If you want the Favorites sorted automatically (on-the-fly sorting), try this advice from Keith Miller:
Open Registry Editor (regedit.exe) and navigate to:
HKEY CURRENT USER\Software\Microsoft\Windows\CurrentVersion\Explorer\Menu Order\Favorites
and delete the value named 'Order'. Also delete this value for any subfolders. Then, with the favorite key highlited, click on Edit > Permissions and deny 'Full Access' to Administrators, yourself, etc. This will prevent the key from being automatically recreated.
Bruce, XP Pro doesn't offer that option it seems. However I solved the problem using the registery key Ramesh offered. It doesn't take effect until all browsers are closed and you reopen IE.