Last week’s answer

Founded in 1888, I’m a big player in financial services, education, and information and media services. My Standard & Poor’s division offers credit ratings on more than 220,000 securities and funds worldwide, indexes for benchmarking, independent investment analysis and more. I’m the biggest K-12 publisher in America, publish BusinessWeek magazine, and also sport information operations in the health care, construction and energy arenas. I bought Standard & Poor’s in 1966 and television stations in 1972. American Express tried to take over me in 1979. I have 350 offices in 33 nations and take in nearly $5 billion annually. Who am I? (Answer: McGraw-Hill)

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The fool take: Sears’ sad situation

It probably seemed like such a good idea at the time. Sears (NYSE: S) would start offering customers credit cards and reap all the hefty rewards associated with it. For a long time, it did work well, with Sears’ healthy and growing credit unit driving the bulk of the venerable retailer’s operating profits.

My, how times changed. Management must rue the day the company decided to sell more than just washing machines, clothes and tools. For more than two years now, as consumer default rates have risen, Sears has felt the bite of its customers’ own lingering obligations.

In March, Sears announced plans to sell its credit division. In the meantime, the credit monkey isn’t off its back. The credit division’s operating profits in the recent first quarter tanked 10.8 percent to $395 million, a drop of $48 million. The provision for uncollectible accounts grew by $100 million, or 27 percent. Ugly stuff.

Scarier still is that Sears’ credit operations have moved beyond making up a chunk of operating income. In this quarter, the unit produced all operating income, with retail sucking out a $23 million operating loss. A very sick limb is essentially holding up an equally ailing body.

Sears’ management says it will continue to “evaluate strategic alternatives” for the credit segment. We hope they’ll remember to juice their weak retail business, too. Perhaps last year’s purchase of Lands’ End will help.

Dumb investment: All the way down

The dumbest thing I ever did was not taking some of our stock gains off the table when the market was high. I rode them all the way down. I finally sold Enron, AT&T and Qwest when I gave up hope of any quick recovery. — Paul Cherubino, Gladstone, N.J.

The Fool Responds: You’re in good company. As the ’90s drew to a close, too many of us were apparently too giddy or greedy to think clearly and recognize dangerously overpriced stocks for what they were. Remember, though, that most strong long-term performers go through temporary slumps, so hanging on may well be the right thing to do. Unfortunately, some companies such as Enron weren’t healthy firms experiencing temporary slumps — they were frauds conning investors. This is why it’s best before investing in a company to try to understand exactly how it makes its money and to get a feel for how trustworthy its management is. With current holdings, be sure to keep up with their progress each quarter, and if you lose faith in their strength and promise, sell.

The fool school: Capital structure

When you’re getting to know a company as you contemplate investing in it, look into its “capital structure,” which reflects the components of its value and how it finances its operations. A firm’s capital structure will typically reflect one or more of the following: cash, debt financing (borrowing from a bank or issuing bonds), and equity financing (selling a chunk of the company and/or issuing shares of stock).

To understand the concept better, consider some examples.

Imagine a company financed completely through debt. If it’s paying 7 percent interest on its debt but growing earnings at 12 percent yearly, its payments can be met and the financing is effective. The lower the interest rate and the greater the difference between it and the company’s earnings growth rate, the better.

If a company is carrying a lot of debt at high interest rates but is growing slowly, that’s a red flag. Fluctuating earnings can also be problematic, as interest payments may sometimes completely wipe out profits.

Next, imagine a company that raises needed funds only by issuing more stock. This is an appealing option when the market is hopping. The firm’s shares trade at steep prices and buyers are plentiful, so cash is easily generated.

The downside to equity financing, though, is that the value of existing shareholders’ stock is diluted every time new shares are issued. This is OK only if the moolah raised creates more value for the company than the value eroded by dilution. Eventually, many great companies grow so profitable that they can methodically buy back shares, driving up value for existing shareholders.

Finally, imagine a firm that’s financing its operations completely on its own. This means that it’s fueling its growth with the cash created from operations.

The advantage of internally financed growth is that it forces a firm to plan and budget carefully, resulting in (sometimes gradual) value creation for the company’s owners. The weakness is that it can be a slow, grueling process.

Worse yet, competitors effectively issuing debt or stock can fund more rapid growth than this company.

Ask the fool: Some debt is OK

I know debt can be dangerous. But isn’t some debt OK? — L.C., Kansas City, Mo.

It’s very reasonable to carry a mortgage, a car loan, etc. Just pay attention to the cost of the debt. If you’re carrying revolving debt on a credit card that’s charging you 18 percent per year, you’re in trouble. But a student loan charging you 7 percent is much less worrisome.

Consider what else you might do with the money you’d use to pay off a low-interest loan.

Imagine that you’ve borrowed $5,000 at 6 percent and you now have the money to pay it off in full. You could do so. But if you’re bullish about a stock or the market and are fairly sure that, over the next few years or so, you’ll earn at least 10 percent on it per year, on average, you might choose to keep the loan and pay it off gradually, as you originally planned. You can then take the $5,000 and invest it. If the investments perform as expected (not a sure thing), you’ll be earning more than you’re paying out in interest.

If your mortgage rate is low, it makes perfect sense to keep paying it off gradually. If your rate is 7 percent or higher and you plan to stay in the house for at least a few years, consider refinancing, if you can. Mortgage interest brings some tax benefits. Learn more about mortgages and refinancing at www.fool.com/homecenter or www.mtgprofessor.co.

The stock market can’t fall much more than it has over the past few years, right? — R.M., Columbus, Ohio

Sorry. No one knows. It could fall for another three years or have a strong recovery next week.