Nothing much ever happens out here in Santa Colada. However, amigo, one day stands out clearly in my mind...

As is my custom, all day long I sit and watch the sun move across the sky, until it turns the dust on the horizon red, and then settles. I'm the operator of the Santa Colada Hotel round these parts, but for some reason no one ever seems to need a hotel room in town. In fact, my hotel had never had a single person stay in it, ever. Then again, there's nothing here to draw people except for the world's largest tumbleweed. Not a single tourist has ever come to see it. A few years back someone tried to make it a national landmark but the request got tied up in red tape. Truth is, I feared that nothing of note would happen in this town, ever.

Then, coming from all directions like a horn out of the heavens, music started...

"Doo-doo-doo-wa-wa-wa"

Over and over again the creepy music played.

Yonder on the horizon the sheriff, a few cow herders, and I spotted an approaching ball of dust. When it reached us we saw a man dressed all in black riding a black horse. His red bowtie was his only splotch of color. He was a pretty weird-looking fellow and I could tell that the hat on his head was no sombrero.

Sinister and icy, the man said "Hello, fellows, people call me Doc...Doc Stocktout, to be exact. I've got an amazing proposition for you. That is, if you stiffs are interested in hearing it."

"Why yes, suh, we're interested in anything you have to say, Doc," called out a local cow herder. "Ain't we, ya'll?" he said, glancing at the rest of us.

Mumbles of "uh-hm, er, well sure do" rumbled from the crowd.

Hearing approval, Doc picked a rattesnake off the ground, gripped the tip of its tail and its head, and pulled it straight out into a long stick. Using the stiff rattler, he drew figures on the ground. "These, my friend, are the financial statements of Bucktooth Cola Co. [Nasdaq: BUCK]. Maker of, you got it, that miracle elixir, Bucktooth Cola. Look at those profit margins, that return on equity (ROE), those rising sales. Trading at thirty bucks on the Dullsville Stock Exchange, that's only twenty five times earnings per share! Right now Bucktooth is going to start selling Bucktooth Cola in Japan, which will drive sales growth, causing the company's ROE to shoot up. And when ROE is up, that's bound to drive the stock price up too! You'll all be millionaires!!"

Being a doubtful guy, I walked over to Doc and looked at his scrawls in the dust. If my memory does serve, they were:

            Sales     Profits    Profit     ROE
                                 Margin
1996  $1.0 million   $110,000     11%      17%
1995  $.75 million    $75,000     10%      16%
1994  $.50 million    $50,000     10%      14%

"Those figures look pretty good, Doc, I think I'll throw me some bucks into Bucktooth Cola. You can even stay the night, free, in my hotel, as a sign of gratitude."

Lightning flashed and the sky turned black as I said those very words. Even more shocking was a lone rider tearing down Santa Colada's main and only street. The man stopped his horse, dismounted, tipped his cap, and bowed to us all, in a single fluid motion.

Then we got a better look at him.

Cookie, my hotel chef, said "Hey there boss, look at him, with that hat and all them colored clothes, he looks like a Prickly Pear cactus in bloom, don't ya think?" The growing crowd of spectators chuckled.

"You ain't from around these parts, are ya partner?" I said to the man.

"They call me Motley Fool," he said.

"That don't sound like much of a compliment. What do you for a living?" the Sheriff questioned.

"I ride from town to town, setting things right. Then I move on," said the Fool.

Doc Stocktout sneered.

"I'll tell you the way it is," said the Fool. "And I'm telling each and every one of you not to buy Bucktooth Cola stock."

*Why did Motley Fool know not to buy Bucktooth Cola's stock?*

1) Return on equity has no effect on the valuation of a stock.

2) The sale of cola and soft drinks is explicitly forbidden by Japanese law.

3) Rising sales do not necessarily translate into a higher ROE.

4) Bucktooth's increasing profit margin is a sign of trouble.

The answer is 3.

Motley Fool continued, "Sales growth actually has very little to do with return on equity (ROE). There are only five ways for a company to increase ROE:

1. Increase leverage (debt).
2. Use cheaper leverage.
3. Pay lower taxes.
4. Increase asset turnover.
5. Widen operating margins.

Although Bucktooth Cola's move into Japan might conceivably allow any one of these things to happen and thereby increase ROE, there is no guarantee from the information given that this will occur. For these reasons, it is not clear that the valuation of the company would increase as a result of a rising ROE based merely upon Doc's speculations that sales would go up. An investor would need to take a long, hard look at Bucktooth's financial statements before knowing for sure where growth in ROE might come from."

Cries of, "Thank you Senor Fool! Thank you!" came from the townsfolk.

I said to him, "Well, Mr. Motley Fool, the least I think I can do is allow you, for the night, to have that room I was preparing for Doc Stocktout."

"I think I'll take you up on your offer," said the Fool.

And so it was that the Santa Colada Hotel got its first guest, ever.

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