Don't believe a word of what you're about to read.
Not right away, anyway. It's not that I'm going to lie to you. (Am I?) It's just that we human beings inherently want to believe everything we see, hear, and read. That assumption of truthfulness is one of the basic building blocks of civilized society. And when smart, dishonest people exploit that trust, even the savviest investors can get suckered in. Just ask founding Fools David and Tom Gardner.
The question we wish we'd never asked
Let's set the way-back machine for January 2000. Tom and David have managed to snag an interview for The Motley Fool Radio Show with America's hottest CEO, whose company has been praised to the heavens by the likes of Fortune and Forbes magazines for its dazzling profits and impressive record of innovation. After David and Tom listen raptly to the CEO's insights on the future of commerce, Tom asks the following question:
Tom Gardner : I don't know if you've read, in perhaps some of the financial magazines that have reported on this, but The Motley Fool is actually out searching -- because Dave and I have decided we don't have the capacity, the talent, any of the skills to be the CEO of The Motley Fool -- we're out searching for a CEO, and we're wondering if you'd be willing to leave [your company] to be The Motley Fool's CEO.
Ken Lay, chairman of Enron: Well, I might entertain that.
David Gardner [joking]: By the way, Enron's stock is now falling! Down two, down two-and-a-quarter!
Ken Lay: Well, I thought maybe I could do that and Enron.
Yep. That Ken Lay. From that Enron.
Now, Dave and Tom may be Fools, but they're not stupid. (Witness their market-stomping stock-picking prowess month after month in Motley Fool Stock Advisor.) Ken Lay, President and CEO Jeffrey Skilling, and the numbers wizards at Enron ran a skillful and successful scam. They made Wall Street, the mass media, and most of America think they were untouchable golden boys, even as they booked profits that didn't exist, stuffed skyrocketing debts into shady subsidiaries run by their CFO, and watched their traders shut down power plants to artificially inflate electricity prices in California.
See the next scam coming
How can you avoid getting duped -- and possibly losing a hefty investment, as millions of Enron employees and stockholders did -- when the next Enron rolls around?
Follow the money
According to the recent documentary Enron: The Smartest Guys in the Room, Enron used "creative" accounting methods -- initially sanctioned by the SEC! -- to book expected future earnings as immediate profits. This let Enron essentially invent its own revenue and profit numbers, ensuring that it would consistently beat Wall Street's expectations and send its share price ever higher. Fortune reporter Bethany McLean uncovered the first chink in Enron's armor when she sat down with its financial statements and worked out its cash flows, which just didn't match its stellar surface numbers. Free cash flow isn't the only way to judge a company's merit, but it's one good way to get an idea of its true performance.
Don't believe the hype
There's an old journalism-school saying: "If your mother says she loves you, check it out." Beware of companies that make sky-high promises without hard details on how they'll actually deliver. Enron's stock soared when it announced a pairing with Blockbuster
Be willing to change your mind
Enron wasn't the only recent fraud to hoodwink otherwise brilliant business leaders. When billionaire Oprah Winfrey first learned that A Million Little Pieces, the memoir of drug abuse she'd championed on her talk show, had largely been fabricated by author James Frey, she still defended him. She even called in to express her support when Frey appeared on Larry King Live. But as more details emerged, Oprah's opinion changed; she won back a measure of credibility by summoning Frey to her show and publicly raking him over the coals. The lesson here: If you stubbornly hang on to an investment that's quickly souring, you stand to lose more than you would by simply letting go. Don't be afraid to admit you were wrong. As Warren Buffett once said in a Wall Street Journal profile, "If you don't make mistakes, you can't make decisions."
The power of second-guessing
At Motley Fool Stock Advisor, David and Tom Gardner have taken the lessons of Enron to heart. Every issue includes a "Dueling Fools" section for each of the Gardner brother's monthly stock picks, where the rival brother plays devil's advocate to his sibling's optimistic forecast. Tom will question whether David's pick Whole Foods Market
More importantly, Tom and David are willing to confront their mistakes head on. Stock Advisor's December 2005 issue reprints an earlier interview with Scott Livengood, CEO of former newsletter pick KrispyKreme
To read that interview, along with the complete Stock Advisor archives, all the Gardners' six- and 12-month review issues, and the two newest picks in the next issue, sign up today for a free 30-day preview of the service. No one's completely immune to a well-played scam, but Stock Advisor can help you discover the tools to see past the hype and find investing truth.
Don't take my word for it -- see for yourself.
As a rookie, Fool online editor Nathan Alderman once fell for a reporter's bogus account of a Chicago criminal trial whose defendant insisted he was actually Eminem. He has a deep dislike of phonies and holds no financial position in any stocks mentioned in this article. (Don't believe it? Check out his Fool profile.) The Fool's disclosure policy can always be trusted.