How to manage a Rule Breaker portfolio, why a company's performance matters more than its stock's, thoughts on company buy backs, and more. Plus, was Kris Jenkin's last-second shot to win the NCAA National Championship really clutch? Fools weigh-in on the April mailbag episode.
Rule Breaker Investing
April Mailbag: Portfolio Management, Business vs. Stock Performance, and More
It's the Rule Breaker Investing Podcast with Motley Fool co-founder, David Gardner. Welcome back to Rule Breaker Investing. It's a beautiful April day here in Alexandria, Virginia and I hope your day, whenever you hear this, is just as beautiful, approximately 79 degrees sunny, perfect temperature for us in the Washington, D.C. area. It's mailbag week, always a lot of fun for me, got a lot to get through, not going to spend much time introing because of your good questions. However, before I start the roster, I do want to speak to a few things. I got a nice note from Stratomatic Baseball. They're out on Twitter seeing me mention my love of Stratomatic Baseball, the dice game. I talked about that a few podcasts ago and the head of Stratomatic wanted all Rule Breaker Podcast listeners to know that Baseball Daily is their new game. So if you're a dice baseball or a Stratomatic fan, check out Baseball Daily. In a nutshell, they update the player cards throughout the season dynamically. So if that floats your boat and you're a Strat fan, get on over there. I also have these notes from last week's podcast where we talked about the top three performers on the S&P 500 last year. And I asked you out there in the Twitter sphere, what are some of the traits that thread through these three companies that you see? And I had covered nine or ten of them that I saw, but I had some really good responses back and I want to just share a couple of them with you right now. Jason Newman pointed out that those three companies, again, Netflix, Amazon, and Activision Blizzard all have the following traits shared in addition, pricing power, global reach, and exemplary leaders. So thank you, Jason. I agree on all counts there. And Stuart Brown at Stu to fly on Twitter said, how about founder led companies that have dynamic forward thinking CEOs, founder led companies. Really important. That's right. Bobby Kodak at Activision Blizzard and certainly read Hastings and Netflix and Jeff Bezos at Amazon. So really an amazing list. If you think of the shared characteristics, about 12 to 15 that we can see through those three companies last year's top performers on the S&P 500. I also introduced last week. The concept of your fang score, and a lot of you let me know your fang score to briefly recount for anybody who didn't hear last week, fang, that's Facebook, Amazon, Netflix, and Google. It's not an acronym I use. I don't group these stocks together. I think it's a little bit overwrought and over hyped, but I had fun with it. I said, as long as we're going to talk about those four companies and hype them up a little bit that way, not something that I want to do, I encourage us all to actually count the number of years that we've held those four stocks because that's great proof against short-term thinking. If you have a fang score, just summing up the number of years that you've owned those stocks, if you had a fang score of 10 or higher, I said, give yourself a gold star because most people talking about fang on the internet or on investment TV don't really have much of a fang score in my experience, but who does have a good fang score? How about Robin Rifkin at Zaga Investment? Robin said, David, mine's about 21. So that's Netflix, he wrote, and Google didn't recognize Bezos's magic till 2014. Hey, that's great. We don't actually have to figure out every great stock at the outset. I think Amazon's been darn good stocks since 2014, so you could have waited about 17 years and felt like you were late to the dance and still had an amazing year last year. Ryan Kenfield said his fang score was 18.5. I mentioned that one because he's @fedthefoot on Twitter. He's going to actually include a decimal place for their fang score has my heart. Rick Engdahl, my own show producer said, David, my fang score is 16 for the record, looking forward to 32. Thank you, Rick. Good man. And Deborah Gray at Gray Heath 13 on Twitter. Deborah said, my fang score is 14, looking forward to your 1,000th episode. And I think Deborah is certainly alluding to market foolery, our long time, our longest Motley Fool podcast, a wonderful daily listen hosted all these years by Chris Hill. Just hit the 1,000 mark last week. And by the way, if you're not already listening to all five Motley Fool podcasts, I truly think we can enrich your life beyond just what you hear from me each week. So whether you're a daily listener, somebody who really enjoys following the markets and one of the fools think market foolery is your friend or maybe a weekly listener for something like Motley Fool money, Motley Fool answers or industry focus. We got your back. Finally, Rick Meenera is one of my favorite fools, long time rulebreaker stock picker himself at market on Twitter. Rick said, my fang score is just 14, but thankfully it's all been with the same stock Netflix. That would be 14 good years. All right, which brings us to mailbag. So your questions through Twitter and through email rbi@fool.com, I randomized the order here because I like to gamify everything in life and why just have some predictable order of your questions. When they come, everything goes, anything goes in the next 20 minutes or so. First one up this month, Barry Inceon coming from our Facebook group. This is our new Facebook group. You can join Motley Fool podcasts. It is a private group. You have to ask to be invited and we will always answer yes if you ask. Barry wrote, just got through the RBI show where David talks about the highest performing S&P 500 stocks of 2015 Netflix Amazon Activision, which is great since stock advisor told me to buy all those. They got me to wondering, however, what the best companies were over the last five and 10 years or even longer periods and whether stock advisor picked any of those. Barry, I'm really glad you asked that question because it's a more important question than what was the hot stock last year. And indeed, I addressed that on the July 29, 2015 RBI podcast, it's entitled the top five stocks of the past 10 years. I highly recommend you listen to that and I will just say that podcast is one of my proudest moments. All right. Mailbag number two, this is from Luke Gruber at Luke underscore Gruber David, I love the show. Listen, since the beginning, what's your thought on automatic dividend reinvestment programs? Great question, Luke. And like a lot of these kinds of topics, they work for some and don't work for others. So let me talk out both sides of my mouth briefly. First up, I love automatic dividend reinvestment programs. Overall, it's taking the worry and the just additional stress of having to make more financial decisions off of your plate and mine. It's just automatically you sign up with a company and you automatically have the dividend reinvested back in the stock. In the same way, we encourage a lot of people to pay themselves first with the salary check. Always be deducting 10% or more from your salary right away. Add it to your 401k plan or your investment IRA portfolio, whatever it is. You're kind of doing the same thing with your dividends rather than be tempted to spend them. You just right away reinvest them back in the company. And it's really a wonderful way to build up long-term positions in companies that you really do intend to own for the long term. So I like automatic dividend reinvestment programs. Now out the other side of my mouth, automatic dividend reinvestment programs, first of all, only happen with companies that pay dividends, paying dividends, not the most efficient use of capital. You probably know this, but when companies make a profit, they have to pay taxes to the federal government, corporate tax rate for their profit, and then from the money remaining, they can pay it to you sometimes they do in the form of a dividend. And then you have to pay tax on the dividend that you get. So if you're a company, is that the most efficient use of capital to have it go through the tax-ringer twice? All that said, I really like dividends for a lot of people and some people only invest in companies to pay dividends. And it's a longer topic than I can really cover in mailbag. But I think that overall I like automatic dividend reinvestment programs, the world would be a better place if there were more of them and more people use them, but dividend investing isn't for everybody and not so much of a focus here on Rule Breaker investing. Number three, this one comes from Mark Fitzgerald, MP underscore Fitzgerald. On Twitter, he said, saving my credit card rewards for a TMF stock advisor membership. The Motley Fool has really ignited my passion for investing. Mark, I really appreciate you saying that. In fact, that makes me probably just about the happiest fool that I can be when I hear that we've inspired you and anyone listening to become an investor to begin investing. The earlier we start investing in our lives, the earlier we start the compounding clock, the compounding clock that every seven years or so doubles your money because at about a 10% rate of return for the stock market, give or take, you end up really doing well. And the earlier you start and allow those compounding doubles to double and double again. But regardless of how old you or I am, all of us should be investing all the time. It should be a lifelong endeavor. It's extremely rewarding. It's a lot of fun. It doesn't take a ton amount of time. And Mark, to close, you've been really active on Twitter. I've appreciated all of your following of the Motley Fool, and I'd like to make sure you get that Motley Fool stock advisor subscription free. So thank you very much. I will make that happen for you. Thank you for all of your attention. And you're good working. Good luck investing. Mailbag got him. Number four, hello RBI podcast greetings to David from listener number 349. I'm touched that you're counting. First off, I've listened since the first podcast really enjoyed the content, a question for Mailbag. We've talked about buying great companies. We've talked about when to sell. But my conundrum is how does a rule breaker manage a rule breaking portfolio? When does a rule breaker add? When does a rule breaker trim? Does a rule breaker dollar cost average? How much cash does a rule breaker keep in a portfolio? Goes on to say, from personal experience, I've had great success adding to positions when they drop in the short term by buying more shares of a company within the first year of my initial purchase when they've dipped due to a market wide pullback. But longer term, I've had good success letting losers lose and adding to positions that have performed well and appreciated so long as the thesis is intact. Well, more questions that I can answer all at once, and it reminds me that maybe in an upcoming podcast, we should talk some more about portfolio management. It's one of those things that is very personal and very contextualized. There isn't a single cookie cutter approach or an emphatic answer I would give to any one of those questions that would work for everybody. So I weighed in very cautiously and will give you a few thoughts here because I didn't want to blow off a really good set of questions. But I also in the first to say that each of us has to know our own situation and make decisions for our portfolio accordingly. So how does a rule breaker manage a rule breaking portfolio? First of all, I manage a rule breaking portfolio several of them actually because for my kids, et cetera, and I do it patiently. I tend to add stocks. I tend not to sell much. Over the course of time is a net saver. I'm just adding more and more money to the market and I'm diversifying my positions. A typical rule breaker portfolio that I would manage for a family member would probably have approximately 25 to 30 stocks. And when does a rule breaker add? When does a rule breaker trim? Well, I've kind of addressed this a little bit and I've talked a lot about this in the podcast in our first year together. But I tend to add to my winners, not to my losers, and when do I trim? Very rarely. I am very willing as a rule breaker to allow positions to grow outsized, larger percentages than many people would be willing to. I've had stocks over the course of history in my portfolio that have been more than 20% of the whole portfolio largely because I just allowed a winner and we talked about some of our fang scores earlier, just allowed a winner to win and win big. It also means that when those stocks give away value, like Netflix did dramatically a few years ago, it hurts a lot and you have to be willing to accept that hurt. It's not an easy ride. It's kind of like riding a bucking Bronco, which by the way, I've never done it. I'm assuming most of us haven't, but on television it looks awfully dangerous, but it's not that different from what it's like to manage a rule breaker portfolio if you're allowing positions to grow to the sizes that the stocks are earning out there on the market over the course of time, and that is not for everybody. Finally, does a rule breaker dollar cost average and how much cash does a rule breaker keep in a portfolio? I think dollar cost averaging is a wonderful approach. It's basically just mechanically adding funds to the market and into existing positions so that you're kind of averaging out your cost bases over time, and we've already talked about, I tend to add to my winners, not to my losers, but even that is not a hard and fast rule, and how much cash does a rule breaker keep in a portfolio? I try to keep it to approximately zero percent. I think having your money invested in the market at all times is going to end up maximizing your returns. Every percentage point you have sitting outside the market means it's not getting the 10 percent or so per year. Of course, some years the market loses 30 percent and other years it goes up 40 percent, so in any given year it might feel really good or not to have cash, but for my own standpoint, having it as close to zero percent is highly optimal. That said, I will confess that for a while now, probably the last few years I've had personally probably more like 10 percent in cash, but that's not because I'm worried about anything in the market. It's just that I'm so busy, I don't always get to invest, and also I'm at the stage in life now we're having a little bit more cash for children's tuitions and this sort of thing is helpful, but I am pretty much all in the market all the time. Thanks for a great question. I hope I gave some relevant answers, but I will mention again, before I move to the next one, those are personal replies and a personal approach, knowing thyself as was written on the Greek oracle at Delphi, the celebrated Greek oracle at Delphi thousands of years ago, know thyself is so important, not just for investing, but for life. Oh, and by the way, we do have Motleyful Supernova, my portfolio management service, reopening in May. And next month, if you're looking forward to learning more about investing and portfolio building, that's what we do in Motleyful Supernova. It opens up two times a year. It already opened up in January, so this will be it for 2016 in May, and for those who are at a stage where they would like help building portfolios, we do that Motleyful Supernova with several different types of portfolios matching you up with what's most appropriate for you. So I'm really looking forward to portfolio dynamics and becoming a more serious investor. I do encourage anybody listening to take a hard look at Motleyful Supernova in May. And now to number five. This one comes. This is a long email. Can't read all of it, but it's from scott@arterburn.info, scott, you wrote, David, listen to all the Motleyful podcasts, other financial shows too. When I hear experts talk about company buybacks, all I hear about is how good they are, how they can increase the company's earnings per share, which can increase the stock price. It says, I am completely against company buybacks. There's a lot of research indicating companies do it at the wrong time. I feel if companies don't want to reinvest the money back into their own company, they should just give it out as dividends, et cetera. Ultimately, Scott, you're asking me what I think about stock buybacks. You did close by saying, I was thinking that if anyone can convince me this is worthwhile for investors, it would be you. Well, no pressure on me. I will say this. I generally like stock buybacks. I mentioned earlier how companies can pay out dividends, and I know you appreciate that, Scott. That may be your focus as an investor. You may really appreciate dividends, and we can do a separate podcast sometime on what's good and bad about dividends, but it is an efficient way to deploy capital to buy back shares. That's why Warren Buffett and his ilk have typically bought back shares and encourages companies to do that because when you have extra capital, rather than just pay it out as dividends and have a double-tax, you can just buy and retire shares of the company, making each share that you or I own count as a bigger slice of the pie. This is why I think in general, it's a good thing to do. Now, a lot of companies ill-time them. You're right. There are some people who, there's no great evidence that shows that CEOs or the corporate finance people, whoever are making these calls, are actually good at picking prices on their own stocks. However, sometimes companies can consistently do it well over time. If you want to become a student of that, you probably could notice that. You could study the companies that do it well. I'm sure there's a list out there on the internet. It's not the sort of focus I have as an investor, but there's no doubt in my mind that some companies make good decisions when they announce a big stock buyback. A lot of companies in closing on this one, a lot of companies do it just a little bit piecemeal in order to be able to retire shares that they've just given out as options to employees. They're trying to run a keep their outstanding shares. Their shares outstanding at a neutral number, not allowed to grow over time, but they keep giving out stock options if they're a growing company to more and more employees, and so they just retire shares that way to remain kind of share neutral. So there are many different motivations and no doubt there's some people who are horrible at it, and some people who are quite good at it, and we'll just leave that one right there. Number six. Ah, yes. This is one of those. We have some Uber themes that kind of run not just through one podcast to the next, but really through the whole story arc of Rule Breaker investing. And my friend, even though we don't know each other, Mike Steele, who's @othermikesteele on Twitter, is clearly also a fan of the language of investing. Mike writes, "Language of investing peeves. Writers using gambling metaphors to describe investing." For example, he says, "bet on," like we bet on this stock, or "double down," a term that comes from, I think that's blackjack. I'm not a big gambler myself. All in this kind of phrase, and Mike, I agree. I think we should watch that, both in our own language, and also we should hold others accountable if we hear them using gambling language, because investing is very, very different from gambling. Here's the biggest difference between investing and gambling, by the way. Typically, slot machines, which are some of the best deals that you can find when you are in a casino, are, I think, taking about three to five percent of the proceeds. So still paying back about 95% or whatever that you put in, but did you notice it's a negative return? When every dollar or coin you put in a slot machine, you expect back less money. Yes, it's awfully fun when you get more money on those occasions, and there's a lot of lights and sounds, but the reality is it's a negative return every time you do it. That is the opposite of investing, where you are getting paid to be an investor. So you're right. We should not be allowing gambling language or metaphors to start to pollute our our lovely uplifting discussion of investing that we do here at The Motley Fool. I want to mention, especially the phrase, and you didn't have this one, Mike, but I'll add it to your own hit list, your watch list, and that is the concept of, you know, allowing a stock to double. This is, I think, one of the silliest ideas that I hear consistently, sometimes people do. They allow a stock to double, then they sell half, and now they are, quote, "playing with the house's money," period, end quote. You are never playing with the house's money unless you're the house. You're playing with your money, and I wouldn't even be playing with your money. I would be investing your money, and I certainly wouldn't be thinking that just because something's done well, you should sell out your initial cost basis so that all you have left now is just profit. That's a great way to undercut your investment returns over the long term, all under the guise of, quote, "playing with the house's money," end quote. Number eight. She comes from Cartaquilla, Agarwal. She says she is a 20-year-old student from India. She's in college. She sees herself as a stock investor five years down the line. I've listened to each and every RBI podcast, huge fan. She goes on to ask, "How do you minimize the timeframe that you will lapse during which a stock does not rise, even though it still has potential?" She cites Netflix as an example. There were some years there that were lean years. Are there ways to avoid that? I often think of Activision Blizzard as stock we talked about last week, which four several years while the market was booming in the space 2011, '12, '13, Activision Blizzard did nothing. It was very frustrating. The discussion board, a Motleyful Stock Advisor, full of people waiting thinking, "Does this stock ever move above 12?" The good news is it's closer to 30 these days. I think there's no way that I've found that you can eliminate the downtime of being a patient investor. I don't find myself good at trying to time my way and to buying a stock at the right point. For a long-term holding, there's no real way I've found to maintain that holding and not have periods that the stock is either going down or sideways, sometimes for a prolonged period. I'll say this. Rather than look at the stock, Garticchia, how about let's just look at the company. Let's feel good about our operations. Activision Blizzard through that lean time was operating extremely successfully. Those of us who held the stock, who had to be very patient, more patient than we expected, found a great reward. It also was one of the top performers, the S&P 500, which we talked about last week just last year. So rewards will come when the companies keep operating successfully. That's what I think you and I should be watching the company less of the stock. Two more. Number nine. This one I'm just going to summarize. This one is from G. Tessier or Tessier, if it's a French pronunciation. It's about sports. We're closing a loop on sports and investing. This is another one of the uber themes that will run through this podcast some over the months. And this one was about that final basketball shot that ended the college basketball March Madness championship. And what G. Tessier goes on to say, I thought was really great. He said, Mr. Gutter, I enjoyed last week's podcast. However, I must say, I disagree with your comment and most if not, all of the nation's contention that Chris Jenkins shot to win the national championship was, as you put it, quote, incredibly clutch. End quote. Now, Chris Jenkins was the guy who hit the winning shot for Villanova to topple North Carolina in the final second of the game and win the national championship. He goes on in so many words to say this, that Chris Jenkins shot was taken from a long distance without any expectations he would necessarily hit it. And the game was tied. So there was no real downside to him missing that shot. And so I think that's a really good point. He actually praises the shot just before it, which was attempted by Marcus Page of North Carolina. Talk about clutch. Marcus doubled clutched just to get the shot off. It was when his team was down three and time was ticking down. And so G. Tessier, who's by no means a Tariel fan, he actually says he's a Yukon fan. He said, I think objectively, I can say, pages shot was clutch. Jenkins shot was, as our correspondent put it, a shot any one of us would love to have taken very little downside. But if you hit it, you are immortalized. I think that's a good point. And number 10, coming from at Theo, Fylo, SWO, Kate and Lambert said, would a company whose name has negative connotations associated with it be penalized under risk rating questions three, five, or both? Love it. A great one to close on. Really appreciate it. Yes, our risk ratings framework. We did a few podcasts on that earlier this year. I would encourage anybody who's interested in this to go back and listen. But the question is, would a company's name, if it doesn't negative connotations, let's go with, I don't know, what's a good name that would have a negative connotation these days without being too controversial? How about a company named Super Sugar Sotas? Super Sugar Sotas. I mean, it sounds enticing, but I think a lot of people these days know that they're not the most healthy thing. So if a company actually went out forward with the corporate brand name, Super Sugar Sotas and was out there selling that, I think there would be, you know, I think a lot of people, there would be a little bit of a backlash. So let's go with that company. And the two questions under consideration are the brand question, does the company's business rely on recognizable branding truly valued by its buyer base? Now looking at the buyers of that company, my answer is, yes, they probably really like the brand Super Sugar Sotas. It may have a negative connotation, but at least for the question number three about the brand where we're assessing companies risk based on whether their brands are effective or not, I think that brand is effective for its buyer base. Question number five to close was, does the company on the whole receive positive word of mouth from its customers? And again here, it's going to come down to what the customers think of Super Sugar Sotas. So regardless of what you or I think of the product or of any name that has a negative connotation, and I think most of us want names with positive connotations both in our lives and in our stocks, but for those, you really have to in the end ask not what do I think of it, what do you think of it, but really what do the people buying from the company or the product think of it, and their impressions are what count for those questions and for assessing risk for companies. All right, that's it for Rule Breaker Investing. That's April Mailbag this week. Next week, I'm going to do something I've done every 10 podcasts or so, and it's about time we do it again. I'm going to pick some stocks. So I'm looking back podcast numbers 11, 21, and 34. I went over fresh stock picks for you five stocks that I liked in each circumstance, and next week, we're going to be at podcast number 45. So I think it's high time I came up with another five stock list. Not sure what it'll be, but I guarantee you I will have it for you next week. In the meantime. As always, people on this program may have interest in the stocks they talk about, and the Miley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker Investing at rbi.fool.com. [MUSIC] (upbeat music)