ASK THE FOOL

Bill Gates in a Bikini?

Q: What is a company’s “business model”? – B.B., Fort Wayne, Ind.

A: 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. Ebay’s business model brings tears to many investors’ eyes – connecting individual buyers and sellers online, and profiting by taking a percentage of each sale, all without carrying any inventory. Amazon.com’s main model is more capital-intensive, requiring warehouses to store many products so that they can be quickly shipped out to customers. Even more capital-intensive is Barnes & Noble, featuring hundreds of brick-and-mortar stores.

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

Q: I plan to buy my first home in three years. How should I invest the money I’m saving in order to get maximum returns on it? – S.K., Atlantic City, N.J.

A: Unfortunately, the place that’s usually best for long-term investment appreciation, the stock market, should be off-limits to your moolah. 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 that is an average, not a guarantee.

Don’t risk money you’ll need within three to five (or even 10) years in stocks, or you may end up 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.

FOOL’S SCHOOL

When to Fold ‘Em

Many of us spend a lot of time deciding whether to buy a stock, but we give little thought to when to sell. That’s risky, leaving us holding some stinkers too long.

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

â If you can’t remember why you bought in the first place.

â If you don’t know what the company does and how it makes money.

â If the reason you bought a stock is no longer valid. If you bought shares of Microsoft because of its high profit margins and then it announces it’s buying a large supermarket chain, stop and re-evaluate the situation. Supermarkets are a different business, with lower margins.

â If the stock has become significantly overvalued relative to your target price, if you have one. If you bought shares of Apple at $40 per share and it’s now trading around $70, well above your target price of $55, you might sell. Consider the tax consequences, though. If you expect the stock to hit $90 in a few years, you might do well to just hang on.

â 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, you may stand to gain more in the other stock. Again, consider tax effects.

â If a stock is your only holding. Portfolios should be diversified. Our rule of thumb is to aim to hold eight to 15 stocks. If one grows to represent more than, say, 20 percent to 30 percent of your portfolio, consider rebalancing it.

â If you’ll need that money within a few years. Any greenbacks you’ll need in three to five (or 10) years should be in a less volatile place than stocks, such as a money market fund or CD.

â If you’re hanging on only for emotional reasons.

MY SMARTEST INVESTMENT

Banking on It

When I retired in 1991 from what is now U.S. Bancorp, I had invested about $12,500 through my 401(k) plan in company stock. Instead of cashing it out, I rolled it over into an IRA account. I haven’t withdrawn any of the money. With the reinvested dividends, the account is now worth more than $200,000. It’s the best investment decision I have ever made. – A.A., Florence, Ky.

The Fool Responds: You did very well. We hope you’ve had other investments along the way, though. Concentrating too much of your nest egg in any one company’s stock is risky, even if it’s an employer or former employer that you know very well. Just think of Enron. You were also smart to roll the money into an IRA (for the tax benefits) and to let it grow over many years, reinvesting dividends. The reinvestment of dividends can really turbocharge a portfolio’s performance, as the small sums of money regularly buy you more shares of stock, which then kick out dividends of their own. It’s a beautiful circle. Learn more about your IRA options at www.fool.com/ira

FOOLISH TRIVIA

With 27,000 employees, operations in 40 countries and annual sales near $8 billion, I’m the largest industrial gases company in North and South America. I produce and distribute atmospheric gases (such as oxygen, nitrogen, argon), process gases and specialty gases (such as carbon dioxide, helium, hydrogen), and high-performance surface coatings. My products serve the aerospace, chemicals, food and beverage, electronics, energy, health-care, metals and manufacturing industries. I also offer cryogenic and non-cryogenic supply systems. My name is a combination of the word “air” and the Greek word for practical application. Who am I?

Last Week’s Trivia Answer: Born 37 years ago in San Francisco, where I sold records and jeans, I’m now one of the planet’s top specialty retailers, with more than 3,100 stores and annual revenues topping $16 billion. In addition to stores carrying my company name, I also run stores that might seem targeted at babies, retired seamen, and politically corrupt, unstable governments. In 2004, I unveiled a new brand, Forth & Towne, to serve women over 35. I employ more than 150,000 people. My ticker symbol evokes satellite-based navigation systems. Who am I? (Answer: Gap Inc.)

THE MOTLEY FOOL TAKE

Pfizer in Pflux

A recent business update from the world’s largest pharmaceutical company, Pfizer (NYSE: PFE), revealed some progress along with an uncertain future.

First of all, growth is currently stalled. Revenue and adjusted earnings for 2006 are expected to stay roughly flat year over year, as patent expirations offset gains from new launches. In 2007 and 2008, the company is projecting high single-digit average annual growth.

Pfizer is cutting costs and regaining its focus. It’s slashing the number of its manufacturing plants from 93 to 66, and it’s seeking efficiency improvements in research and development (R&D) and sales. Pfizer expects an impressive $2 billion in cost savings in 2006, followed by $3.5 billion in 2007 and $4 billion in 2008.

As for growth from new drugs, the outlook is unclear. Pfizer’s Exubera, an inhaled insulin for diabetics, is a breakthrough treatment, but it won’t hold market exclusivity for long. Eli Lilly and others are developing their own inhaled insulin. In addition, rumblings regarding the drug’s effects on lung function may curb sales a bit.

Finally, despite its massive cash pile and R&D focus, Pfizer expects to file just two additional new drug applications (NDAs) in 2006 and just three in 2007.

Pfizer will continue to generate healthy profits for the foreseeable future, but if it wants to regain its vibrancy, it will have to do more.