ASK THE FOOL

Investing Homework

Q: When I find a company with strong sales and earnings growth, what else should I examine before deciding whether to invest in it? – W.S., Medford, Ore.

A: There are many factors to check out, and the more you learn, the better you’ll likely do. One chief consideration is whether the company 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. So is a rising debt level with high interest rates. Examine the statement of cash flows to see how cash is being generated. 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 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 in “The Motley Fool Investment Workbook” by David and Tom Gardner (Fireside, $14) and “Reading Financial Reports for Dummies” by Lita Epstein (For Dummies, $20).

Q: If I donate $100 to charity and my company matches that donation with another $100, can I claim a $200 deduction in my tax return? – T.N., Biloxi, Miss.

A: Sorry. You may deduct just the $100 that you contributed. (Your employer may deduct $100, too.)

FOOL’S SCHOOL

The Roth IRA

To many people, God’s gift to retirement savings is the Roth IRA. It is indeed powerful, offering potentially massive tax breaks. There are some important issues to consider, though, before jumping on board.

Like other IRAs, the Roth allows you to accumulate funds for retirement and to enjoy some tax advantages at the same time. While traditional IRAs are tax-deferred, Roth IRAs are designed to be tax-exempt. Traditional IRAs permit you to contribute pre-tax dollars; Roth IRAs accept only already-taxed dollars.

Let’s say you’re 35 years old and you invest $3,000 of your post-tax income into a Roth IRA each year, starting today. You earn a 10 percent annual return for the next 30 years until you retire at 65. By then, your contributions would have grown to about $500,000. With a Roth, that’s your take-home pay – no taxes on it.

If those investments had been made into a regular IRA, you would pay taxes on any withdrawals, netting just $420,000 or so, assuming a 15 percent tax bracket during retirement, or merely $365,000 if you are in a 27 percent bracket. So far, this makes a great case for the Roth. But remember that if the $3,000 had gone directly into a traditional IRA, you would have reaped about $810 in tax savings each year at a 27 percent tax rate (and possibly more than $1,000 each year if your tax rate is higher). If that savings is also invested, the total difference between the Roth and the regular IRA becomes slimmer. Still, the Roth is a very compelling proposition to most investors.

You can roll over, or convert, your traditional IRA into a Roth by paying taxes on it, counting the entire value of the account as income. You can also roll over a 401(k) account into an IRA when you change jobs.

There are more benefits and limitations to consider before you decide whether the Roth is for you. You can get details from your local tax professional, from the IRS Web site, www.irs.gov, and at www.fool.com/ira and www.fool.com/retirement.htm.

MY DUMBEST INVESTMENT

Limited Investments

My broker had made some good investments for me. I’m sure he knew I wasn’t too knowledgeable about investing. He told me how great some limited partnership investments were and invested $65,000 in three of them. Those investments are now worth nearly $5,000. Now I know that it was the great commissions he received that excited him more than the money he expected me to make. – P.T., Oro Valley, Ariz.

The Fool Responds: Limited partnerships (LPs), which include hedge funds and private equity firms, can be particularly risky – especially those not listed on stock exchanges. Sometimes attractive because of tax benefits, LPs are run by a general partner and sport one or more limited partners (investors such as yourself) who are only liable for the sums they’ve invested. So all you can lose is your entire investment. You may also have trouble selling or be prohibited from selling for a few years. Some have done well for investors, but many are small and of dubious quality. As with stocks, it’s often best to steer clear unless you’re very confident in the company and its management.

FOOLISH TRIVIA

Founded in 1897 and based in New Jersey, I’m a leading medical device company, with annual revenues topping $5 billion. I focus on medication delivery, blood collection, diagnostic testing, flow cytometry, infusion therapy, surgery, anesthesia delivery, ophthalmology, critical care, immunization, sharps disposal and medication management, offering syringes, needles, IV catheters, surgical instruments and more. I developed ACE bandages and modern stethoscopes. I introduced an insulin injection syringe in 1924 and, to deliver polio vaccines, completely disposable syringes in 1954. In 1999, I teamed with UNICEF to help eliminate maternal and neonatal tetanus worldwide. Who am I?

Last Week’s Trivia Answer: 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? (Answer: Praxair)

THE MOTLEY FOOL TAKE

New Targets for Target

Like it or loathe it, Wal-Mart (NYSE: WMT) is one of the best-run retailers out there. Yet Target (NYSE: TGT) continues to grow despite going head-to-head with Wal-Mart in virtually every market. Target even has room for improvement in the years to come.

Target’s revenue was up more than 11 percent in its recently reported fourth quarter, as the company saw sales at stores open longer than a year rise 4.2 percent (on top of a 5.4 percent rise last year). Gross profit margins improved very slightly, and earnings from continuing operations rose 14 percent. Cash flow improved, too. So how can Target do better? Three ways, mostly.

First, the company could improve its profit margins by doing more direct sourcing (i.e., bypassing wholesalers and distributors) for its stores. Second, it can continue to roll out more private-label merchandise. Target generally attracts a more affluent customer base than Wal-Mart, and it could reap better profit margins from that with the right sort of private-label products. Finally, it could do more with the Internet as a sales channel.

In the meantime, there’s still plenty of potential just in grabbing more grocery business from the likes of Kroger and Safeway, and more apparel and housewares dollars from the likes of Sears and J.C. Penney.

Couple that potential with the stock’s recent price, and you have a stock that appears to still have some upside to it.