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Archive for Sunday, January 27, 2002

The Motley Fool

January 27, 2002

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Last week's answer

My founder launched me as a baby furniture store in Washington, D.C., in 1948. He soon realized that his customers also were looking for toys. Today I rake in more than $11 billion per year. I operate more than 1,600 stores roughly 700 in the United States, 500 in more than 25 other countries, 180 special clothing stores, 160 baby-focused units and about 50 "Imaginarium" stores. In 2000, I announced a 10-year partnership with Amazon.com to create a co-branded online store. I've also signed branding and/or licensing agreements with the likes of Scholastic, Animal Planet, Home Depot and OshKosh B'Gosh. Who am I? (Answer: Toys R Us)

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.

Military tax breaks

Are there any special tax breaks for military personnel? C.H., Flint, Mich.

There are indeed some breaks and protections. The first document that any member of the armed forces should read is IRS Publication 3 "Armed Forces' Tax Guide" which outlines many of the issues that affect our men and women in uniform. Some of the more beneficial provisions include:

The exclusion from income of combat pay and some other allowances and payments.

The deductibility of travel expenses for reservists.

Tax forgiveness for those who die in active service in a combat zone or from an injury received in a combat zone.

Other protections exist under the Soldiers' and Sailors' Civil Relief Act of 1940. While many in the armed forces are aware of the tax issues relative to their service in the military, some still are not familiar with the protections provided by the Civil Relief Act, which offers, among other things, protection from eviction, delay of civil court actions and reduced interest rates (6 percent maximum) on mortgage loans and credit card debt.

Learn more at www.defenselink.mil, www.irs.gov and www.Fool.com/taxes.

What's the Dow Jones industrial average? K.J., Lake Worth, Fla.

"The Dow" is an index of 30 major U.S. companies chosen to represent U.S. industry. The current list: Alcoa, American Express, AT&T, Boeing, Caterpillar, Citigroup, Coca-Cola, DuPont, Eastman Kodak, Exxon Mobil, General Electric, General Motors, Hewlett-Packard, Home Depot, Honeywell, Intel, IBM, International Paper, J.P. Morgan Chase, Johnson & Johnson, McDonald's, Merck, Microsoft, Minnesota Mining & Manufacturing, Philip Morris, Procter & Gamble, SBC Communications, United Technologies, Wal-Mart and Walt Disney.

Rumor didn't have it

I invested $500 in a company that I did not know anything about. I'd heard through industry rumors that it was ripe for a merger that would push its price up.

I bought 100 shares at $5 and watched it rise to $12, then split. A year later, it was back down to $5. I sold it, but learned a lesson: Although I gained a little, I should have researched the company on my own and not put much stock in industry rumors. Three years have passed, and it's still an independent company. Vicki A., Cincinnati

The Fool Responds: Touch. It's tempting to buy stocks on promising rumors, but many of those rumors never prove true. Even if this expected merger was indeed in the works, it might have fallen through. Before plunking down your hard-earned dollars on any investment, learn as much about it as you can and focus on facts, not rumors. You're lucky that you made money on this lesson!

Investors: Beware of 'fake' earnings

Understanding companies' earnings reports has recently become more difficult, thanks to the Financial Accounting Standards Board (FASB) ruling 142 on goodwill.

"Goodwill" is money that a company pays in an acquisition above the actual value of assets received. If Company A buys Company B for $100 million and Company B has assets only worth $60 million, Company A would write off the extra $40 million that it "lost" in the acquisition. Companies would amortize such losses (kind of like depreciating it) over a period not to exceed 40 years.

Under the new ruling, goodwill is still recognized as an asset, but automatic amortization of goodwill is no longer allowed. Companies must instead perform an annual test to determine "impairment of value" for their acquisitions. This means valuing all acquisitions (as separate business units) each year to determine whether their value has fallen or risen in relation to the price paid.

Many companies are struggling with the new rules, but few are complaining loudly. That's because FASB 142 will cause merger and acquisition costs to decline radically at least on paper. For example, AOL Time Warner recently reported that its net income could surge by as much as $6 billion this year due to the new rules. It previously had a great deal of goodwill to automatically amortize, and now it doesn't.

Higher net income sounds great, but this isn't real money. Will companies clearly state where these increased earnings are coming from? Probably not clearly enough, as companies like to report results as positively as possible. Additionally, since 2001 was a difficult year, some upcoming year-over-year "growth" numbers will be deceivingly impressive.

So what can you do? Read earnings reports thoroughly. When the cash flow statement is available, determine how much free cash flow (cash from operations minus capital expenditures) was generated. Additionally, in some cases you'll want to avoid companies relying on an acquisition strategy to grow, because they'll have more confusing financials.

Finally, if owning individual stocks proves too nerve-wracking for you (heck, even the companies themselves are confused by new accounting practices), invest in an index fund instead and rest easier.

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