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The Best of the Fool in Newsprint

Looking for a more extensive treatment of the basics than what's in "Ask the Fool"? You'll find it in the newspaper column's "Fool's School" section (as well as in our online Fool's School, of course). Here are three examples of the feature:

Mommy, Where Does Stock Come From?
Turn to the stock listings in a newspaper and you'll see column after column of stocks. In case you've wondered how a stock becomes a stock, read on.

Imagine a company called the Glitter Factory, which manufactures glitter worn by teenage girls. Its glitter is flying off the shelves. To meet demand, the company needs to build more factories, buy more shiny plastic, hire more workers, and make more glitter. But it doesn't have much cash.

The Glitter Factory has some choices at this point. It can borrow money from a bank. It can issue bonds, which involves borrowing money from individuals or institutions and promising to pay back the lenders with interest. It can find some wealthy person or company interested in investing in the happening glitter industry. Or it can "go public" with an initial public offering (IPO), issuing shares of stock.

To go public, it will need to hire an investment banking firm, which underwrites stock and bond offerings. The bankers will study the Glitter Factory's business. If they think the company is worth around $150 million, they might recommend (based on the company's needs) that it sell 10 percent of its business as stock, issuing 1 million shares priced at $15 per share. Once it's announced that the company is going public, if it seems that people will be scrambling to buy shares, the bank might raise the opening price. A lack of interest might cause the price to be lowered, or the Glitter Factory might even decide to postpone the offering.

If all goes as planned, $15 million will be generated. The investment bank will keep roughly 7 percent for its services (a whopping million dollars), and the Glitter Factory will get the rest. From now on, people will buy and sell Glitter Factory shares (ticker: SPRKL) from each other on the market, trading through brokerages. The Glitter Factory will not receive any more proceeds from these shares -- it got its money when it issued them.

Once it's a "public" company, the Glitter Factory will have obligations to its shareholders and the Securities and Exchange Commission (SEC). For example, it will have to announce earnings four times a year.

What's Return on Equity?
When evaluating a company to see whether it belongs in your portfolio, you should calculate its return on equity (ROE). The ROE reflects the productivity of the net assets (assets minus liabilities) that a company's management has at its disposal.

Whenever a company generates earnings, there are four main things it can do with that profit. It can pay shareholders a dividend, pay down its debt, buy back shares of its company stock, or reinvest in operations. Return on equity reveals how effectively reinvested earnings (and capital that shareholders originally invested in the company) are used to generate additional earnings. For example, profits might be used to acquire another company. Or a new factory might be built, upping the firm's output and sales.

To calculate return on equity, take one year's (or four quarters') worth of earnings (often referred to as "net income") from the income statement. Next, look at shareholders' equity on the balance sheet. Average the shareholders' equity by adding the figures from the beginning and end of the year and dividing by two. Now divide the year's earnings by the average shareholders' equity. (Whew!)

Consider Johnson & Johnson(NYSE: JNJ). For fiscal year 1999, it reported net income of $4.2 billion and average shareholder equity of $15.1 billion. Dividing 4.2 by 15.1 yields a return on equity of around 28%. That's an impressive number, but it's even more meaningful when compared to the company's past performance. The company's ROE for 1998 was about 23%, down significantly from 1997's 28%. Executives at this pharmaceutical and consumer-product enterprise seem to be getting back on track, improving the use of shareholders' capital.

Another way to add context is to compare a company with its peers. Here are recent ROE figures for some of J&J's peers: Merck(NYSE: MRK): 45%, Procter & Gamble(NYSE: PG): 29%, Pfizer(NYSE: PFE): 36%. This is clearly an industry with robust performance, and J&J appears to have some room for improvement.

When crunching any numbers for a company, it's valuable to compare them with previous quarters or years and with those of industry peers. And when evaluating management effectiveness, return on equity can be very telling.

It's Morbid, but Important
Done any funeral planning lately? Take the time to get informed about it now, when you're not in a state of emotional upheaval. Learn what various things cost and think about what might be best for you and your loved ones. Here are some tips:

  • Make decisions before you need to. Record your wishes and your loved ones' wishes. Once you know that grandma prefers cremation and grandpa wants a simple pine casket, you'll have fewer decisions (or guesses) to make later.
  • Consider inexpensive caskets. Bodies will decay in any casket, and the cost difference is great between various caskets. Some cost many thousands of dollars, others several hundred dollars. (A $3,500 casket may have cost the funeral home just $700 wholesale.)
  • You don't always have to buy a casket from the funeral home. You can often buy the same casket from a discount vendor (at substantial discounts) and have it delivered to the funeral home -- which is likely required to accept it.
  • Embalming is not usually required, except for open caskets. Many funeral homes will try to talk you into paying for it, though, at an average cost of $400.
  • Beware the recommended rubber gasket (a.k.a. "protective sealer") that, according to some sources, costs just dollars to make but is sold for several hundred dollars. It's pitched as protecting the body from decay, but nothing can stop a body from decaying.
  • Don't tell a funeral director more than you need to, such as how much the deceased was worth, or what insurance benefits may be forthcoming.
  • Take a friend with you when you talk to death-care providers.
  • Save some money and honor a death in a more personal fashion. You don't have to buy a casket -- you can build and decorate one yourself, or have one built. You needn't use a funeral home's viewing room, either -- a loved one can "lie in honor" in someone's home, or a community hall or church.

Get more information and guidance at funerals.orgNational Funeral Directors Association (NFDA) and from helpful books such as At Journey's End by A. and N. Fatteh.

Next: Part 3 »


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