The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [194]
Stryker was in a different league. Over the last four quarters, the company had generated $301 million in net income. Stryker’s book value was $570 million. So the company was trading at fat multiples of 30 times its earnings over the past 12 months and nearly 16 times its book value. On the other hand, from 1992 through the end of 2001, Stryker’s earnings had risen 18.6% annually; its dividend had grown by nearly 21% per year. And in 2001, Stryker had spent $142 million on research and development to lay the groundwork for future growth.
What, then, had pounded these two stocks down? Between July 9 and July 23, 2002, as WorldCom keeled over into bankruptcy, the Dow Jones Industrial Average fell from 9096.09 to 7702.34, a 15.3% plunge. The good news at Ball and Stryker got lost in the bad headlines and falling markets, which took these two stocks down with them.
Although Ball ended up priced far more cheaply than Stryker, the lesson here is not that Ball was a steal and Stryker was a wild pitch. Instead, the intelligent investor should recognize that market panics can create great prices for good companies (like Ball) and good prices for great companies (like Stryker). Ball finished 2002 at $51.19 a share, up 53% from its July low; Stryker ended the year at $67.12, up 47%. Every once in a while, value and growth stocks alike go on sale. Which choice you prefer depends largely on your own personality, but bargains can be had on either side of the plate.
Pair 7: Nortel and Nortek
The 1999 annual report for Nortel Networks, the fiber-optic equipment company, boasted that it was “a golden year financially.” As of February 2000, at a market value of more than $150 billion, Nortel’s stock traded at 87 times the earnings that Wall Street’s analysts estimated the company would produce in 2000.
How credible was that estimate? Nortel’s accounts receivable—sales to customers that had not yet paid the bill—had shot up by $1 billion in a year. The company said the rise “was driven by increased sales in the fourth quarter of 1999.” However, inventories had also ballooned by $1.2 billion—meaning that Nortel was producing equipment even faster than those “increased sales” could unload it.
Meanwhile, Nortel’s “long-term receivables”—bills not yet paid for multi-year contracts—jumped from $519 million to $1.4 billion. And Nortel was having a hard time controlling costs; its selling, general, and administrative expense (or overhead) had risen from 17.6% of revenues in 1997 to 18.7% in 1999. All told, Nortel had lost $351 million in 1999.
Then there was Nortek, Inc., which produces stuff at the dim end of the glamour spectrum: vinyl siding, door chimes, exhaust fans, range hoods, trash compactors. In 1999, Nortek earned $49 million on $2 billion in net sales, up from $21 million in net income on $1.1 billion in sales in 1997. Nortek’s profit margin (net earnings as a percentage of net sales) had risen by almost a third from 1.9% to 2.5%. And Nortek had cut overhead from 19.3% of revenues to 18.1%.
To be fair, much of Nortek’s expansion came from buying other companies, not from internal growth. What’s more, Nortek had $1 billion in debt, a big load for a small firm. But, in February 2000, Nortek’s stock price—roughly five times its earnings in 1999—included a healthy dose of pessimism.
On the other hand, Nortel’s price—87 times the guesstimate of what it might earn in the year to come—was a massive overdose of optimism. When all was said and done, instead of earning the $1.30 per share that analysts had predicted, Nortel lost $1.17 per share in 2000. By the end of 2002, Nortel had bled