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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john
john
12 years ago

I think CAPs is bologna. A large group of people can’t predict the market because that same large group of people are what make the market to begin with! If you click on my name, i have an article up comparing the top ten picks to the S&P500

Lifeson
Lifeson
12 years ago

I’ve always found the Motley Fool website to feel very strange; within two clicks of each other, I see them pushing index funds and dollar-cost-averaging as the “boring but dependable” strategy suitable for every investor, then throwing out 20 different strategies for picking the “right” stocks individually and pimping one of their newsletter services. I see them fess up occasionally and point out that their individual picks are not always right, but like any other investing service, their history as they present it is glamorized by emphasizing their good picks and not reminding anyone of their follies. I keep thinking… Read more »

J.D.
J.D.
12 years ago

I don’t have much time, but I feel like I should note my own feelings about CAPS: I’m skeptical that it’s of much value. It’s an interesting experiment, but I doubt that it’s any more useful than other stock-picking strategies. (And I find those to be of dubious value.)

I was just talking with a friend last night, and I mentioned that I’ve learned that I’m more risk-averse than I once believed. Index funds are just fine for me right now.

Randy
Randy
12 years ago

I am skeptical as well. Not because I don’t believe it has merit, but because I haven’t seen any studies that show how CAPS picks perform relative to any indices or stock ranking systems, such as Stock Scouter or Valueline. Until I see such data, I plan to avoid using it as a basis for an investment strategy.

Randy
Randy
12 years ago

Lifeson: A few thoughts… Investors who don’t have the time or inclination to get involved in stocks should steer clear and stick with index funds. That being said, it is possible to beat the indices…Just look at the investing records of people like Warren Buffet, Peter Lynch and David Dreman. The key is to identify high-quality stocks that possess traits that are indicative of out-performance. James O’Shaunessy did a study of such traits over a 50-odd year period in his book ‘What Works on Wall Street’, which I consider to be required reading for anyone who is interested in stock… Read more »

jerichohill
jerichohill
12 years ago

What I’ve noticed about CAPS is that its a good source of information about stocks, as many CAPS bloggers regularly source information from company publications, but its only as good as the amount of time and effort you can put into it. I think the biggest challenge is that sheer amount of information available, processing what is good and what is bad quite frankly is a large investment, and its not guaranteed. While CAPS auto-updates stock picks and ranks by users, it does so on a past-looking basis. That’s an issue that any forecasting system has. Stocks are something that… Read more »

John Egan
John Egan
12 years ago

A wonderfully comprehensive and extremely easy to implement system is “Invest with Success” by Dr. Paul Schaap. He has written two books now and this is his second. It is a a very worthwhile $90 and can be ordered through his webpage. Aside from his 50-50 strategy, the book also shows you how to very quickly decide if a stock is worthwhile. A 1 minute read at Yahoo Finance. More importantly, as you go through the book, he explains what moves the market, what to ignore and that which is of value. Lastly, this is no ‘black box’ program. It… Read more »

Martin
Martin
12 years ago

I think the “Bogleheads Guide to Investing” is a good introduction for new investors.

Stick to low cost index funds; and save yourself the anxiety of having to watch everything every day.

The Bogleheads forum is also a good start:

http://www.bogleheads.org/forum/index.php

The Motley fool is definitely a split personality — you can find great advise on saving money next to endless spam on smelly investment schemes.

Writer's Coin
Writer's Coin
12 years ago

Definitely some useful information for the active investor

Luca
Luca
12 years ago

I am very disappointed by their answer to Jericho’s very good questions about index funds. It’s like “if you need surgery you should go see a doctor, but I can give you a scalpel and talk you through do-it-yourself surgery…”

JerichoHill
JerichoHill
12 years ago

Luca,

That wasn’t the impression I got from them. They do believe that index funds are appropriate for every investor, and that they are plan A. I think they do the stock research for individual stocks as helping inform an investor who wants to do more than 401K/IRA indexes. The Fool Idea I think is to inform individuals and have them choose how to build an actively managed portfolio, versus paying someone hefty fees to do it for you.

GenYRetireRich
GenYRetireRich
12 years ago

The Motley Fools offer some pretty good advice about funds and indexing, and I reference some of these articles in my blog. But I really wish they would tone down the “You can get rich by buying stocks” stuff. I know that’s something people want to read about, but why pander. They should tell the truth: only a tiny fraction of their readers has a chance of beating the market with individual stock picking. The rest should use low cost index funds.

Moltar Lavamann
Moltar Lavamann
12 years ago

John Egan Says:
“Check your fund’s weekly on Yahoo’s ‘interactive chart’ against the 50 EMA …. If it drops below the line, sell… If it pops up over the line again..Buy. Why lose money?”

Umm, this makes no sense. Essentially you’re saying “Buy high, sell low”. I do the exact opposite. I buy more shares of my index fund when it dips down (i.e. goes on sale) and buy less when it goes up (i.e. when it gets expensive). In other words, “Buy lots low, buy fewer high”. After all, in your own words: “Why lose money?”

M. Lavamann

John Egan
John Egan
12 years ago

In reply to Mr. Lavaman…. You are correct, I did leave one piece out of the formula … The EMA20 has to be on an uptrend.. (In other words moving uphill.. ) Their approach is to buy when the trend is working for you and sell when the stock or fund drops below the trend – Check it out with your own funds. It does work and their approach is designed for those that do not have a solid background in investing, and don’t have the stomach for high risk. In my defense, anyone interested **should** at the very least… Read more »

datadave
datadave
11 years ago

I tried the link to get onto CAPs at motley fool…and dude, they wanted me to jump through so many loops of advertised books and junk I don’t want and to force me to subscribe to their newsletter by giving them my bank card number. Just wading through the forced links was too much knowing that I’d. probably forget to cancel their “free offers” in a month and they’d start raiding my bank account as a result. I went instead to zecco.com which was much more easy and they have “zimulator” which does the same thing as ‘Caps’. So far… Read more »

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