"South Park's" Investing Lesson

A "South Park" episode, of all things, has yielded some investing insight. Its underpants gnomes have built a business based on "Phase One: Collect underpants. Phase Three: Profit." Look around your portfolio and you might discover some similar firms missing that critical element: Phase Two.

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By Selena Maranjian (TMF Selena)
November 8, 2001

I don't have cable television, and that's on purpose. Since I watch a lot of television already, I'm afraid of how much I might watch if I had 10 times as many channels. Without cable, I've not had a chance to get hooked on the show "South Park." But I have managed to see two or three episodes. And one of them actually gave me some insights into business and investing.

I'm referring to Episode 217. What? That's not enough information? Well, here's a quick summary of the key plotlines:

-- A big coffee chain ("Harbucks") is moving into town and threatening to drive the local mom and pop shop out of business. (Ironically, it's eventually revealed that Harbucks coffee is actually much better than the local brew.)

-- A teacher assigns a current events report to the kids who are the main characters. The boys end up deciding to write their report on the underpants gnomes that one of them has spied stealing underwear from his dresser.

(Still with me? Good.)

The part that I loved about this episode was when the boys followed the gnomes to their cave, and started asking questions about how such a business is run. I found what seems to be a transcript of the episode, and here's the snippet I'd like to draw your attention to:

     [In the gnome's cave]
Gnome 1: This is where all our work is done.
Kyle: So what are you gonna do with all these underpants you steal?
Gnome 1: Collecting underpants is just phase one. Phase one: collect underpants.
Kyle: So what's phase two?
Gnome 1: Hey, what's phase two?!
Gnome 2: Phase one: we collect underpants.
Gnome 1: Ya, ya, ya. But what about phase two?
Gnome 2: Well, phase three is profit. Get it?
Stan: I don't get it.
Gnome 2: (Goes over to a chart on the wall) You see, Phase one: collect underpants, phase two-
Gnome 2: Phase three: profit.
Cartman: Oh I get it.
Stan: No you don't.
Kyle: Do you guys know anything about corporations?
Gnome 2: You bet we do.
Gnome 1: Us gnomes are geniuses at corporations.

Does this sound familiar to you? Once I stopped and thought about it, I realized that the gnomes' underpants business is a lot like many other businesses in America -- ones in which you and I might be invested.

Have you ever reviewed a company and found much to get excited about: promise, demand, compelling products, high profit margins, etc.? (I have.) The important thing is to make sure you're looking at enough of the picture. Make sure that you nail down phases one, three, and two.

For example, a company might have terrific profit margins, but if it's not able to sell many of its wares, then it's in trouble (or at least, you are, if you've invested in it). A company that sports lower profit margins but turns over its inventory rapidly may be the better investment.

In the past, when I've thought about Yahoo! (Nasdaq: YHOO), I've probably come up with something like this business model for it in my head: 

Phase One: Build a huge website, attract the highest traffic volume possible, hook lots of people, sell lots of advertising.
Phase Two:
Phase Three: Profit.

Yahoo! has struggled mightily in the past year, as the advertising market has deteriorated. Perhaps if I'd been more vigilant in my assessment of the company, I'd have seen some possible holes in the company's business model that left it susceptible to major changes in the economic environment. Perhaps I'd have ended up losing less money on Yahoo!

Take another example: WebMD (Nasdaq: HLTH). It's been losing money for the past few years -- more and more money. Could it be that my review of the company yielded the following exciting strategy?

Phase One: Provide, in its own words, "connectivity and a full suite of services to the healthcare industry that improve administrative efficiencies and clinical effectiveness enabling high-quality patient care."
Phase Two:
Phase Three: Profit.

Dang -- looks like I neglected Phase Two again. Might that explain, to some degree, why I've lost so much money on WebMD? It would have been smart for me to try to determine exactly how the company's offerings would reliably translate into profit. WebMD isn't necessarily a hopeless case, though. People investing in it today might do well. But did I research and understand it as much as I should have before I bought in? Nope. I bypassed Phase Two.

The same phenomenon is evident in The Motley Fool itself, as well as other companies with major websites full of content: (Salon Media Group (Nasdaq: SALNC)), (Nasdaq: TSCM), etc.

Perhaps the plan below applies:

Phase One: Build rich websites, full of compelling content, and attract many readers. 
Phase Two:
Phase Three: Profit. 

In fairness, for many such companies Phase Two used to exist. It was "sell lots of advertising." But that's often not enough anymore. Now companies are having to find new ways of generating revenues: making some or all of their websites no longer free, offering premium services, etc. Here at the Fool, for example, we've developed some exciting (to us, at least!) new offerings in the past year or so. Consider:

-- The Motley Fool Select: An e-mail subscription product, offering several compelling companies as investment ideas each month.
-- Online seminars and crash courses (which have gotten positive reviews from more than 90% of participants) on topics such as cracking the code of financial statements, retirement planning, beginning investing, choosing mutual funds, and more.
-- TMF Money Advisor: A unique package that offers three sources of objective financial advice via toll-free access to financial planners, online financial modeling tools, Fool seminars and crash courses, and more.

If the gnome-underpants model of company evaluation appeals to you, I invite you to post your thoughts on our Fool on the Hill discussion board. (You'll likely need to be registered at the Fool to follow or participate in the discussion, but fear not -- registration is free, easy, and yields some perks for you, too.) What other companies can you think of that might have some Phase-Two issues? Let's hear from you!

Selena Maranjian is considering locking her dresser at night and sleeping with the lights on. She owns Yahoo! and WebMD. To see her complete stock holdings, view her profile. The Motley Fool is investors writing for investors.