Fool's Proof

If your idea of investment begins and ends with a savings account with a bank, then this book, which attained cult status, is just for you.

By Narayan Krishnamur thy | Print Edition: December 28, 2006

When Feste, the fool in Shakespeare's comedy The Twelfth Night advocates that foolish things of life ought to be taken seriously and serious issues must be treated with irreverence and triviality, David and Tom Gardner were definitely listening. Or why would they claim in their personal finance guide, The Motley Fool, (named after Shakespeare’s fools) that the book can do away with the need of financial consultants and money managers to work the markets better and fill your coffers? Foolish, impractical philosophy surely.

Or is it? The Gardners have done very well for themselves since they cofounded Fool.com one of the early websites to educate and enrich people on personal finance issues. All the while entertaining them with bizarre analogies, hilarious anecdotes and examples. So much so, that it soon became a cult with a fan following who swore by the fun method of dealing with serious money matters. Remember Feste?

Now with a book out, the Gardners are still following the typical Fools' philosophy and style. Permeated with Internet values, the book is all virtues of the online autobahn that offers information on stocks, companies, markets and flood of stock brokerage reports. In the Indian scenario too the power of is evident by the swelling online investors' list and the quantum of trading happening directly from offices and homes.

Just like a fool might do, the most prized information of the book comes in two appendix sections at the end. The essence the book is captured in late chapter that talks Why to invest with virtues of what is taught in the first half and when to look otherwise.

What the book offers

INSIGHT: For the uninitiated there are the basics to the expert level stock market information to learn everything about trading

RULES: There are broad rules that are framed to assess a company to invest in
INFORMATION: The appendix is full of useful and funny nuggets and to gain from

But first the book takes the uninitiated through a journey; teaching the virtues of online information on stocks, companies and analyst reports before embarking on investing instruments mutual funds and stocks. It then talks about portfolios, what and how they are formed before exploring how to invest in companies and quality stocks for long-term returns. It teaches you how to read the balance sheets and income statements of companies and what to look for in them. There is a brief introduction to margin trading for the advanced investor. Then there are the Eleven Fools' rules, which focus your attention on small, inactively traded companies with high profit margins, high recent stock price increases, and a low Fool Ratio (the priceearnings multiple divided by anticipated growth in earnings per share).

The Indian reader is slightly disadvantaged since the book is loaded with examples from Wall Street and often, you will need to know about companies listed on the Dow to get a sense of why it is being referred to. However you can always skip the examples and go straight to the tools being talked of, which do have an Indian implication.

Gardners claim that by reading about stocks in the public domain, doing a bit of research into the financial statements of small cap companies, and using the Foolish rules, you can outperform the market in no time. Some examples in the book are of stocks that have a high volatility compared to the S&P 500. The range of outcomes is very wide, because high risk usually accompanies high returns. No surprise that risky stocks did well in the strong bull market of 1995-96. But small investors should be aware that this is a twoway street.

Mantras of Investment
The four key things to look at before picking the right stock:
Industry: Understand what drives profitability in an industry
before investing in it
Interest:Buy stocks that you like and have a large mindshare
Insight:You should have the common sense to see the future
of the business your stock is into
Investigation:The stock and business page of any financial
newspaper is a good starting point.The Net is another tool
to investigate the company you plan to buy stocks in

Internal consistency is not a hallmark of the Fool philosophy. Many of the holdings in the book violate their own investment rules. Some stocks were picked as they were high-yield Dow stocks following the contrarian strategy and some were chosen because of their relative strengths, following a momentum strategy. Not only is there an apparent conflict in these strategies, but the continued holding of some of these further add to the inconsistency of the rules. The wise Fool must not only know the rules, but also know when not to use them.

The book directs our attention to small and undiscovered firms. This certainly has some appeal, for all big firms were once small and we know that share prices grow more rapidly for small firms than for large firms. But only a few small firms get big, and betting the farm on thinly traded companies entails risks for which even highcurrent performance might not compensate.Their advice about Dow stocks and index funds should be taken to heart; the rest should be taken with salt. Also, the book's focus on comparing the average annual returns for various strategies will not sit well with the Wise.

As the book reaches its end the Gardners warn against managed mutual funds, which generally perform badly relative to market averages and, moreover, charge you to do so. Instead, they advise investing in Vanguard's S&P 500 Index Fund, which turns in a market performance with no load and low turnover costs. A move towards exchange traded funds is something that is making things brighter in India as well and will be a good lesson for those looking for ETFs.

So while The Motley Fool does succeed to be an investor's guide for the neophyte, it doesn't spell doom for financial consultants. It just teaches the investor how to use his money manager better and tweak his ears when he knows that the consultant isn't really doing the right thing.

Read the reviews of two other
timeless classics:
The Richest Man in Babylon
by George Clason and
The Warren Buffett Way
by Robert G. Hagstrom, on

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