The internet is responsible for some of the most innovative tools investors have ever had.
Where else could you acquire instant access to all financial data for a company you are researching?
In just a few seconds, you can have…
- The annual report for a prospective investment over the last ten years;
- Their current stock quote; and
- Ten unique analyst reports to help you make a decision.
You can even watch video interviews and paper trade the stock with a verified broker to get an edge on your investing.
Okay, so hopefully, you can see that the internet is an amazing place for the modern investor.
However, the internet has also provided a platform to fraudsters who want to steal from unsuspecting traders.
These frauds involve using misleading schemes to trick their victims into investing in products that are not what they have been advertised.
One of the most popular cons that has grown in popularity with internet investing is the pump and dump scheme.
What is a “Pump and Dump?”
Out of the many ways to defraud investors, “pump and dump” schemes are very clever.
Pump and dump involves manipulating the share price of a public company rather than promoting a company that does not exist.
These scams are scary because much of the information the fake investors report contain only slivers of truth.
So, how does a pump and dump scheme work?
When a company has its shares listed on a stock exchange, they want to access public funds and outside investors to raise more money to grow their business and generate profits, which is why we call them “publicly traded.”
However, not all companies are the size of mega-cap titans like Apple and Amazon.
With companies that size…
- Their financials are carefully audited;
- They have thousands of employees; and
- There are government representatives that get involved with their regulation.
Massive companies like that are usually safe enough to invest in for the average retail investor because there is so much data available to analyze.
But, what about small-cap stocks?
Small-cap companies may have a market capitalization of only a couple million dollars without many analysts covering their business.
It is these small companies that are most susceptible to pump and dump schemes.
In order to initiate a pump and dump scheme, there must be a shareholder or group of shareholders who bought a lot of shares of the small company around the time of its IPO.
Now, shares of a very small company may not be trading very high because they have not had time to deploy the new capital and grow the business, respectively.
Since the share price may not be very high, and these investors have many shares, they will try to pump up the stock price by utilizing misleading marketing tactics and promoting blatantly false information to attract new investment.
Once the fraudsters decide to launch a pump and dump scheme, they will usually invest some money into a fake marketing campaign that claims amazing results and “insider information” that will cause the stock to skyrocket.
The idea is to attract as many new investors as quickly as possible by creating a sense of urgency.
Their message is essentially, “if you don't invest now, you're going to miss the investment opportunity of a lifetime, buy-in now.”
As a result, the more investors who believe these messages and invest will push the stock price up.
Once the stock price jumps a little, other investors will see the interest in that stock and start piling in because they want a piece of the action.
Do you see a pattern?
Once the stock price reaches the desired exit point for the fraudsters, they will sell off (i.e.,”dump”) the large number of shares they had purchased at the beginning of the scam.
After they sell their shares, the scheme is finished, and then the stock will drop dramatically because the company's fundamentals reveal the immense overvaluation caused by the false advertising.
Unfortunately, the investors who bought in and pumped up the price usually lose a lot of money, and that is how a pump and dump scheme works.
Pump and Dump Example
Let's look at the hypothetical Power Sports Corp., which recently went public because their goal is to open offices in 5 new states, and they decided that an IPO would help them achieve that goal quickly.
Power Sports hires Shady Marketing company to help grow its advertising.
The executives at Shady Marketing recognize this amazing opportunity to make a quick profit by exaggerating the client's business and run a pump and dump scam.
They take their advance payment from Power Sports and buy as many shares of the company with it as they can.
Next, they create this elaborate and fraudulent ad campaign that focuses on getting in on this great stock before it takes off, instead of promoting the business.
They send email blasts and use paid ads to attract as many new investors as possible, and they watch the stock price climb steadily over the next few weeks.
Before Power Sports can realize what happened, Shady Marketing has cashed out all of their shares, closed up shop, and left town.
In their wake, they leave conned investors and a severely injured Power Sports Co.
This type of scam is all too common thanks to the power of the internet.
There are many stock picking services that utilize loud marketing tactics and creative promotional material to set themselves apart and gain new subscribers for their stock-picking service.
One of the most famous and established stock picking services is the Motley Fool. Many investors are familiar with their advertisements promoting “The next big stock,” so do they qualify as a pump and dump scheme? Let's do some digging find out.
Intro to Motley Fool
Before we determine whether the Motley Fool is a pump and dump or not, we need to take some time to understand what it is and how it operates.
The Motley Fool is an investment newsletter, media company, and stock recommendation service.
Their primary revenue drivers are their subscription-based newsletters that focus on various aspects of investing in the stock market.
You have probably seen their advertisements everywhere, from investment magazines to stock valuation videos on the internet.
Their marketing approach is certainly bold and in your face, because that is what serves their business model best.
Some of the more familiar commercials focus on their ability to pick the “next big stock” or the “New Netflix” or something like that to spark interest and draw in potential customers.
There are some people who don't go any further with the Motley Fool solely because of the marketing, and that is perfectly fine.
As the name implies, the Motley Fool does not take itself too seriously because the team believes in the quality of their work, and they want to be accessible to the average, everyday investor.
But don't let the casual name trick you into thinking their service is a joke. They have been in business for decades, and they are consistently rated as some of the best investment services available on the market today.
Not only do they offer multiple investment recommendation services, but they have also grown to expand into personal finance and retirement planning advice as well.
At the end of the day, they need to sell their service to stay in business, which requires extensive advertising in an ever-competitive market, and they have found the strategy that works best for them.
History of Motley Fool
Now that we know what the Motley Fool is, we should dive into the history of the company.
The Motley Fool was founded by brothers Tom and David Gardner in the mid-1990's because they realized that the average retail investor did not have access to great stock recommendations with research to back up the analyst's claims.
In the late 90s through the early 2000s, Wall Street investors were the only people with access to the most up to date financial data, and they did not have any reason to distribute it to the average investor.
This lack of quality information inspired the brothers to create a service that was both accessible and of impeccable quality, and thus the Motley Fool was born.
What began as a small business in Alexandria, VA, has evolved into a massive financial media company that has offices all over the United States, England, Germany, Australia, and more.
Now that we know what the Motley Fool is and a little bit of their story, let's look at the services they provide.
In order to identify why some may confuse the Motley Fool with a pump and dump scheme, it is imperative that we understand how their service operates in practice.
So, let's check it out.
Motley Fool Stock Advisor
The flagship service of the Motley Fool is the Motley Fool Stock Advisor subscription newsletter.
Stock Advisor is almost as old as the company itself, and it has evolved to become one of the most cohesive and insightful investment services on the market today.
Both founders, Tom and David, have their own team of analysts, and every month they work with their teams to sift through hundreds of stocks to find their top recommendation for the month.
This process can become quite competitive because each team wants to recommend the most promising stock to its subscribers at the end of the month.
One of the unique features of this monthly process revolves around the analysis of the stocks themselves.
The teams utilize both fundamental and technical analysis to aid them in their research, which is not very common for investment recommendation newsletters.
Fundamental analysis relies on financial data from the company being researched and how their business model works within its industry and the market as a whole.
Other fundamental questions dive into how Company A has a competitive advantage over Company B and how long they can remain ahead.
Technical analysis does not care about the specifics of the company.
Technical analysts rely on the mathematical movements of the stock price over time.
By tracking trading volume and other key indicators, investors can identify patterns and shapes that may help them predict what a stock is going to do next.
Since the Motley Fool synthesizes data from both fields of study, they end up with a robust picture of each stock they research, and as a result, have a pretty good idea if they will recommend it or not.
Once the brothers each settle on their recommendation for the month, they submit their pick to the newsletter to be sent out to subscribers.
The monthly stock picks are the most important component of the Stock Advisor service, but subscribers receive much more than those every month.
All new subscribers receive a starter stock list, which can be a godsend for new investors.
Many new investors do not know how to build a portfolio because they only invest in what they know (which is a great place to start), but soon they run out of investment ideas and may start making risky trades.
The starter stock recommendations are a unique solution to this problem because it provides a list of stocks that have great longevity, have performed well over the years, and are inherently diverse from each other.
Reputable stocks with built-in portfolio diversity combine to offer new investors a relatively safe and accessible strategy to enter the market.
Subscribers also receive a list of other top recommended stocks from Tom and David's teams that are very promising but did not make it to the top recommendation spot.
Finally, subscribers are granted access to members-only forums where other investors can talk to each other about their trades and share advice about their investing journey.
Motley Fool Rule Breakers
Motley Fool Rule Breakers is another subscription stock recommendation service provided by the Motley Fool that focuses primarily on growth stocks.
Rule Breakers promises to…
“Discover market-beating growth stocks, learn which businesses are poised to be tomorrow's stock market leaders, and see which companies are the best stocks to invest in today.”
The Rule Breakers team is led by founder David Gardner and his group of analysts, and their goal is to find stocks with an ‘X Factor' that sets them up for rapid growth.
Not all of their stocks are smashing successes, but they consistently choose companies that perform well and help add portfolio diversity.
The Rule Breakers service is great for investors who understand their market and want to go to the next level with their investments by bringing on some more risk.
The companies recommended under the Rule Breakers model are on the verge of a breakout year (or they are intended to be).
Motley Fool is know to pull a rabbit out of their hat now and again — see Netflix and Tesla.
However, it is important to understand that Rule Breakers is generally more volatile compared to its stock-picking counterpart, Stock Advisor.
For the investor with a firm understanding of portfolio management, or wants more exposure to growth stocks, Rule Breakers can be a GREAT addition to your stock picking research.
Whether you decide to go with Stock Advisor or Rule Breakers…
…you really can't go wrong!
Is Motley Fool a Pump and Dump?
If you have read the article to this point, you will likely can tell where our decision is heading.
So, is the Motley Fool a pump and dump?
First off, loud advertising is not always false information.
And, now that we have a much better understanding of pump and dump schemes and the Motley Fool, it is time to discuss whether the Motley Fool does or does not qualify.
One of the key components of a pump and dump scheme is the false promises and overinflated marketing about the company in question.
Very often, the stocks at the center of a pump and dump are small-cap companies that do not have much detail about their financials or business model.
And more often than not, the companies also recently went public, which does not give investors enough data to perform in-depth research.
The Motley Fool does have very loud advertising, and I don't think anyone can deny it.
Also, the company does make bold claims when it comes to their stock picks.
However, the companies that they recommend usually have market capitalizations in the billions of dollars, and they have years of public financial data on record.
They also do not recommend super small stocks without any financial data since they rely on that data to make their recommendations.
Whenever they send out their newsletter, they provide the research materials that they used to come up with their recommendations.
Another criteria for a pump and dump scheme is the requirement for perpetrators to own the stock prior to advertising and to dump it.
The Motley Fool has very specific rules for its analysts.
These rules include instances where analysts are not allowed to enter into a position on a stock before they recommend it.
This rule mitigates the possibility that someone on the team will take advantage of their research.
Since pump and dump schemes are so dangerous to investors, they are illegal and heavily monitored and punished by the Securities and Exchange Commission.
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One of the biggest reasons that the Motley Fool should not be confused with a pump and dump scheme is their decades of experience and happy, loyal customers.
Pump and dump companies are not built for the long haul.
They practice what they preach when they say they want investors to hold onto stocks they recommend for the long-haul – not a few weeks to get rich quick.
It helps to understand that they are not an investment company, nor do they manage any money.
If they consistently practiced fraudulent behavior and advocated for getting rich quick style investing, they would have gone out of business many years ago.
Instead, Motley Fool offers a 30-day money-back guarantee on all of its services (and yes, they will follow through on their promise).
Do you have experience with Motley Fool? Can you confirm whether they are a pump and dump scam?
Let us know with a comment below!