Archive for Sunday, March 10, 2002

The Motley Fool

March 10, 2002

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Last week's answer

I'm the product of a merger in 1986 of two well-known soft-drink companies. In 1995, I was acquired by Cadbury Schweppes. One of my main brands is America's oldest major soft drink, first made in Waco, Tex., in 1885. (Contrary to rumors, it's not flavored with prunes.) My other key brand was first called Bib-Label Lithiated Lemon-Lime Soda, and no one remembers how it got its current alphanumeric name. It sold well during World War II because it required less (rationed) sugar than other sodas. I'm North America's largest non-cola soft drink company, with 16 percent of the market. Who am I? (Answer: Dr Pepper/7UP)

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.

A different March Madness

With its merger vote just weeks away, the fireworks show no sign of winding down in the proposed pairing of Hewlett-Packard and Compaq.

The Hewlett-Packard founding families have been protesting the course the company is taking in its attempts to swallow troubled computer-maker Compaq, and now the dissension is spilling over into the institutional investor ranks. This battle is still too close to call before the March 19 date with the ballot box.

While Hewlett-Packard CEO Carly Fiorina continues to champion the companies as two interlocking puzzle pieces, board member and corporate namesake Walter Hewlett is urging the company to forget all the Compaq nonsense, trim some of the company's own fat, and focus on its printing stronghold.

Recently, while conceding that the merger would be saddled with $1.4 billion in one-time charges against earnings, Hewlett-Packard continued to pound the table on the "accretive" nature of the deal (meaning it will add value to the company). While Wall Street is expecting the company to earn $1.35 a share in fiscal 2003, add in Compaq's projected earnings and adjust for the new shares that will be issued, and it is up to $1.51 a stub.

Hewlett-Packard has taken to running full-page ads to sell the deal to the public. It's going to be March Madness, folks. Grab a good seat for the rest of the show.

Healthy, wealthy and wise

My husband and I found ourselves in our 50s without any retirement funds other than Social Security. We had an opportunity to buy our neighbor's home, so I sold my car, used the money for a down payment and bicycled to work each day for two years. Later, we were able to buy another neighbor's home and the bike was put back into service. Two years before my husband's 62nd birthday, we began paying off our home and both rental houses by applying all rents and all of my husband's paycheck to our debts. We lived on my paycheck. It worked! He retired with all our property debt-free. Our property has proven to be the very best investment we could have made, well worth riding a bike to work for several years! Theresa Rucker, Port Charlotte, Fla.

The Fool Responds: If you know what you're doing, real estate investments can be profitable.

But it's often best not to think of your primary dwelling as an investment, since most of that money will usually remain tied up.

Priced for perfection

What does it mean when someone says, "The stock is priced for extraordinary growth"? I.R., Peoria, Ill.

A similar phrase is "the stock is priced for perfection." It means that the stock's price is steep so steep that those investing in it at the current price must be expecting extraordinary growth and perfect execution of the company's strategy. If the company were to stumble, or sales to slow, then the stock price would likely retract, too. A very sensible way of investing is "value investing," which involves looking for stocks that are selling for significantly less than you think they're worth. This approach can minimize your downside risk. Other investors prefer looking for high-flying stocks, many of which are "priced for extraordinary growth." If such growth happens, the stock may continue to rise. But anything less can spell trouble.

The P/E ratio

You probably see price-to-earnings (P/E) ratios everywhere, but you may not know the particulars. The P/E ratio is a measure that compares a company's stock price to its earnings per share (EPS) for the previous 12 months. Think of it as a fraction, with the stock 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 Wanton Punctuation (ticker: ?#$@!), trading at $30 per share. If its EPS for the last year (adding up the last four quarters reported) is $1.50, just divide $30 by $1.50 and get a P/E ratio of 20.

Note that if the EPS rises and the stock price stays steady, the P/E will fall and vice versa. For example, a stock price of $30 and an EPS of $3 yields a P/E of 10. You can calculate P/E ratios based on EPS for last year, this year or future years.

Since published P/E ratios generally represent a stock's current price divided by its last four quarters of earnings, they reflect past performance. Intelligent investors should really be focusing on future prospects.

You can do that by calculating forward-looking P/E ratios. Simply divide the current stock price by coming years' expected earnings per share, available via many online stock quote providers.

Many investors seek firms with low P/E ratios, as they can indicate beaten-down companies likely to rebound. (Of course, a low P/E may also indicate a company that's about to fall further.)

Low P/Es might be attractive, but understand that P/Es vary by industry. Car manufacturers and banks typically sport low P/Es (often in the single digits), while software and Internet-related companies command higher ones (often well north of 30).

It can be good to examine the earnings growth rate along with the P/E. A company with a P/E of 40 that's expected to grow earnings by 50 percent next year is most likely a better value than a company with a P/E of 20 growing earnings 4 percent annually.

The P/E ratio is useful, but don't stop your research there. There are many other numbers to examine when studying a stock.

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