OUR TAKE
The Motley Fool Take on Friday, July 19, 2002
Johnson & Johnson Investigated

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Let the weekend begin -- if for no other reason than the stock exchanges will close and stop dropping. Sheesh. With today's losses, the Dow, Nasdaq, S&P 500, and FOOL 50 have been knocked down in nine out of the past 10 sessions, and we're finishing off our ninth straight losing week.

Are your eyes seeing red? Or have you tuned out by now? Is anybody out there even reading this or have you run screaming from anything related to the market? Let us know in our poll on the Motley Fool Take discussion board.

The S&P 500 closed below 900 yesterday for the first time in nearly five years. Five years of gains wiped out. With declining stocks out-numbering advancers 3-to-1 today -- and in general over the last several months -- it makes being a stock picker all the more challenging. But we haven't capitulated here at the Fool.

We're all in this together, folks, and we continue to learn from our mistakes. Heck, we made a big one in our educational portfolios by not having a clear sell strategy when we needed one. We left a lot of money on the table. That's why we developed our When to Sell: The Foolish Selling Strategy online seminar. If you want to join in and learn along with us, we hope you'll do so. If not, you can still read the first lesson right here on Fool.com.

Relax this weekend. Stay out of the heat, and don't think about money. The market will still be there come Monday -- we promise.

In today's Motley Fool Take:

Johnson & Johnson Investigated

Johnson & Johnson (NYSE: JNJ) fell 15% to a price it hasn't seen since March 2001 on news in The New York Times that the Food and Drug Administration (FDA) and Justice Department are investigating a circumstance in its Puerto Rico drug-manufacturing facility. A boiler operator at the plant, who was fired in 1999, is suing J&J, claiming he was pressured to falsify data to hide "manufacturing lapses." He also claims he was suspended from work just before an anticipated interview with the FDA.

Johnson & Johnson is cooperating fully with the investigation and said it will defend itself aggressively against the lawsuit.

What's hurting the stock most today, we believe, is that people are coupling this lawsuit investigation with recent health problems experienced by Eprex drug takers in Europe and Canada. J&J markets Eprex for anemia. Amgen (Nasdaq: AMGN) markets a similar drug. Recently, 141 Eprex patients developed a rare blood disorder, called red blood cell aplasia, which is potentially fatal.

Eprex is manufactured at the Puerto Rico facility. Nervous shareholders are suddenly worried that any transgressions at that plant could lead to much larger lawsuits from sick Eprex patients.

One fact people seem to be overlooking is that 140 of the 141 patients who developed the blood disorder were given injections of Eprex rather than given the drug intravenously. The company is recommending Eprex be given intravenously. So, the method of drug delivery is more likely to be the culprit than manufacturing issues at the Puerto Rican plant.

FDA investigations are not uncommon at drug facilities. They, along with criminal investigations, just sound especially ominous.

Discussion Board of the Day: Johnson & Johnson

Is J&J a good buy at this price? One employee thinks so. Find out what he has to say on the Johnson & Johnson Discussion Board. Only on Fool.com.

Flee the 12b-1 Fee

You've heard that index funds, which seek to match the performance of the overall stock market as measured by an index such as the Standard & Poor's 500, stack up pretty well against other types of equity investments. There are many theories about why index funds, over the long term, beat most other stock funds, but one reason is simple: low fees. While the average actively managed stock fund charges more than 1% a year in fees and expenses, index funds charge as little as 0.16% a year.

The bottom line is fees matter. For example, $10,000 invested at 8% a year would be worth $46,610 after 20 years (ignoring taxes). However, if that money earned just 7% a year, because 1% went to fees and expenses, the 20-year result would be just $38,697 -- a $7,913 difference.

When it comes to expenses, one of the most pernicious leeches in the mutual fund pond is the 12b-1 fee. Named after a rule added to the Investment Company Act of 1940, the 12b-1 was invented in 1980 to allow smaller fund companies to recoup the expenses of marketing and distributing their funds. The idea was that marketing would result in more assets, eventually leading to an economy of scale that would allow mutual fund companies to lower expenses charged to shareholders.

Yeah, right. According to an article in Investment News, 12b-1 fees totaled $9.5 billion last year, up from $6.5 billion in 1998. Seventy percent of all funds charge 12b-1 fees, according to mutual fund rating service Morningstar. This is up from 62% in 2000. Some funds even charge 12b-1 fees after they're closed to new investors.

What does the Securities and Exchange Commission have to say about all this? In a December 2000 study on mutual fund fees, the SEC said:

[B]ecause it is unclear what expenses are properly considered distribution expenses, some funds, out of an abundance of caution, adopt "defensive" 12b-1 plans. Defensive plans exist solely to ensure that if a court found any fund operating expense to be also a distribution expense, the expense would be covered under a 12b-1 plan. The result: some funds have 12b-1 plans although no assets are used for distribution purposes. Similarly, other funds, that do use their assets to pay for distribution, extend their 12b-1 plans to cover operating expenses as well.

More recently, SEC Chairman Harvey Pitt announced in a speech to the Investment Company Institute, the mutual fund industry's advocacy group, that the SEC will begin looking into how 12b-1 fees are really used. But most experts agree that nothing will come of the inquiry. It is up to you, dear Fool, to take the real action: Avoid 12b-1 fees by steering clear of any fund that charges them.

Quote of Note

"Greed is all right, by the way... I think greed is healthy. You can be greedy and still feel good about yourself." -- Ivan F. Boesky, U.S. financier.

eBay vs. Perfection

After yesterday's close, online auction specialist  eBay (Nasdaq: EBAY) reported second-quarter earnings of $0.19 per share on $266.3 million in revenue. The company earned $54.3 million -- a 120% increase over the $24.6 million the company earned in the same period last year. Though net transaction revenues in the online sector rose 66% to $235.3 million, third-party advertising revenues declined 11% from last year, biting into overall revenue growth.

Net margins rose 50% year over year, from 13.6% to 20.4%, showing the impressive scalability of eBay's business. Registered users increased 46% to 49.7 million, while gross merchandise sales (the total value of goods sold on its website) increased 51% to $3.4 billion.

eBay also spent $30 million on a new corporate jet, causing free cash flow to decline 41% to $30.1 million from $51.2 million last year. To account for the plane, full-year capital expenditures were raised from $95 million to $130 million. That'll do wonders for public relations.

While the composition of its revenues is news, eBay's earnings numbers are not. On July 8, eBay pre-announced earnings along with its approximate $1.4 billion all-stock purchase of payment services company PayPal (Nasdaq: PYPL). Analysts had previously expected earnings of $0.17 per share on revenue of $264 million.

In the current quarter, the company now expects to earn $0.19 per share, a penny higher than its previous guidance. However, revenues will come between $278 million and $281 million -- lower than the average analyst estimate of $283 million.

For the full year, eBay forecasts $1.1 billion in sales, and earnings of $0.76 to $0.78 per share -- better than its previous guidance and in line with current analyst estimates. eBay's forward guidance excludes PayPal's figures.

Strong performance is not enough for eBay's investors, who seem to expect it to grow beyond perfection. The advertising market is still weak, but eBay's core online auction business is going strong. Disappointment in its upward revenue forecasts dragged the stock down nearly 6% in midday trading.

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Quick Takes

Microsoft (Nasdaq: MSFT) said "robust customer demand" for the Windows XP operating system helped fuel a solid fiscal 2002. However, the $11.91 billion of operating income represented only a 1.6% increase over 2001.

PepsiCo's (NYSE: PEP) second-quarter earnings of $0.52 per share were in line with expectations, but revenue missed targets. As a result, investors knocked the stock down as much as 13% during the day.

Shares of AOL Time Warner (NYSE: AOL) continued to slide, one day after Chief Operating Officer Robert Pittman resigned. The stock is down 15% this week, and 75% over the past year.

ConAgra Foods (NYSE: CAG) is voluntarily recalling over 18 million pounds of raw beef, which may be tainted with the E. coli bacteria. The beef was processed at the company's plant in Greeley, Colorado, between April 12 and July 11.

United Airlines (NYSE: UAL) and America West Airlines (NYSE: AWA) reported second-quarter losses of $341 million and $8.5 million, respectively. Of all the major carriers, only Southwest Airlines (NYSE: LUV) was able to turn a profit in the quarter.

And Finally...

Today on Fool.com: You don't have to expense stock options to know they exact a high price. Take eBay, for example.... Discover new tax-saving options for education.... In Fool's School, the difference between fixed-rate and adjustable-rate mortgages.

Contributors:
Bob Bobala, Robert Brokamp, Jeff Fischer, Jeff Hwang, Tom Jacobs, Bill Mann, Selena Maranjian, Rex Moore, Rick Munarriz, Jackie Ross, Reggie Santiago, Dayana Yochim

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