The tagline for The Motley Fool’s web site reads, “To Educate, Amuse, and Enrich™.”

Really.

Let me begin by saying that I have read articles on Motley Fool (among countless other investment-related sites) extensively, and many of them… dare I say most, are well-founded. However, let me tell you what is not well-founded. A group of 118,000+ investors rattling on about which stocks they believe will outperform or underperform the market. The site boasts that this group of investment “experts” have made more than 2.5 million stock recommendations thus far. There is a stringent selection process to join this team of financial gurus:

An e-mail address and a password.

Are you [expletive] kidding me? How can this conceivably legitimize this operation? My four year-old nephew has an e-mail address. He also knows his letters. Therefore, he could make stock recommendations.

The CAPS rating system (an acronym with origins apparently unknown, but my vote is for Cocky Amateurs Pick Stocks) is an interactive stock rating program that allows users to weigh in on whether they believe a particular stock will outperform or underperform the market. The CAPS system keeps track of these votes, and gives ratings to both investors and individual stocks.

The idea behind this goes as follows: more “correct” predictions raises the member’s rating in the system, and the more weight his recommendations will carry. The more of these investors that select a stock as “outperforming” the market, the higher the stock’s rating.

This sounds like it makes sense, but statistically it’s a highly organized group of Monday-morning quarterbacks. The process has very little to do with a person’s investing expertise and everything to do with basing future earnings on past results. If you have over a hundred thousand investors flip a coin (an intentionally similar analogy to the two possible ratings on a stock), there’s bound to be a few who land heads more than a couple times in a row.

The selling point of all this hogwash is that it’s a “community”. It’s investors helping investors. It’s a sense that we’re all in this together, and we can help each other. Hence, another tagline: “investors helping investors beat the market™”.

Let’s get something straight: the only thing these “investors” (a loose term, as there is no actual investment or investment experience requirement to contribute to this system) are beating is each other over the head with a duffel bag of stock predictions.

Some outperforming recommendations on some underperforming stocks

Take MRX, PAE, and SCU. Please. Medicis Pharmaceuticals, Inc., Peace Arch Entertainment Group, and Storm Cat Energy Corporation are but three of many stocks that tout the highest rating on the site: five stars.

Each of these has been rated as a 5-star stock for a good while, the clearest indication that the CAPS investing population believes these equities will outperform the market. MRX has lost 43% of its value year-over year. It got smacked for 13% just yesterday. And it’s not four people that made recommendations to give this a 5-star status, the pick count is at nearly 200.

PAE and SCU are down 92% and 70% on the year, respectively, with each one getting socked for 21% and 25% yesterday alone. They sure sound like winners to me.

A penny for your thoughts. Or a share of stock.

Here’s a problem: a five-star rating on a stock gives the impression that the company is worth something. A little experience with the OTC BB can tell you that shares of good, strong companies do not sell for under one dollar, much less under a shiny quarter. With these stocks trading around $0.20 per share, how could they possibly be construed as 5-star stocks?

I realize these facts – and many of my readers realize these facts – but the general public may not. This is irresponsible.

Allow me to share with you a quote from – you guessed it – a prior Motley Fool article on penny stocks:

“Yes, they have big potential. But their daily gyrations are unpredictable — the stock-price movements have next to nothing to do with the underlying company the stock represents. In fact, trading in pennies is highly illiquid, and prices are often manipulated by forces not at all related to the business.”
~Why We Love Wild Penny Stocks, by Tim Hanson and Brian Richards, 2/13/2008

Wild, indeed.

Looking to the stars for investment advice

Interesting, to say the least, that Buffett (Warren, not Jimmy) is just about to load up on about $5 billion in Goldman Sachs (GS) stock. Careful, Berkshire, I looked at www.fool.com and Goldman Sachs only has three stars. The Oracle of Omaha must be out of practice. There’s five-star stocks to buy out there, big W.

Why don’t we all work on our own cars, perform our own dentistry, and build our own houses as well? Because most people are incapable of doing so. Unfortunately, in this age of MySpace and YouTube, persons in the general public have succumbed to delusions of grandeur, sporting an ill-conceived notion that they are important, and now: that they are capable of making informed decisions on stocks, mutual funds, and other investment products.

I can hear some cynics saying, “John, you sound threatened by the fact that the internet has allowed average investors to make stock picks, and you don’t feel as important or as indispensible.”

Threatened? No. I’ve made my money. Disgusted? Yes. And as for their initial tagline, I feel only moderately educated, amused only by the chaotic façade, and certainly not enriched.

John K. Whitehall
Analyst, Oxbury Research