Leaning back in his chair, James Maguire was trying to catch a little rest while a 'Seinfeld' episode played in the background. His arms felt like lead. Chinese take-out boxes littered the floor, allowing his poodle to lick the last remains of dinner. Out of nowhere an insulting "brrrring" shattered the calm of the room. "Ugh," thought James, "I'll just ignore the phone."

After about 15 rings, he managed to move his arm enough to bring it crashing down on the phone. He lifted up what felt like a forty-five pound receiver and brought it to his ear. A smooth voice with a bad French accent that oozed conceit came from the phone: "Allo, bonsoir, mon Dieu! I am Cold Call Pierre, an analyst for many respected people, I would love to share with you a stock tip from my sources on ze Street.."

"Boy oh boy," thought James, "This guy sounds like he knows his business, or at least how to order snails in Paris. Plus, I could use a few bucks to buy Fluffy a new flea collar."

"All right," he said tentatively, "what stock and why?"

"Bad Credit Securitizers 'R Us <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SHAM)") else Response.Write("(Nasdaq: SHAM)") end if %> is cheap as dirt! My sources say it is set to rocket. As I'm sure you know, there are many people in this country who do not have stellar credit. Bad Credit capitalizes on this opporring in beaucoup de bucks! Which is to say, tons of money. They do this by bundling the loans together and then selling them in a process called securitization. Right now Bad Credit trades at only 17 times earnings, despite being expected to grow 25% a year. That makes the company a bargain!"

"Uh, didn't auto lending companies like Mercury Financial, which did the same thing, go bankrupt?" James asked.

In his cool-to-cooler voice, Cold Call Pete said, "Nonsense, Mercury Financial was a single accident that has just give the industry a bad name."

But something else stirred deep in the recesses of James's memory. "I thought that Jayhawk Financial, another auto lender for people with bad credit, had similar problems."

Somewhat icily, Cold Call Pierre replied, "Those were companies that were mis-managed. Bad Credit has had the same CEO for three years. And really, can you argue with a company that has pretax profit margins of 50%? At this price, and with all those huge earnings, this company is set to soar. Like a oiseau! A bird!"

"I dunno...Well....you're the expert and you seem pretty sure. Okay, I'm buying into tomorrow, thanks so much!"

"No problem, mon ami, always glad to help out the little guys like you."

Out of the TV, just as George and Jerry and Kramer were ordering pastrami sandwiches in their favorite restaurant, and arguing with the waitress over whether or not the rye bread had seeds, and whether or not seeds were high in cholesterol, leapt Motley Fool.

."Hold on just one second, James!" cried Motley. "Bad Credit might be a value, but from what Cold Call Pete said, there just isn't enough information to buy it."

*How did Motley Fool know that Bad Credit Securitizers 'R Us was probably not a good investment?*

1. Earnings growth does not apply to financial stocks.

2. Companies that rely on securitization often have inflated earnings.

3. Valuations for financial stocks should only be based on book value.

4. All of the above

The answer is number 2.

A company that securitizes loans earns money by keeping part of the interest on the loan (known as the spread) and collecting fees from servicing the loans. 'Servicing' is the process of collecting payments from borrowers and then distributing them to the holders of the loan for a fee.

That is all well and good; however, accounting standards allow for several questionable doings. A securitizer can book all the income it expects to earn on the spread for the life of the loan as current profit. In addition, it can book all the income it expects to earn in servicing fees as current income. This allows some of the more successful companies that use securitization to attain profit margins in excess of 50%. Even so, despite the appearance of amazing earnings from these companies, little of it may actually be coming into the company as cash. For these reasons, earnings should not be the only basis for valuing and evaluating companies that rely on securitization.

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