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Archive for Sunday, March 30, 2003

The Motley Fool

March 30, 2003

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Last week's answer

Based in the Netherlands and founded in 1891, I'm the world's biggest lightbulb and electric shaver manufacturer. I'm also Europe's largest electronics company, with annual revenues topping $30 billion. I offer such wares as color television sets, lighting, electric shavers, computer monitors, semiconductors, medical diagnostic imaging and one-chip TV products. I employ 170,000 people in more than 60 nations. My brand names include Marantz, Norelco and Magnavox. One in seven television sets and 60 percent of telephones contain my components. I light 30 percent of offices and hospitals around the world. I hold 85,000 patent rights. Who am I? (Answer: Royal Philips Electronics)

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.

Gap's not hot enough

Back in February, giant clothing retailer Gap (NYSE: GPS) upped its fourth-quarter earnings expectations, impressing the market. But it recently reported those fourth-quarter numbers, and they're a bit of a mixed bag.

It wasn't a horrible quarter or fiscal year for the company, but it has an ugly couple of years to rebound from. Fourth-quarter sales improved 14 percent to $4.7 billion, and annual sales inched up 4 percent to $14.5 billion. Sales at stores open a year or more grew 8 percent in the fourth quarter, well above the year-earlier drop of 16 percent. For the entire year, these sales were off 3 percent vs. a year-ago 13 percent decline.

Gap earned $249 million in the quarter, reversing the prior-period loss of $34 million. Higher profit margins, greater cost-cutting and a more favorable effective tax rate boosted its bottom line. But the retailer noted that customers have been reluctant to buy clothes at full price and, as a result, markdowns will reduce profits in the near future.

Another troublesome factor is the relative weakness of the flagship Gap U.S. stores.

Gap's Old Navy division is again the company's workhorse, with total sales up almost 14 percent for the year to $5.8 billion, while stateside Gap store sales were down slightly for the year to $5.1 billion.

In order to truly fashion a turnaround, the company needs to grow sales again at its flagship stores.

The pros doze

My dumbest investing mistake was thinking that investment professionals who manage mutual funds actually know what they're doing. When I invested in mutual funds in the mid- and late 1990s, I mistakenly thought that if the stock market went down, these professionals would sell the stocks that were going down because they would have more information than I did. They would know why these companies were in trouble and would ruthlessly weed them out of my portfolio. How wrong I was. -- Ronald Kangas, via e-mail

The Fool Responds: It's a painful lesson, but even when investment professionals are smart and skilled, they often still work in a system riddled with conflicts of interest and other challenges. Many mutual fund managers, for example, have short-term outlooks because they're judged on short-term results. If they hang onto a falling stock they think will eventually soar, their performance can look bad for a while, not attracting more investors. So they might sell, and instead pursue a less reliable, shorter-term gain. If they didn't earn hundreds of thousands of dollars per year, we'd pity the poor mutual fund managers.

Business models

What is a company's "business model"? -- S.R., Quincy, Mass.

No, it's not Bill Gates in a bikini. A business model is how a company makes its money. To best understand the concept, think of online marketplaces eBay and Amazon.com.

The business model of eBay is to connect individual buyers and sellers online, and to profit by charging fees and by taking a percentage of each sale -- all this without carrying any inventory.

Amazon.com's main model is more capital-intensive, requiring warehouses to store many products, so they can be quickly shipped out to customers.

When evaluating a company as a possible investment, learn exactly how it makes its money. Then think about how attractive and profitable that business model is. Will it permit the firm to grow quickly and to fend off competition? Is the model expensive to maintain?

Is a weak dollar bad for stocks? -- J.T., Las Cruces, N.M.

The U.S. dollar recently hit a multiyear low, which can be good for companies with extensive international operations, such as Procter & Gamble and McDonald's. They'll get more dollars for their rubles and pesos and francs when they exchange currency -- and more dollars means higher earnings.

Imagine that you used to get 10 glopnaks for each dollar, and you now get only five glopnaks per buck. That's the same as 10 glopnaks for two dollars, so you're getting more dollars per glopnak.

Of course, if your business does more buying from foreign countries than selling to them, as is the case with many firms, a weak dollar hurts you.

A weak dollar makes U.S. exports more affordable to foreign buyers and imports more expensive.

Calculating growth rates

When you set out to study a company's financial statements, you'll need to employ a little math (though not much more than multiplication and division). Don't be intimidated. With a little practice, you'll be just fine. Here's a short lesson on calculating growth rates.

Imagine the Rubber Chicken Catering Co. (ticker: CHEWY), with sales of $12 million in 1999 and $48 million in 2002. If you have a fancy calculator, it might actually calculate growth percentages for you, so check the manual. Otherwise, here's what to do:

Subtract $12 million (earlier number) from $48 million (later number), and you'll get $36 million (the difference). That's how much sales grew. Now divide the $36 million difference by the earlier number, $12 million. You'll get 3. We'll call that the growth factor. Finally, let's convert that to a percentage. Just multiply the growth factor, 3, by 100. Voila -- 300 percent.

Note that the sales quadrupled between 1999 and 2002, but the increase is 300, not 400, percent. That might seem wrong, but remember that if you increase something by 100 percent, you're doubling it.

Here are the formulas:

  • New amount minus Old amount = Difference.
  • Difference divided by Old amount = Growth factor.
  • Growth factor multiplied by 100 = Percentage growth.

Try it yourself. Wal-Mart's sales for the year ended in January 2003 were $245 billion. In the previous year, its sales were $218 billion. By what percentage did sales grow over the year?

(The answer is ... the same number you get if you divide the number of letters in the alphabet by two and then subtract one.)

Once you master this calculation, you can evaluate how quickly metrics like a company's sales, earnings, inventory levels, accounts receivable, cash and debt are growing. Then you can compare the results with those of its competitors. Insights galore!

A little time spent learning how to crunch a few key numbers can help you make much better investment decisions.

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