Last week’s answer

I was founded as a watch-repair business in 1897 by a guy named Otto, and today I run rings around many competitors. My products help create memories and celebrate life’s most important moments. Some of my products are worn, while others are signed or framed. You can find me in schools, in corporate offices, and even at high school proms. I’ve created jewelry for the likes of the Green Bay Packers, the Chicago Bulls and the Detroit Red Wings. The second quarter of the year is by far my busiest one. In 2002 I booked sales of $756 million. Who am I? (Answer: Jostens)

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.

Evaluating companies

When I find a company that has strong sales and earnings growth, what other factors should I examine before deciding whether to invest in it? — T.J., Lake Worth, Fla.

There are many considerations, chief among them being whether it has sustainable advantages over competitors.

On the balance sheet, if inventory levels or accounts receivable are growing faster than sales, that’s a bad sign. Another red flag would be if the company were taking on lots of debt. Two companies performing similarly on the income statement can look very different on the balance sheet.

Examine the statement of cash flows to see how the firm’s cash is being generated. Look at how much investment is required to create earnings. Generally, you want to see most cash coming from ongoing operations — the stuff produced and sold — and not from the issuance of debt or stock or the sale of property.

Also look at the companies’ profit margins (gross, operating and net). Higher margins can suggest that a firm has a proprietary brand or technology it can charge more for. They often indicate a higher-quality company.

You could also examine return on equity and return on assets, comparing a company with its competitors. See which firm is generating more dollars of earnings for each dollar of capital invested in the business. Check previous years’ numbers, to see whether the trends are positive.

Learn more about how to evaluate companies at www.Fool.com and www.Morningstar.com.

What’s an “institutional investor”? — P.B., Amarillo, Texas

Institutional investors are the big guns — they include mutual funds, pension funds, banks and insurance companies. Trading in large volumes, they can account for more than two-thirds of daily market activity.

Pfizer’s foggy financials

The world’s largest pharmaceutical company, Pfizer (NYSE: PFE), increased sales by 11 percent year-over-year in 2001, 12 percent in 2002, and 10 percent in the recently reported first quarter of 2003.

International pharmaceutical sales led the charge, rising 18 percent, while U.S. drug sales climbed 8 percent. Ten Pfizer drugs are on track to top $1 billion in annual sales, including cholesterol-battler Lipitor.

Lipitor’s first-quarter sales alone topped $2 billion (23 percent of Pfizer’s total sales), up 13 percent.

Many news organizations praise Pfizer’s results, relying only on the company’s press release statements and income statement — neither of which addresses the more important cash flow statement and balance sheet.

Ignored is the fact that Pfizer has a subpar cash conversion cycle (CCC). Pfizer’s 2002 CCC was 154 days, meaning that it took the company 154 days to turn a dollar spent on goods sold back into cash. This is up from 144 days in 2001. For comparison, Johnson & Johnson (NYSE: JNJ) clocked in at 57 days in 2001. Pfizer’s slow cash conversion rate isn’t enough reason to avoid the company, but a quicker rate could meaningfully boost free cash flow.

At $31.50 per share, the stock trades at a premium to peers and the total market. The stock has traded in a lofty price range since 1998’s Viagra hype days, and earnings and free cash flow seem to still have some catching up to do.

When to sell

Figuring out whether and when to buy stock in a company is only part of the process for successful investors. You also need to know when to sell — and when not to.

Don’t sell just because a stock or the market is falling, or you’ve heard some rumors about the company, or someone tells you to sell. Do consider selling:

• If you can’t remember why you bought in the first place.
• If the company doesn’t interest you and you don’t keep up with its progress.
• If the stock has become significantly overvalued relative to what you think it’s worth. Consider the tax consequences, though. (If you expect the stock to keep rising in the years ahead, you might do well to just hang on.)
• If you don’t know what the company does, its competitive position, and exactly how it makes money.
• If the company’s financials are deteriorating.
• If you’ll need that money within a few years. Any greenbacks you’ll need in three to five (or more) years should be in a less volatile place than stocks, such as money market funds.
• If you’ve made as much money on the stock as you wanted and expected to.
• If the reason you bought is no longer valid. If you bought shares of eBay for its high profit margins and then eBay buys a large supermarket chain, stop and think. Supermarkets are a different business, with lower margins. You might decide to hang on, but first re-evaluate the holding.
• If you find a much more attractive place to invest your money. If your calculations suggest that a holding is now fairly valued and another stock appears to be undervalued by 50 percent, transferring your dollars might make sense. Again, though, consider tax effects.
• If a stock is your only holding. Portfolios should be diversified. We suggest aiming to hold eight to 15 stocks. If one grows to represent more than 33 percent of your portfolio, consider rebalancing it.
• If you’re only hanging on for emotional reasons.