less profit on Zip drives sold to computer makers for factory installation than it does on
drives sold to consumers through retail computer outlets. Netscape (NSCP) recently
announced that it would begin giving away its Navigator Internet browser software. I
understand why the company is doing this, since competitor Microsoft (MSFT) gives away
its browser. But Netscape's move wipes out at least 13% (a category Netscape calls
"stand-alone browsers") of the company's revenue stream. And that will need to be replaced.
(Investor is published by Microsoft.)
Working from a general trend is often harder, since even after identifying the trend you
have to figure out what company really benefits from it. For example, it's clear from the
difficulties at Oxford Health Plans (OXHP) and other HMOs that the industry needs better
software to track costs. That should work to the benefit of a company such as HBO & Co .
(HBOC), which sells patient-care and financial-management software to this industry.
But while HBO & Co. has an important lead in this market, other, larger application-specific
database companies, such as PeopleSoft (PSFT), Baan (BAANF) and SAP (SAPHY), aren't that
far behind. They certainly lack HBO & Co.'s experience in solving the problems of the
health-care industry, and they don't have that company's familiarity with potential
customers. But they each already make financial-management software and are looking to
expand into new industries. HBO & Co. just reported fourth-quarter 1997 earnings of 28
cents per share, beating analyst estimates by 3 cents. But to justify a price-to-earnings
ratio of 62, the stock has to deliver that kind of surprise in the future too. The trend is
blowing in the company's favor, but competition is bearing down hard.
Snapshot
3-year Chart
Snapshot
3-year Chart
Once you've found either an internal or external lever, it's time to judge its power. I know,
for example, that Coca - Cola (KO) has been hard at work introducing and acquiring new
brands. U.S. consumers have seen ads for new Coke brands -- acquisitions like Barq's root
beer and Orangina, and the launch of Surge. But come on! Efforts like these may be
encouraging signs of corporate vigor. However, given Coke's global sales of $14 billion in
1997, these are hardly developments that will add significantly to the Atlanta company's
bottom line. For that, I need to see how the Smart and Ciel projects go. The former is a soft
drink in flavors such as melon, designed for the Chinese market. The second is a brand of
water to be sold in Mexico. Now, those are products that could, if they succeed, make a
difference down the road. Right now, though, Coke's battle with PepsiCo (PEP), which sets
prices for the flagship colas, and the company's ability to use its bottling network to add
international market share are far more important levers of growth.
Ideally, what I want to find as an investor is a lever that will have a powerful but relatively
easily quantified impact on a company. That's a hard combination to find, but you do have
more than 7,000 equities to try on for size.
Some effects are powerful but too vague. A new CEO at Silicon Graphics (SGI), especially one
such as Richard Belluzzo, the respected former head of Hewlett - Packard's (HWP) computer
division, will certainly help. But will he take earnings to $1 a share in 1999 or 2000 or 2001? I
can buy on faith, but I can't crunch the numbers.
Some effects are powerful but completely unpredictable. I know that Micron Technology's
fortunes rise and fall with the price of memory chips. But given the severe cash crunch at
Korean chip makers, Micron's part of the chip market is in such chaos right now that I don't
feel I can call the bottom for chip prices.
I think that
Checkfree is a good
example of
opportunities that
this kind of analysis
can turn up.
Snapshot
3-Year Chart
Press Releases
Earnings Estimates
I have found one example -- Checkfree (CKFR) -- that's just right. (I own shares purchased
about two years ago. Hey, I was early.) Adding new subscribers for its electronic-banking
and bill-payment service drives growth at Checkfree -- that's pretty simple. At this point in
the company's life, the benefits of scale are really starting to kick in. The company reports
that at the end of December, 2.2 million people were using its electronic-banking and
bill-payment service. That's up 70% over the December 1996 quarter. Revenue grew by 47%
year to year.
Checkfree, which once tried to grow its business by mailing free software to individual
consumers just as America Online (AOL) does, now acquires most of its new users by signing
deals with big banks. In 1997, for example, deals with Wells Fargo (WFC), Citicorp (CCI),
NationsBank (NB) and Chase (CMB) funneled new users to the company. In the second half of
1997, Chase alone was sending Checkfree 25,000 new customers a month.
That makes growth at Checkfree lumpy -- a big deal one quarter pushes up the growth rate,
a smaller deal the next sends it down -- but also remarkably transparent. By tracking the
number of big deals that Checkfree is signing (you'll find a link to the company's Web site at
the bottom of this page), an investor can get a good idea of what growth will look like in
future quarters.
Right now I like the stock because of a deal that Checkfree signed with the Integrion
Financial Network last October. Integrion is a consortium owned by big names in banking
such as Banc One (ONE), Bank of America (BAC), First Chicago (FCN) and Fleet (FLT). IBM
(IBM) is the group's technology partner. The deal incorporates Checkfree's
electronic-banking and bill-payment system into the online banking platform that the group
will roll out in 1998. In its Jan. 27 conference call, Checkfree predicted that six of the
Integrion banks will be up and running in the current quarter with the rest to follow. That
should produce another big lump of growth for the company.
The timing of that growth couldn't be much better. In the just-completed quarter,
Checkfree reduced its loss to 2 cents a share (far better than the 4 cents a share loss
projected by analysts). The company is on track to report its first break-even quarter in
April. That will give the stock new visibility and should push up the price as those
institutional investors who, by their charter, can't buy companies with losses are now able
to buy shares. I'm adding Checkfree to Jubak's Picks with a 12-month target price of $35 a
share. (It doesn't hurt that the deal with Integrion also brought Visa, a Checkfree
competitor, into the fold.)
Snapshot
Year-to-Date Chart
I think that Checkfree is a good example of opportunities that this kind of analysis can turn
up. But let me add a few words of advice about how to apply this method. Don't confuse the
"news" of the day with the kind of lever that you need to discover. For example, Ciena
(CIEN), a stock that tumbled $6 a share after Lucent (LU) announced a competitive
product, may indeed face new pressure to cut prices as the buzz had it last Monday and
Tuesday. But the Lucent product isn't due until December -- if everything goes right.
Meanwhile, Ciena has its own new product due out this summer -- one that, while not
matching the announced performance of Lucent's version, is about three times better than
Ciena's current offering.
I think that, in this case, the buzz has actually picked out the wrong lever for attention.
The danger to Ciena isn't pricing pressure, but the possibility that Lucent's announcement
will freeze sales as potential customers put off orders to wait for Lucent to deliver. Suppose
that's what Lucent wanted the press release to do?
And never forget that levers change overnight. Just look at Compaq (CPQ). A few days ago I
would have said that the key to the stock was management's ability to get inventory turns
up from 11 times a year -- the current level -- to the 17 times Dell manages. Progress in that
direction would have gone straight to the bottom line. Well, the acquisition of Digital
Equipment (DEC) pretty much blows up that piece of analysis.
Oh, well. An investor's work is never done. Expect a column on Compaq and who wins and
loses from this deal next time. |
