Archive for Sunday, June 26, 2005

The Motley Fool

June 26, 2005

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Last week's question and answer

Based in Massachusetts, I'm the premier global provider of wireless tracking and recovery systems for mobile assets, leading the world in stolen vehicle recovery for nearly 20 years. My success rate tops 90 percent, and around the world I've recovered more than 150,000 stolen vehicles valued at more than $3 billion. (There are more than a million vehicles stolen each year in America: one every 25 seconds.) You'll find me in 22 states and 25 countries. I employ radio frequency technology that works even when a vehicle is hidden in a steel container, concrete garage or under dense foliage. Who am I?

(Answer: LoJack)

Merck's innovation

Pharmaceutical investors know that there's plenty of uncertainty in the drug sector. Experimental medicines that at first seem promising can, and often do, fail even in the most advanced clinical trials.

At the moment, Motley Fool Income Investor recommendation Merck (NYSE: MRK) may be the poster child of uncertainty. Its Vioxx withdrawal was a major catastrophe. But just how big a debacle it is remains to be seen. Some analysts have put the liability at R18 billion, and given that Wyeth (NYSE: WYE) has taken $21 billion in charges related to litigation over the diet drug fen-phen, that estimate may not be far off the mark.

But there is some good news that at least partially offsets the gloom and doom. Two potentially multibillion-dollar medicines, the human papillomavirus (HPV) vaccine Gardasil and diabetes treatment muraglitazar, appear to be on track to hit the market soon. Merck recently showcased another potential winner: an experimental vaccine for shingles called Zostavax. In April, Merck submitted paperwork seeking FDA approval for Zostavax.

Vioxx is going to be a major drain on Merck. But investors should keep in mind that Merck continues to have some aces up its sleeve. In the near term, the stock probably won't see huge gains, but the company will keep innovating.

Expensive lessons

Like last week's story, I, too, invested in fiber-optics company JDS Uniphase. But during the height of the stock market bubble, I sold it near the top, at more than $100 per share. My son-in-law had just discovered a gem that we were sure would soar. I invested all my profits at about $1 per share. A few years later, it was trading for less than a penny per share. I don't blame him, though - I blame myself. I did his family far more harm than I did to myself because I got them excited during the bubble and they lost most of their savings. I got wiped out on just one investment. Much was learned, but it wasn't free. I'm still holding that dog, hoping for a turnaround. - A.D., via e-mail

The Fool Responds: Many people lost money when the bubble burst. Stocks trading for less than a few dollars per share can be extremely risky. Ask yourself how confident you are in your stock's recovery. If you're not too confident, move what's left to another stock, where you're more likely to see a gain.

Invest while in debt? Sure

We Fools have long advocated stock investing only once you're free and clear of other, more pressing financial obligations. But if you wait until the house is completely paid off, you're robbing yourself of your most powerful tool - time. Time, amount invested and rate of growth are the three drivers of market-beating returns.

If you have debt, you might still invest. Here's how.

¢ If your employer matches a portion of your 401(k) contributions, sock away at least as much as necessary to take full advantage of that benefit, as long as you are not overwhelmed by credit card debt. The hundreds of dollars your employer contributes today - with you contributing just the minimum to get the match - will be worth thousands after a decade or two of growth. Plus, the money that you contribute comes directly out of your paycheck before Uncle Sam takes a sizable bite. While you watch that money grow, get serious about paying off those cards in the next six months to one year.

¢ If you are seriously burdened with credit card debt - able to cover just the minimum payments or a little more - put your investing career completely on hold, and pay off your debt. If your debt carries high interest rates, there is no way invested dollars will be able to outrun what you owe to Mr. Visa. Put all your energy and extra money into wiping it out. We can help you get out of debt at www.fool. com/ccc.

¢ Student loan debt is OK, as long as it comes with a locked-in low rate (perhaps 5 percent-ish). Even better is when the interest you pay is deemed tax-deductible. If that describes your loan, then go ahead and stock up your 401(k) and stuff your IRA until it's full.

Price matters

If I buy stock in a great company at an overvalued price, as long as it keeps going up, won't I still make money in the long run? - L.M., Richmond, Va.

Yes, but it may not keep rising. You're right to think of the long run, but you also need to consider a company's intrinsic value.

Imagine Scruffy's Chicken Shack (ticker: BUKBUK) trading at a fair price of $10 per share. If it's expected to grow at 12 percent per year for the next 10 years, it should trade around $31 per share in a decade.

If you buy it at $10 per share, your total gain over the decade will be 210 percent. However, if you have to pay $15 per share for it now, it will return only a total of 107 percent on its way to $31. That's about 7.6 percent per year. Worse still would be buying it at $20 per share. Sure, you'd make money, but your total gain would be just 55 percent, or roughly 4.5 percent annually. Making matters worse, BUKBUK might not live up to its expectations. When you buy at high prices, you have less of a margin of safety.

Prudent investors aim to buy companies at a discount to their estimated fair value. If you buy at a higher price, you'd better be sure the firm will grow at a reliable pace.

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