Advertisement

Archive for Sunday, August 11, 2002

The Motley Fool

August 11, 2002

Advertisement

Name That Company

I'm the world's largest chewing gum company, with such brands on my shelves as Juicy Fruit, Doublemint, Big Red, Extra, Freedent, Orbit and Winterfresh. I was launched in Chicago in 1891, and my founder's descendants still run me. My founder initially sold soap, and began offering free gum as a bonus to soap buyers. I sell about half the gum in America and also sell in 140 other nations. My market share in Europe tops 80 percent. I'm now developing gums that deliver medicine, such as Surpass, for heartburn. I rake in more than $2 billion per year. Who am I? (Answer: Wrigley)

Know the answer? Send it to us with Foolish Trivia on the top and you'll be entered into a drawing for a nifty prize! The address is Motley Fool, Box 19529, Alexandria, Va. 22320-0529. Send questions for Ask the Fool, Dumbest (or Smartest) Investments (up to 100 words), and your Trivia entries to Fool@fool.com.

How to invest

I hear about putting money into mutual funds, index funds and individual companies, but how do you do that? R.J.N., via e-mail

Great question. Here are a bunch of possibilities:

You can invest in most mutual funds either through an account you set up at a brokerage, and/or through the mutual fund's parent company. Some funds have small minimum initial investment requirements (such as $1,000) and others have high minimums (such as $10,000 or more). A good place to look up mutual fund track records, fees and phone numbers is www.morningstar.com. Remember that for many investors, index funds are the best mutual fund bet. For more on mutual funds and index funds, drop by www.indexfunds.com or www.fool.com/school/mutualfunds/mutualfunds.htm.

To open a brokerage account, just read up on a variety of brokerages and see which one best fits your needs. (Compare minimum investment amounts, fees, range of mutual funds offered, etc.) Then fill out an application and mail it in with a check. Through a brokerage account, which can often be opened with as little as $500, you can buy and sell shares of stocks, mutual funds and more. For more information on finding a brokerage, visit www.broker.fool.com.

Finally, look into investing in companies directly, bypassing brokerages, through direct investing plans (DRIPs). Learn more at www.themoneypaper.com, www.netstockdirect.com, or www.fool.com/School/DRIPs.htm.

Can you recommend any mutual funds besides index funds? J.W., via e-mail

Yup. Here are a few (of the many out there) with good track records whose managers we admire: the Legg Mason Value Fund (ticker: LMVTX, 800-577-8589), run by William Miller III; the Longleaf Partners Fund (ticker: LLPFX, 800-445-9469), run by Mason Hawkins; and the Oakmark Fund (ticker: OAKMX, 800-625-6275), run by William Nygren.

S&P 500 goes All-American

The S&P 500, the flagship stock market index of Standard & Poor's Corp. and a common benchmark for the overall stock market, has just made a major policy change. As of July 19, its component companies based outside the United States were removed, replaced by businesses based here in America. This makes the index a true barometer of America's (and only America's) leading corporations.

Removed were the following: Royal Dutch Petroleum, Unilever, and five Canadian companies: Alcan, Barrick Gold, Nortel Networks, Placer Dome and Inco. Added were: Wall Street investment bank Goldman Sachs, delivery giant United Parcel Service, life insurers Principal Financial and Prudential Financial, online marketplace eBay, video game publisher Electronic Arts, and integrated IT solutions provider SunGard Data Systems.

Since hundreds of millions of dollars are invested in index funds tracking the S&P 500, all these funds had to sell their shares of the outgoing firms and snap up shares of the incoming firms. The changes will affect the Canadian stock market, too, since the Canadian companies removed made up roughly a tenth or more of several major Canadian indexes.

Standard & Poor's expects that these changes will result in lower operating expenses for index funds and exchange-traded funds, which might translate into even lower fees for these investments. By the way, the Fool has long recommended index fund investing learn more about it at www.indexfunds.com and www.fool.com/school/mutualfunds/mutualfunds.htm.

Earnings yield

Many investors look at a company's price-to-earnings ratio, or P/E, to get an idea of its relative price. An alternative is to calculate the P/E's inverse the earnings yield.

As an example, to calculate the P/E of Oxygen Bars International (ticker: HOTAIR), you simply divide the current stock price by the annual earnings per share (EPS). If its current annual EPS is $2 and the stock is trading for $74 per share, the P/E is $74 divided by $2, or 37. While 37 might seem steep, it's not meaningful until you compare it with the P/E ratios of industry peers and consider its growth prospects. A high P/E means the market is assuming rapid growth, which may or may not be reasonable.

To calculate Oxygen Bars' earnings yield, just reverse the P/E ratio, dividing the annual EPS by the current stock price: $2 divided by $74 equals 0.027, or 2.7 percent. Compared to risk-free Treasury bond rates of roughly 4 percent to 5 percent, this doesn't seem a bargain. But remember: Whereas bond rates are fixed, earnings typically grow. If Oxygen Bars is expected to increase earnings by 10 percent per year, in 10 years its EPS should grow to $5.19. Assuming we bought our shares at $74, the earnings yield for us has now become 7 percent, considerably better. ($5.19 divided by $74 is 0.07.)

It can be instructive to see how long it takes for the growing earnings yield to pass the current 30-year bond rate, which is now about 5.4 percent. Oxygen Bars passes it in eight years.

If your desired rate of return for your invested dollars is 15 percent, it will take nearly 20 years of earnings growth before the earnings yield of Oxygen Bars beats that target if earnings actually grow at the estimated pace. You can probably find other investments that will get you there more quickly. With riskier companies, you might look for them to pass your target rate sooner rather than later.

One of many tools for investors, the earnings yield can help you think more clearly about your expectations for investments.

It's a small stock

In 1992, I was excited about finally having a few dollars to invest in stocks. Since my heart is with Disney and given Disney's strong track record as a stock, I invested nearly $3,000 in Euro Disney stock. A few years later, I was left with stock worth just $273. So much for my heartfelt investment. P.C., Tampa, Fla.

The Fool Responds: You were right to look for investments among industries and companies you're familiar with and would enjoy keeping up with. But, as you now know, that's not enough. You need to be sure that the company is healthy, growing, and in a strong competitive position. Those new to investing should perhaps consider starting out by investing only in an index fund that tracks the overall market.

Commenting has been disabled for this item.