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STREET WISE by Amey Stone	July 21, 1999

It's getting to be quite a familiar story this earnings season: A company reports quarterly results that far exceed analysts' estimates -- and its stock price falls. That dynamic brought about a major slide in technology stocks (as well as the broader market) on July 20 as investors took profits following the stellar earnings gains reported the day before by tech bellwethers IBM (IBM) and Microsoft (MSFT). Both companies also hinted that the year's second half might not be so favorable, which spooked investors. The Dow Jones industrial average fell 192 points, or 1.71%, and the Nasdaq Composite fell 98 points, or 3.5%.

Lexmark International Group (LXK), a Lexington (Ky.) company that makes printers and related supplies, is another technology high-flyer that reported earnings on July 19 and suffered the same sell-off afterwards. On the morning of July 19, the former IBM spin-off reported second-quarter earnings of $75 million, or 55 cents a share. That easily beat consensus analyst estimates of 49 cents and was 45% higher than earnings of 38 cents Lexmark reported in the second quarter of 1998. Revenues were $817 million, an increase of 17% over 1998's second quarter. Yet the stock fell 1 1/16 points that day, followed by a 3 15/16 point drop on July 20. It closed on the 20th at 60 7/8 -- a 7.5% drop since the positive earnings reports.

Hand-wringing news? Not exactly. This kind of sudden slump can give buy-and-hold investors an opportunity to build a position in a dependable stock with long-term growth potential. Indeed, Lexmark's stock may have been a little too hot for more conservative investors to handle in 1998, when it nearly tripled in price and earnings per share grew by 57%. But this year, the returns have been more tepid, and some momentum investors may have bailed out. While the stock is up about 20% year-to-date, it has essentially been treading water for the last two months. Since printer sales are tied to PC sales, Lexmark trades in sympathy with PC stocks, which have stumbled recently on fears of slowing demand and intense price competition. But Lexmark is more stable than its PC brothers because competition, while stiff, isn't as fierce in the printer business as it is in computers, and sales of low-cost PCs only help its business.

PROFITABLE INK. Lexmark has a two-tiered strategy. For sales to the corporate market, it targets specific industries, selling laser printers to pharmacies, retail stores, bank branches, and automotive shops that have been designed for their particular uses. For retail customers, Lexmark makes high-quality, low-cost inkjet printers. Its consumer strategy is to sell as many printers as possible and boost profits with sales of high-margin ink cartridges.

This is the side of Lexmark's business that has Wall Street excited. Growth in the Internet as well as the sale of cheap PCs have stimulated demand for Lexmark's inexpensive printers. The company recently lowered the price of its Z11 color inkjet printer to a skimpy $49 (including rebate) from $89. The price cut raised a few eyebrows from analysts. Merrill Lynch's Steven Milunovich noted in a July 20 report that the move surprised him since the company was already facing supply constraints (it's now building more manufacturing capacity) and was earning favorable reviews to competitor Hewlett-Packard's Apollo printer.

But other analysts cheered. BancBoston Robertson Stephens analyst Alex Mou reiterated his buy rating on the news, since he thinks the lower cost will dramatically increase the user base. "We think inkjets are going to be the catalyst for Lexmark," he says. Gains in market share will drive the stock higher, predicts Ben Reitzes, a PaineWebber analyst. He estimates that Lexmark has 18% share of the retail inkjet market in the U.S. (including its sales of Compaq-branded printers) and believes it will be up to 20% by yearend. His price target is $80.

A TOP TECHIE. Lexmark has also reported other positive financial news. The second quarter of 1999 was its 15th straight quarter of earnings growth. Its stock split 2-for-1 on June 10. It repurchased $1.3 million in stock in the quarter, and its board has authorized $273 million more in stock buybacks. And, in June, it earned the No. 11 spot on Business Week's 1999 listing of the top 100 technology companies.

Lexmark's stock is a bit cheaper now than it was days ago, but hardly cheap. It's trading roughly in line with the S&P 500 based on 2000 earnings. "Lexmark has excellent momentum, but the stock's valuation seems to fairly reflect the company's prospects, and we are maintaining our neutral rating," wrote First Albany analyst Pete Enderlin in a July 20 research note. But Mou believes Lexmark has the kind of earnings predictability that investors should pay a premium for. "I think the price is relatively low," he says.

Mou does note a potential cloud for Lexmark. The company expressed concern to analysts that corporate buying might slow in the fourth quarter as the Year 2000 date change approaches and companies "lock down" their technology spending in preparation. But if Y2K causes a slump in the fourth quarter, he thinks Lexmark will be less affected than many other technology companies, thanks to its strong retail business. Investors worried about that dynamic should stay away from tech stocks in general for a while. But long-term investors looking for a company with a strong track record and a proven growth strategy might do well by keeping an eye on Lexmark.

Stone is an associate editor at Business Week Online _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

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