The Motley Fool: Inform, amuse and help you make money
September 1st, 2007 by moniesWhat’s makes mortgage interest go up and down?
R.W., Norwich, Conn.
Interest rates are influenced by inflation and the market for debt (notes, bills, bonds, etc.). With inflation relatively low in recent years, we’ve enjoyed low interest rates. But when the economy appears to be growing too briskly, which can spur inflation, the Federal Reserve (led by Alan Greenspan’s successor, Ben Bernanke) may hike short-term interest rates via the “federal funds” rate. That’s the rate a bank can charge another bank for use of its excess money. When the economy is sluggish, the Fed might cut rates to boost American enterprise. Lower rates give companies and people (including home-shoppers) an incentive to borrow money.
The Fed can also change the “discount rate” — the rate paid by a bank to borrow short-term funds from the Fed. The prime rate and other interest rates are based primarily on these two interest rates, while mortgage rates are linked to Treasury bill rates. The money markets themselves (basic supply and demand for money) also exert great influence over interest rates.
If I sell a stock for a loss in my IRA account, ca I deduct that loss on my personal tax return?
-R.Y., Lawrence, Kan.
Nope. You typically deposit pre-tax money into a traditional IRA. Eventually, you’ll be taxed on your entire withdrawals from it, regardless of any gains or losses. (Of course, if you make non- deductible contributions to your traditional IRA, they won’t be taxed when you take them in the form of distributions.) With Roth IRAs, you invest post-tax money and eventually withdraw it all tax- free. But you don’t claim losses (or pay taxes on gains) in the interim.
THE MOTLEY FOOL’S TAKE
NO ZZZ’S FOR ZUMIEZ
RETAIL: IT’S HOT, BUT PROCEED WITH CAUTION
High-growth board sports retailer Zumiez (Nasdaq: ZUMZ) may not be invincible (its shares wiped out at one point last year when it couldn’t keep up with investors’ high expectations), but its recent fourth-quarter earnings release drove shares to a new 52-week high.
The company reported net profit up 67 percent over year-ago levels and sales up 49 percent. Cash and short-term investments rose 21 percent, with free cash flow rising by 56 percent. Zumiez also offered an outlook for 2007 above analysts’ expectations.
Among the elements at work for Zumiez is its acquisition of Fast Forward stores last June. According to its management’s conference call, all the Fast Forward stores now have in-store Zumiez branding, and almost all have been refurbished to allow for greater capacity. Outside signage on the stores should bear the Zumiez name by the end of this year.
Zumiez expects impressive 30 percent growth, and factors like that explain the premium valuation attached to the shares. It recently traded at a price-to-earnings ratio of 54. While you may like Zumiez as a company and a concept, and you may respect its strong growth, hold your horses. You may well end up with a more appealing stock
FOOL’S SCHOOL
MULTIPLE GROWTH
Imagine you’re researching PomPoms.com (ticker: RAHHH), an online cheerleading supply firm, and you read that “it deserves to trade at 24 times earnings, or about $56 today.” You’re flummoxed. The concepts involved are simple and valuable, though, so let’s clear them up.
The word “multiple” usually refers to a company’s price-to- earnings, or P/E, ratio, which is its current stock price divided by its last 12 months of earnings per share. A company trading at $40 per share with an EPS of $2 has a P/E of 20. It is trading at “20 times earnings,” or at “a multiple of 20.”
It can be helpful to compare a company’s multiple with what seems to be a fair multiple, given its industry and competitive position. Let’s say that PomPoms.com’s peers all have multiples in the high 20s and its own multiple is in the mid-teens. A low multiple can be promising, suggesting that the stock is undervalued and that the price will increase as the multiple catches up to its peers.
Also auspicious are briskly growing earnings. Earnings growth drives stock price growth. Rapid growth can sometimes justify a relatively high multiple. How fast earnings grow is also a good indicator of how high a company’s P/E should be.
Expected earnings growth coupled with multiple growth can offer a powerful one-two punch. (Warning: numbers ahead!) Imagine a stock trading at $30 per share — 10 times its EPS of $3. As earnings grow, the stock price will likely increase, maintaining the multiple.
For example, when earnings are $5 per share, the stock price should be near $50. But if the multiple itself is also growing, the price is likely to increase even more. If a reasonable multiple is more like 15 and the earnings are $5 per share, the stock should eventually approach $75 per share.
MY DUMBEST INVESTMENT
GOOD FRIEND, BAD INVESTOR
Author: Array
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