Archive for Sunday, July 16, 2000

Motley Fool

July 16, 2000



Burn Rate

Q: What's a "burn rate"? -- C.R., LaCrosse, Wis.

A: A company's burn rate refers to how quickly it's burning through cash. This isn't that much of an issue for large, established companies, but with small and quickly growing enterprises, it's valuable to look at their burn rate. The number to examine is free cash flow, which is income from operations, less capital expenditures.

For example, take a gander at the woman-oriented Web site iVillage. It lost $93 million in 1999, on revenues of $45 million. In its most recent quarterly report, the company reported negative $23 million in free cash flow, as its cash balance fell to $83 million from $106 million in the previous quarter. It's not unusual for firms to lose money in their early years, but it is important for investors to evaluate how much money those firms are taking in and using up. In iVillage's case, at its current burn rate it'll use up its cash hoard in just a few quarters. In order to stay alive, the firm will have to either reduce spending (possibly resulting in slower growth), or find some more money (perhaps taking on debt or issuing additional stock, diluting value for existing shareholders).

Q: I've just heard about pet health insurance. Do you recommend getting some? -- P.F., Greensboro, N.C.

A: Pet insurance can be extremely worthwhile. Without it, you face the possibility of one day having to decide whether to spend thousands of dollars to save a furry friend's life. Pet insurance premiums range from $100 to $300 per year. More and more companies are offering pet insurance to employees. If yours doesn't, ask for it. In the meantime, look into insurers such as Veterinary Pet Insurance ( or 800-872-7387) and Premiere Pet Insurance ( or 877-774-2273).


The P/E Ratio

Our friend the P/E ratio is perhaps the most widely known measure of a company, other than its stock price. People may have some misconceptions about it, though. First, let's examine what it actually is.

The "P" stands for price and the "E" for earnings. So it's simply a measure that compares a company's stock price to its earnings per share (EPS). Think of it as a fraction, with the price on top and the EPS on the bottom. Alternatively, tap the price into your calculator, divide by EPS, and voila -- the P/E.

Consider Legal Beagles (ticker: ARFFF), a company that provides legal advice for house pets. Its stock is trading around $50 per share. If its EPS is $2, you just divide $50 by $2 and get a P/E ratio of 25. Another way to express this is to say that ARFFF is trading at a multiple of 25. If you buy a share of ARFFF at $50, you're paying $25 per dollar of earnings.

If a company's EPS rises and the stock price stays steady, the P/E will fall -- and vice versa. For example, a stock price of $50 and an EPS of $5 yields a P/E of 10. Conversely, if the stock price falls to $20 and the EPS remains at $2, the P/E will also be 10.

Note that you can calculate P/E ratios based on EPS for last year, this year or future years. And with young (or struggling) companies that have losses instead of earnings, a P/E ratio can't be calculated at all.

People often assume a low P/E is good and a high one bad. Well, things aren't that simple. Each industry is different. It's common, for example, to see car manufacturers sporting P/Es in the single digits, while software enterprises might have P/Es of 40 or more. If you're going to do any comparing, compare a firm only to its peers.

Another key consideration is how quickly a company is growing. The faster a firm is increasing its revenues and earnings, the higher a P/E ratio it merits.

The P/E ratio is useful, but it should always be just one of many tools in your investor toolbox.


Watch That Broker

Beware of brokers! Mine sold index options in an up market as insurance against margin calls in a down market -- a clever way to take my money by excessive transactions and commissions. As the market rose, he rolled index calls and puts up and down. He churned my account for 49 transactions and $8,065 in commissions in four months. He lost $86,153 on index options and had margin losses of $146,849 on stocks on which stock calls were exercised and $1,888 on stock dividends. My total loss exceeded $230,000. Beware! - R.E.E., Salt Lake City

The Fool Responds: Yikes. We've long warned people about how most brokers work in a flawed system, where they're compensated according to how many transactions they generate. That's why, as Fools, we prefer to manage our own money. Some brokers will do a great job, though. Just don't assume that yours is one of them without checking first. See what kind of returns he's earned you, net of fees, and compare those to overall market returns.

Foolish Trivia

Founded in 1964 and based in Boston, I'm the world's leading media, research and trade show company for information technology, serving millions of people in some 90 nations. I employ more than 12,000 people and rake in more than $2.5 billion per year. I publish 300 newspapers and magazines, including Computerworld and Macworld. I also publish the "For Dummies," "Cliffs Notes" and "Frommers" books, among others. ("For Dummies" features more than 400 titles, with more than 75 million books in print.) I host more than 160 conferences, such as LinuxWorld, Macworld Expo and ComNet. My 575 research analysts serve nearly 4,000 clients. Who am I?

Last Week's Trivia Answer: My roots can be traced back to a European chemical company in 1900. Today, based in Manhattan, I'm a world leader in odors and tastes. With offices in more than 35 nations, 70 percent of my sales are generated abroad. I help you, your soaps and many of your household products smell better. Since so many of my scents are proprietary, my competitors would have trouble creating a winning fragrance without using my components. My flavors are used in processed foods, snacks, beverages, dairy products, confectionery, baked goods, pharmaceutical and oral care products. I rake in $1.4 billion annually. Who am I? (Answer: International Flavors and Fragrances)


Bio and Tech

Motorola recently announced a deal with biotechnology firm SurModics. Motorola will pay SurModics at least $25 million, and in return will have exclusive rights to SurModics' Photolink technology to use in developing its biochips. As part of the deal, Motorola will also invest an undisclosed sum in SurModics.

This may surprise those who follow Motorola, a company specializing in mobile phones, pagers, networking equipment, semiconductors and that sort of thing. In its press release, the company explained:

"Motorola BioChip Systems was established in 1998 to develop products that enable the delivery of better healthcare through the understanding and practical application of genomics. The business unit is currently developing a family of biochip products and services for research and diagnostic applications. The products under development at Motorola BioChip Systems will enable scientists and healthcare professionals to quickly and accurately analyze the DNA, RNA and proteins in living cells. In the future, the outcomes from this work will lead to the delivery of faster and more individualized healthcare."

Companies are free to enter whatever industries and business lines they choose, even ones seemingly opposite from those they currently compete in. Motorola's investment of significant resources into a new biotechnology unit demonstrates belief that the sector holds a great deal of promise. It's hard to disagree with that.

Investors intrigued by the intersection of computing technology and biotechnology, should keep an eye on this development. Other companies, such as Affymetrix, are also involved in merging chips and biotechnology.

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