Archive for Sunday, November 12, 2000

The Motley Fool

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November 12, 2000


Ask The fool:

How much is too much?

How do you know if you have too much of your portfolio invested in one company's stock? G.B., via e-mail

First, think in terms of total value, not number of shares. You might have 1,000 shares of one stock, worth $15,000, and 200 shares of another stock, worth $18,000. Don't think that 1,000 shares is too much or that 200 is too little. Focus instead on the percentage of your portfolio that each stock represents.

If one of your holdings represents 50 percent of your entire portfolio, for example, that's probably too much risk for most people. If anything happens to that one holding, your portfolio will take a big hit. If you hold too many stocks, though, and your biggest holding amounts to just 3 percent of your portfolio, that's not ideal, either. If that stock doubles or triples, its overall effect will be minimal.

For most people, eight to 15 stocks is a good number to shoot for. You want some diversification, but not too much. And you want only as many companies as you can follow. Offering contrary advice is Mark Twain, who said, "Put all your eggs in the one basket and WATCH THAT BASKET."

If I'd invested $10,000 in Yahoo! when it went public, what would that be worth today? - Harrison Liu, via e-mail

Yahoo! came public on April 12, 1996. If you'd invested $10,000 in it then, it would be worth more than $500,000 today. (Of course, Yahoo!'s stock has been quite volatile. Back in January, your holdings would have been worth $2.3 million!) You needn't look for new economy rockets, though. In these recent years of strong market growth, money invested in such consistent performers as Wal-Mart or General Electric would have quadrupled.

Smart investment

This is embarrassing, because I am a retired financial journalist. In 1977 I was posted to London. With each paycheck, I bought silver coins commemorating Queen Elizabeth. I accumulated about 100 and put them away, hoping to reap a tidy profit from them in the future.

I used to gamble in casinos there, too, and kept one 50 pence chip from the Playboy casino as a souvenir. I recently found the coins in my closet and took them to a dealer. Turns out they were just silver-clad, and besides, silver prices are lower now than they were in 1977. In addition, the coins aren't valuable as collectibles. I probably lost 80 percent of the coins' value by inflation alone. Meanwhile, I checked a Web site for casino chip collectors and sold my single Playboy chip for $150. If only I had collected more souvenirs and not bothered with the coins! Tony Licata, via e-mail

The Fool Responds: You demonstrate effectively how unpredictable collectibles can be. Unless you're very familiar with a kind of collectible, it's probably best to collect simply for pleasure, not profit.

The fool school

Price-to-sales ratio

The price-to-sales ratio (PSR) can be useful, but it's not the magic bullet some people take it for.

Part of the PSR's attraction is that it reflects a company's valuation, as opposed to its quality. Measures such as return-on-equity (ROE), profit margins and sales growth can help you determine whether you're looking at an orchid or a weed, but they can't tell you how richly a company's stock is priced or whether it's currently a bargain.

The PSR can be used with just about any company. It's often used with companies not currently generating earnings, taking the place of the price-to-earnings (P/E) ratio (no earnings, no P/E). To calculate the PSR, first determine a company's market capitalization. For this, you multiply the number of shares outstanding by the current share price. Consider Fryyndar and Ulf Pharmaceuticals (ticker: GULPP), whose motto is "Varsd och svlj!" (That's Swedish for "Here, swallow this pill!"). If they have 25 million shares of stock trading around $40 per share, you multiply 25 million by $40 and get a market capitalization of $1 billion.

Next, you divide the market cap by the last 12 months of revenues (a.k.a. sales). Let's say that Fryyndar and Ulf raked in $500 million in revenues last year. If so, divide $1 billion by $500 million and you'll get a PSR of 2.0. If you compare PSRs of companies in an industry, the ones with the lowest PSRs would seem to be the most undervalued.

But hold those horses! You need to consider some more measures, such as profit margins. Wal-Mart recently sported a PSR of 1.3, for example, vs. Microsoft's 14. Wal-Mart might suddenly seem like much more of a bargain, but note that each dollar of sales results in 41 cents of profit for Microsoft, but only 3.4 cents for Wal-Mart. Companies with higher profit margins might deserve higher PSRs.

PSRs also ignore finance troubles, to some degree. If a company is saddled with a lot of debt, for example, its market cap might be depressed, reflecting that. But as the market cap falls, so does the PSR.

Never evaluate any company solely on its PSR or on any other single measure, for that matter.

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