The Motley Fool: Private equity firms explanied

So what, exactly, are these “private equity” firms you’ve likely heard about in the financial media? Well, they generally make their money by offering companies guidance to make them more efficient and funding to rescue them or help them grow.

There are several different kinds of private equity organizations. One is the venture capital group, which tends to make somewhat risky investments in young, growing firms before they go public and trade stock. Then there are the leveraged buyout (LBO) outfits, which like to buy huge public companies by taking on a lot of debt. The LBO firm will take the company private and use much of its excess cash to pay off its debt, often while trying to improve the efficiency of the company. Eventually, the acquired company will be sold to another buyer or to the public, via an initial public offering (IPO).

Other private equity investments include buying chunks of private companies and buying distressed companies, with the intent of restructuring and then selling them. There are private equity funds, too, which aggregate and invest the money of smaller investors (those who generally still have more than $1 million in net worth). Money invested in private equity is often tied up for at least several years.

Private equity organizations aren’t required to make public the kind of information that public companies must disclose. They needn’t release quarterly performance reports or audited financial statements, for example.

Some of the biggest names in private equity today are Kohlberg, Kravis, Roberts (KKR), with assets estimated at more than $86 billion; The Carlyle Group, with more than $75 billion; and The Blackstone Group, with more than $98 billion. KKR owns bedding maker Sealy and Toys R Us, among many other organizations, while The Carlyle Group, run by former IBM chief Lou Gerstner, owns Dunkin’ Donuts and Hertz. Blackstone owns all or part of Michaels Stores, theme-park specialist Universal Orlando and T-Mobile parent Deutsche Telekom. Companies that were once helped by private equity or venture capital funding include Apple, Microsoft, FedEx, Cisco Systems, Avis and Dr Pepper.

Ask the Fool

Q: Is it smart to seek stocks with low P/Es and high dividend yields? — J.M., Kansas City, Mo.

A: Those are promising factors, but they’re not fail-safe. For one thing, you’ll miss outstanding investments that pay little or no dividends. For example, Apple pays no dividend, and Microsoft introduced one only in 2003. Companies also sometimes sport high yields and low price-to-earnings ratios only because their stock price has tumbled due to some major trouble.

Consider The New York Times Co. Over the past decade, its P/E has usually been in the 20s. A year ago, it was near 30 and its dividend yield was less than 3 percent. Today, its yield is near 5 percent and its P/E near 13. Is it a screaming bargain right now? Perhaps, but it’s also a floundering company, with declining revenues and not-so-stable earnings. You can’t tell enough from just the P/E or the dividend yield.

Never make a purchase decision based on very few numbers. You’ll find stock-picking guidance at www.fool.com and www.morningstar.com.

My dumbest investment

Years ago, I buried myself in investment books and decided to go with stocks. I found out about Warren Buffett and his investment philosophy, and read books by investors he admired, Benjamin Graham and Philip Fisher. Intent on developing my own system based on my readings, I dove headfirst into stocks. Unfortunately, during the first year, I earned 47 percent after taxes. Why is that bad? Because it led me to assume that I had a natural stock-picking gift. In my second year, I lost 10 percent. I’ve redone my system countless times and have tempered my emotions. This year, I am up almost 30 percent. — Dominic L. Guadiz, Tokyo

The Fool Responds: Becoming a great investor does indeed take time. You’re smart to learn from the best and to avoid acting on emotions, such as greed and fear.