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ASK THE FOOL

Risky margin

Q: What is buying stocks “on margin”?

A: It’s when you invest with money borrowed from your brokerage — and pay interest on the loan.

Margin’s appeal is that it will turbocharge your gains — but it also turbocharges your losses. Imagine, for example, that you have $100,000 worth of stocks in your account and you borrow $100,000 on margin to invest in more stocks. If your $200,000 portfolio doubles in value to $400,000, you’ll have earned an extra $100,000 (less interest expense), thanks to margin. But if your holdings drop by 50 percent instead, they’ll be worth $100,000 — and you’ll still owe $100,000 (plus interest). That will leave you with … nothing. Your holdings dropped by 50 percent, but thanks to margin, it became a 100 percent loss. Margin cuts both ways.

The interest expense can add up, too. If you’re borrowing on margin and paying 8 percent interest, your borrowed stocks had better appreciate more than 8 percent. Your brokerage won’t want your portfolio’s value to fall below the sum you valued, so if it drops a certain amount, the brokerage will expect you to add more money or sell some shares — or it will sell them.

Using margin is risky, and only experienced investors should use it. You can do very well without it.

Q: What’s a payout ratio?

A: It’s the percentage of a company’s earnings paid out in dividends.

Boeing, for example, pays out $6.84 per share annually, and its trailing 12 months of earnings total $10.85. Divide the former by the latter, and you’ll see that 63 percent of Boeing’s earnings go to its dividend.

Payout ratios near or above 100 percent can be worrisome.

MY DUMBEST INVESTMENT

I-P-Oh-No

Dear Fool: My dumbest investment was buying more than $6,500 worth of stock in Twitter when it first went public in 2013. Now my stake is worth about $2,500. I don’t know if I should just sell it or hang on to it. I would hate to sell only to have it turn around next year and then go way up. Thoughts?

The Fool responds: It doesn’t sound like you had (or have) a good grasp of the company’s business. Investing without knowing much about a company and then mainly hoping for good results is just speculating — or gambling.

There has been a lot of hype and hope about Twitter. Its user growth has been phenomenal. It recently sported 330 million monthly active users, and that inspires many investors. But it has had trouble converting all that usage of its free service into profits.

Twitter’s share price is up about 50 percent since you wrote to us last year, and its market value recently topped $17 billion. But it has been posting net losses for many years now. It may end up very successful, but it’s struggling now.

It’s best not to invest in young companies at their initial public offering (IPO), as many need some years to prove themselves. IPOs also often surge at first and then fall. Twitter shares soared some 73 percent on their first day, and those who bought then are still underwater.

THE MOTLEY TAKE

Medical device-powered growth

If you’re in the market for a promising little-known company in which to invest and you can stomach some risk, take a look at Masimo (Nasdaq: MASI), a medical-device maker specializing in noninvasive patient monitoring technologies.

While the company sells an array of products, its bread-and-butter business is pulse oximeters. They’re used to track oxygen levels in the blood, which is critical information for health-care providers to have when they are dealing with patients in need of acute care.

Masimo’s pulse oximeters are widely used, and found in 17 of the top 20 hospitals on the U.S. News & World Report Best Hospitals Honor Roll. With 1.5 million devices in use worldwide, customers can be counted on to reorder supplies on a regular basis. This helps makes Masimo’s financial statements highly predictable.

Masimo seems poised for further growth, in part due to opportunities abroad, in developing countries. It is also looking at adjacent market opportunities, such as sleep-disorder treatment and telehealth, that could benefit from its algorithm expertise and sensor technologies.

Free-cash-flow positive and with rising revenue, Masimo is worth a closer look for patient investors. There’s no dividend, as is common with smaller or fast-growing companies, but Masimo has been buying back many shares, boosting the value of remaining ones.