"Trump and 3Com " 3Com reviewed by Jeff Fischer (JeffF@fool.com)
JUPITER, FL (Aug. 13, 1998)
STOCK REVIEW
In our methodical review of each Fool stock, it's time for...
3Com (Nasdaq: COMS)
Stock Price: $28
Market Cap: $10 billion
Trailing Sales: $5.42 billion
Price/Sales: 1.84
Last Qtr Sales: $1.37 billion
Book value: $7.33 per share
Price/book value: 3.8
Recent return on equity: 2.5%
Recent Gross Margin: 45%
Recent Operating Margin: 1.8%
(usually around 16%)
5-year est. growth rate: 25%
Earnings Est: $1.28 in FY99 (ending May)
Earnings Est: $1.93 in FY00
P/E on far earnings estimate: 14.5
What caused the Fool to buy it? Two years ago to the day, the Fool Port sold
the Gap (NYSE: GPS) to buy 3Com (Nasdaq: COMS), a company that was (and
still is) second only to Cisco Systems (Nasdaq: CSCO) in the networking world.
Unfortunately, 3Com is second to Cisco in several ways, including product mix
(3Com's is far less enviable), margins, and growth. In the last three years,
Cisco's stock has compounded 72% annually, while 3Com has lost nearly 10%
annually (the Fool is down 38% on the stock). During the same time, the S&P
500 gained 28% annually. $10,000 invested in Cisco in 1995 is now worth
$50,000. $10,000 invested in 3Com is worth $7,300. Ouch!
OK. Enough bellyaching. But when there's a Cisco in the world, why invest in
3Com?
Well, 3Com is no slouch. It's actually one of the most successful technology
companies of the past decade. When 3Com was bought, the company's earnings
estimates made one think of a Swiss Gondola -- this baby looked like it could only
go higher and then higher. Indeed, within months 3Com had nearly doubled for
the Fool Port. Then something happened.
What has happened since the purchase? Like a meteorite streaking across the
sky, 3Com was afire as it fell. Many people (myself included) found themselves
wishing on this falling star and thinking that an opportunity was afoot as we
watched 3Com fall from $80 to $60, then $50, then $40... until finally it hit the
ocean and its fire was snuffed, sputtering to an eventual bottom $18 below the
sea, at $22.
Growth of the networking industry was slowing for all but the leader (you
guessed it, Cisco). 3Com, Bay Networks, Cabletron, and other networkers paid
the price. Meanwhile, 3Com has primarily been relegated to lower-end product
sales (although network systems sales do represent about half of its revenues,
and growing), and it bought U.S. Robotics just in time for an inventory correction
in modems (which represent almost another half of its sales).
When the networking industry began to slow even modestly, many second tier
players had to fight hard and eventually slashed prices in order to win product
orders away from Cisco. Turns out, Cisco is continuing to win anyway. It's one
of the few networkers still granted a hefty premium price to its growth rate, and
it's still (of late) putting up very impressive sales and earnings growth
quarter-over-quarter and year-over-year, despite Asian woes.
Jump to the present...
We sit, as we have been, on a losing position in what is widely recognized as a
strong, niche leading, usually very profitable company with a respected name. In
history, most fundamentally strong companies have seen their stocks experience
a period of years that they'd rather forget. 3Com might care to forget the past
few years, and why not? The company certainly isn't living in the past. As shared
in the recent conference call, 3Com has a completely renewed line of networking
products now, all launched in the last few quarters. Fiscal 1999 promises to be
considerably stronger than last year, management believes, and the company is
sitting on $1 billion in cash and continues to develop new, often performance
leading and award winning products.
What lessons have been learned? Our 3Com experience reminds one to always
buy the business first, not the "YPEG valuation." I believe if the overall business
and margins were the focus, Cisco might have been bought rather than 3Com.
Sure, 3Com had an attractive YPEG valuation, and if earnings estimates had been
met, this investment could have been a raging success. But, as it turns out,
3Com's business couldn't meet the earnings estimates.
Go back a few years and Cisco might have been considerably more expensive
than 3Com, but it was also (arguably) the stronger business and most likely to
meet its earnings estimates. This reminds that a Fool should always at least
consider the perceived industry leader first, before considering investing in
second- and third-tier players. Thinking of Venus's column from yesterday, do
you marry a second- or third-tier spouse? I certainly hope not. I hope that you
marry the very best that you've found in your life. Likewise, in most cases you
want to invest in the number one leader of any industry. Entire books have been
written on the topic explaining why.
What could cause the Fool to sell? I love to say this, but I also dislike saying it:
3Com has become such a small part of the portfolio (less than 3%) that it
currently hardly matters what we do with it. In a way, that's good. It's survival
of the fittest applied to an individual investor's portfolio. Buffett has this, you
probably have it, and the Fool has it -- your leading stocks become the leaders of
your portfolio. They grow in importance while the significance of your losers
withers, pales, and all but disappears. Perhaps there's a Foolish reminder for
living in this. In your life, amplify the victories and the things that you have to be
happy about, and move beyond and leave behind the failures or imperfections of
your life. In a way, I believe that this is why the Fool Port writers (consciously
or not) give far less attention to the portfolio's losing stocks, be that right or
wrong.
So what might cause us to sell? You've probably perceived by now that the Fool
usually only sells if it finds something better to buy. Even so, it seems
anti-climactic to sell 3Com now. Perhaps the worst is behind it. The stock trades
at 14 times fiscal year 2000 earnings estimates (the company is currently in its
first quarter of fiscal 1999). If estimates are met, we should see a rising share
price. Also, margins should begin to improve again. In fact, on some levels,
3Com's situation reminds me of Intel (Nasdaq: INTC), which I wrote about
tonight in the Drip Port.
Fool on,
Jeff Fischer
fool.com
Mang |
