Last week’s question and answer

I came to life in 1851 as a four-page publication. Adolph Ochs bought me in 1896, beefed up my writing staff, and added a book review section and magazine. A photograph graced my front page for the first time in 1910. Ochs’ son-in-law Arthur Sulzberger took over in 1935. I published my first Sunday crossword puzzle in 1942 and went public in 1967. I publish The International Herald Tribune, The Boston Globe and 17 other newspapers. I own eight television stations and two radio stations, and I run more than 40 Web sites. I’ve won 111 Pulitzer Prizes. Who am I? (Answer: The New York Times

Enterprise value

You may be familiar with market capitalization, which is a company’s number of shares outstanding multiplied by its current share price. It’s like a price tag, showing what you’d have to pay to buy every share of it. But market cap ignores debt – and with some companies, debt is substantial, changing the picture significantly. Enterprise value is a modification of market cap, incorporating debt and cash.

Imagine two companies with equal market caps. One has no debt on its balance sheet, while the other is debt-heavy. Whoever owns the second company will be stuck making lots of interest payments over the years. They may have equal market caps, but one is worth more.

Next, imagine two companies with equal market caps of $50 billion and no debt.

One has negligible cash and cash equivalents, and the other has $5 billion. If you bought the first company for $50 billion, you’d have a company worth, presumably, $50 billion. But if you bought the second company for $50 billion, it would have cost you just $45 billion, since you instantly have $5 billion in cash.

To calculate enterprise value, start with a company’s market cap, add debt (found on a company’s balance sheet) and subtract cash and investments (also on the balance sheet). To get total debt, add together long- and short-term debt.

Let’s examine Goodyear Tire. It recently sported 208 million shares outstanding, trading around $13.25 each, for a market cap of $2.8 billion. To that, we add its $5.4 billion in debt and subtract its $1.7 billion in cash and cash equivalents. The result is $6.5 billion, a significantly higher number than the market cap.

If you paid $2.8 billion for Goodyear, you would actually be ending up with a total bill of $6.5 billion, as Goodyear comes with a lot of debt. The enterprise value represents a company’s economic value and reminds all investors that while debt can be used effectively, it is a cost to the business.

Learn more about how to study companies at www.fool.com/school and in “One Up On Wall Street” by Peter Lynch and John Rothchild (Fireside, $14).

Smart then dumb

My dumbest investment started out as my smartest investment. Near the end of September 1998, I bought 100 shares in Optical Coating for $16 each. The company agreed to merge with JDS Uniphase in 2000, giving me 185 shares of JDSU, which were soon worth almost $57,000. My brother-in-law, an accountant, advised me to sell everything. I was worried about the capital gains taxes, but he said I’d still wind up way ahead. I didn’t sell. The shares split the following week, giving me 370 shares, and then they proceeded to collapse. Almost five years later, with the current price around $2 per share, my investment is worth less than half of the price I paid, and I don’t think I’ll have to worry about capital gains taxes. – Arthur Tuchfeld, Montville, N.J.

The Fool Responds: You’re smart to consider taxes when investing. For example, it can be best to hang on to shares of stock you believe in for at least a year, to take advantage of preferable long-term capital gains tax rates. But it’s hard to avoid paying capital gains taxes – unless you have capital losses.

Clorox gets bleached out

High commodity prices are starting to bite into corporate profits. Accordingly, Clorox (NYSE: CLX) recently posted disappointing results for its third quarter.

Total sales were up about 3 percent over last year. While sales in Latin America were once again quite strong, and sales of home care, litter and Glad products were good, there was weakness in more seasonal product categories such as charcoal, auto care and salad dressings. Gross profit margin dropped as commodity costs took their bite, and net profits were down more than 6 percent. Not surprisingly, operating cash flow was also affected.

Clorox isn’t exactly a scintillating company or stock, but it’s done pretty well during the past 10 years. What’s more, it now trades at a discount to its industry and much bigger competitors such as Colgate-Palmolive (NYSE: CL) and Procter & Gamble (NYSE: PG).

The company faces some challenges, such as dealing with high commodity costs and increasingly powerful retailers like Wal-Mart (NYSE: WMT), but the company has at least a few things going for it. Its brands are well-known, it generally generates good cash flow, and management has a track record of sharing cash with shareholders.

Given that Clorox still has a double-digit return on assets, decent profit margins, and a reasonable valuation, it’s a candidate for investors looking to add a somewhat defensive name.

Going public

I see that the New York Stock Exchange (NYSE) is planning to go public. Is that a good thing or a bad thing? – S.R., Seattle

Well, it will probably make some investors and insiders in the company (which is home to more than 2,760 companies worth a collective $20 trillion) richer, but here’s another take. Billionaire investor Warren Buffett recently noted: “I personally think it would be better if the NYSE remained as a neutral, not-for-big-profit institution. … The enemy of investment is activity. … I know the American investor will not be better off if volume doubles on the NYSE, and I know the NYSE will be trying to figure out how to (increase volume) if it is trying to maximize its own earnings per share. (General Motors) or IBM will not earn more money if their stock (is traded) more actively, but a for-profit NYSE will.”

I’m planning to buy my first home within three years. How should I invest the money I’m saving in order to get the maximum return? – D.A., Kansas City, Mo.

Unfortunately, the place that’s usually best for long-term investment appreciation, the stock market, should be off-limits to your funds. In the short run, the stock market can go up – or down. In the long run, it has averaged about 10 percent or 11 percent per year, but even that is an average, not a guarantee.

Don’t risk money you’ll need within three to five years in stocks, or you’ll risk being able to afford only a corrugated aluminum shack. Short-term scratch should be kept in a safe place, such as certificates of deposit or money market funds, to protect your principal. Learn more about short-term savings at www.fool.com/savings and www.bankrate.com.