Picking stocks with The Motley Fool’s CAPS

The Motley Fool is a web site devoted to helping average people make better investment and financial decisions. Recently, GRS forum administrator (and resident economist) Jericho Hill got a chance to visit The Motley Fool headquarters. This is part one of a report on his experience.

When I was in high school, I participated in my state's stock market game. It was designed to introduce our economics class to the world of investing. That's where I first heard of The Motley Fool, an upstart website for financial investors that went against the grain of having advisors manage your money. Their newsletter analyzed the advantages of managing your investments yourself, and advocated indexed mutual funds over managed funds.

So, when I received an invitation recently to visit the Fool Headquarters in Alexandria, VA for a focus group, I jumped at the chance. The purpose of the focus group was two-fold.

  • One part of the meeting focused on The Motley Fool's free CAPS service, a community stock-picking tool.
  • The second part of the focus group dealt with how the individuals gathered used financial information, where they got it from, and what our views on investing were.

Motley Fool CAPS

Essentially, CAPS is an aggregator of information about stock picks from Motley Fool employees and readers. It is completely free to browse the ratings and blog postings of the CAPS users, to join, and to make picks of your own.

A very simple model of CAPS is that if a CAPS user is making stock picks that are beating the S&P 500 Index and/or other user's recommendations, their rating rises. Over time, those users who are most consistently beating the market or other users begin to determine more of the ranking and rating of individual stocks.

This system is heavily reliant on users making informed stock picks based on information rather than speculation, and those users posting what facts led them to the recommendation. A recommendation without a summary explanation is not as informative as one that does carry an explanation.

CAPS is the Motley Fool's attempt to quantitatively model The Wisdom of Crowds as popularized by James Surowiecki. The idea about crowds being better predictors than individuals in economics is an old one, dating back to Francis Galton's observations on people betting on the weight of an ox at county fairs betting on the weight of an ox. He reported that the average of all the guesses was pretty close to being right.

With such a system, I surmised that CAPS would focus exclusively on U.S. and European stocks. With much of the world's economic growth occurring in the developing world, how useful would CAPS be in identifying stocks for consideration in foreign markets?

Questions And Answers

Prior to the focus group, I emailed back and forth with John Keeling of The Motley Fool about the CAPS system with a few specific questions.

Jericho: Many readers are interested in understanding more about emerging market stocks and funds, how those play into a portfolio, and how CAPS would help with that. My primary concern is that many potential investors are risk averse about emerging markets as the quality of information about stocks and emerging markets is not as high as it is for already developed markets.

John: It's absolutely a valid concern with emerging markets. As you know, what's attractive about these opportunities is the opportunity for increased earning potential, but this opportunity comes with increased risk of volatility within this portion of your portfolio. At this point, CAPS isn't designed to provide answers for how much of your portfolio should be allocated to emerging markets. However, CAPS is a good place to look for international stocks. Currently, you'll be limited to researching ADRs and internationally-focused ETFs, but over time we hope to support non-US exchanges directly.

Jericho: I was also curious how CAPS fits into the recommendation the Fool had made years ago, a recommendation echoed by Warren Buffett, Peter Bogle, and this website among others that most investors are better served to invest in index funds. Does the Fool still like index funds?

John: The Fool continues to recommends that people invest in index funds versus expensive actively managed alternatives, or paying a broker who may be more incentivized by commissions on trades than helping you to create the best portfolio strategy.

However, we also strongly encourage people to take charge of their investments directly—either their entire portfolio or a portion of it. Our mission is to help Fools understand that they can manage their investments and that in certain situations the individual investor can have advantages in the marketplace relative to Wall Street money managers.

First Impressions

My overall impression of the CAPS system is that it is a useful place to gather information on a wide variety of stocks, and the amount of information that is freely available is overwhelming. For investors with experience, CAPS is a huge clearing house of market information and buzz for an unbeatable price (FREE!). The Buzzbox feature grabs a user's attention and focuses on a particular stock, whilst numerous other boxes auto-refresh with new information seemingly every 30 seconds.

But, that also might be CAPS' problem for the average or new investor; there's simply too much activity on the front page for a newcomer to get their bearings. Further, I don't find the top of the page summary of the day's best movers particularly helpful, as most CAPS predictions are buy-and-hold calls for long-term periods. It would make more sense to have the highest rated CAPS users featured in that more prominent spot instead. I do like the Buzzbox feature as it does grab a user's attention.

Next week, in the second part of his report, Jericho Hill will describe the results of the focus group discussion.

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