As always, the last show of the month is mailbag time! Today David answers your questions about risk ratings, conscious capitalism, and when to sell stocks. Then we go Down Under to hear from an awesome Aussie Fool on international investing. Submit your own question for next month's mailbag on Twitter (@RBIPodcast) or by email (rbi@fool.com).
Rule Breaker Investing
March Mailbag
It's the Rule Breaker Investing Podcast with Motleyful Co-Founder, David Gardner. And welcome back to Rule Breaker Investing. I'm David Gardner, and it is the final Wednesday of the month, and therefore it is mailbag. This is a tradition we started some months ago, I think. Was it November? When we decided for the first time, let's have a Q&A, and we piloted it in November. We liked it. December, et cetera, played forward. We're now, this is our fifth mailbag, I think. And I've really enjoyed, once again, your questions and thoughts. This is not designed to be necessarily a Q&A back and forth. I get some really good comments and feedback. Sometimes I talk to that on mailbag, and if there's any tweak or any aspect of this format that you think could be improved, we're always very open. And remember, you can let us know on Twitter at RBI podcast or just our email box, RBI, at fool.com. I've got six items up for grabs this month, and the first one is one of those classic questions that will recur. And I understand why it's being asked, and it was asked well, I'm going to share Brian George's email with you right now. David, I'm relatively new to Rule Breaker's investing into investing in general, but before I get to my question, let me just say thank you for the wonderful information you've put out there. I started with your Rule Breaker's premium service and began looking over all of your recommendations. I'm almost completely caught up on your podcast. I bought your book, The Motley Fool Investment Guide. Brian says he hasn't read it yet. By the way, you might want to hold off, Brian, because we're probably going to update that at some point. In fact, I think this might even be in the next 12 or 18 months, the Motley Fool Investment Guide coming back on its horse from 1996 or 2001 and being updated for the modern era. But regardless, Brian goes on to say I've paid off all my credit card debt. If I may say so, sir, well done. "I'm ready to break into the world of stock investing. I've done a lot of research, not nearly enough," Brian says, "and my knowledge of the stock market has grown from absolutely nothing to average. Thanks to you and the Motley Fool, that sounds a little humble to me. I believe a lot in the philosophy of patience in investing and understand where the benefits from such a strategy payoff in the long term. The only part of the philosophy that I have yet to wrap my head around is when to sell. I understand that as fools, we're playing the long game, holding on to our stocks until we're ready to retire and reap our investments. However, I also know that not all stocks are going to be good forever, and I'm not quite sure what to do in a scenario where a longtime favorite stock of ours is crashing. So my question can be summed up like this. How do we know when to sell? I imagine part of our long term strategy isn't to hold on to stocks that are well past their prime or ones that have become stagnant, let's say I'm 67, Brian writes, and then he says, "Which I'm not, I'm 27," and I've been invested continually in stocks for 40 years. How does one know which stock to sell or how to sell if we've been holding and never selling for the past 40 years? Just as much as one would hate to be the person who didn't buy Amazon when it was cheap, I'd imagine one also would hate to be the person who didn't jump ship before it was too late. Thanks for your help and advice, and I look forward to hearing from you best regards, Brian. Brian, great classic, timeless question. And one that truly, if I haven't already dedicated a podcast to, I need to and should in future, and the danger here will be that I try to say too much during mailbag to such a deep and important question. So I'll try to restrain myself, but nevertheless, really engage you on a couple aspects of your question. First of all, you haven't read the Motley Fool Investment Guide yet, but there's a chapter in there on when to sell, our selling strategy. And I wrote that, and the year was, well, it was actually the summer of 1995, but the book was published in 1996 because that's how the publishing cycle works, Simon Schuster, and it's been our best selling book of all time. The Motley Fool, by the way, has sold over two million books. It's just, we haven't done a lot recently because we've emphasized the internet and reaching people directly through our services as opposed to writing books, which is, by the way, been a much better business decision for us, but enough about us. What I wrote in that chapter still mainly holds true, and I'll summarize it for you here. Rather than think about selling as an individual decision that has to be made on each stock that you hold, whether you've held it for one year or 40 years, rather than make it about individual target prices for each of your, let's say, 35 stocks that you hold, I encourage you and every one of us to think more holistically at a portfolio level. So what I want you to ask yourself, and you can ask yourself this on a regular basis. It's kind of a rhetorical, recurring question. Maybe once a quarter, you could ask yourself this. Am I optimally invested right now for the next five years? In other words, looking over your portfolio is your money right now exactly how you would like it to be apportioned going forward. A lot of people tend to focus too much on where their stocks were. In other words, if you have a stock that's down 70%, you're sweating and saying, "When should I exit that thing?" Or maybe you have a stock that's up eight times in value, and it's taking over a big part of your portfolio and you're sweating that stock. We think too much incrementally about each of the stocks in our portfolio and not overall enough about the percentage of your money that's in each of these things. When I have a stock and I've had them that loses 80% of its value, I don't spend much time thinking about it at all at a portfolio level consideration because probably it's declined to be a very small percentage of my overall nest egg. So what I usually think about those big losers, and again, I have more than the average bear. When I look over my portfolio, I have a bunch of these. They become tax decisions. Generally, I'm looking just to sell them at the end of a year or two, and I'm probably going to net them back against capital gains that I might be taking in order to reduce the capital gains hit that particular year. So it's not at all in this context about the stock itself. On the other hand, if I have a stock that's done wonderfully well, it's not so much what's the right target price for that stock, it's, "Wow, how much of my portfolio do I now have tied to?" Let's say Netflix, and that's a good rhetorical question regardless of what that stock is for you. If you have one or more of those, that's the good rhetorical question to ask yourself about those kinds of stocks in your portfolio. So there's a lot more I could say and probably will say in future about selling, but at the end of the day, you have to ask yourself, "Is there a better place for your money? Any aspect of your money right now? Let buy gons, be buy gons, if you're sitting there like sometimes too many of us are saying, "You know, if that one just gets back to even, I'll sell at some point." Or in fact, what often causes me to sell is because I have limited funds as we all do, if there's some new stock, some new rule breaker that I like a lot, the question is, "How do I get that into my portfolio?" And that usually triggers a sell decision on my part. In other words, it's not so much about what I'm selling but what I want to buy. And I'll look over and see that I'm either over a portion in a given stock or it might be that I'm just like, "Why am I still owning that company when clearly this new one that entices me? Is it better place for my money?" So I hope this helps. I hope it helps you see at a portfolio level the real decisions that you're making as a potential seller and that you are managing toward optimization of how your money is right now going forward because after all, all that really matters is what's going to happen next and how you're invested for that. Brian, thanks for a great question and laying out a little of your story which is very foolish. You know, the hardest thing for most people in my experience isn't getting started investing, it's getting prepared to invest, it's saving the money in the first place, it's getting out of the debt and having that capital. That's the hardest thing for most people in this world and I'm absolutely delighted in your 20s that you've already done that. Congratulations. Mailbag item number two. This is a short question, simple one from Jonathan who writes, "Could you go over what the five and three thing is that I see on the site as a member?" Thank you, Jonathan. Yeah, this is a feature of Motley Fool Rule Breakers and Stock Advisor, my two services. It's called the five and three and it's a concept that anybody can use whether you're a subscriber to what we do or not and it's the way that we form up our view of a stock. It's how we summarize the investment case for a stock. The five are five future events that if they go well start to prove out our hypothesis. The three are three potential future events that if they happen, start to show that things aren't working out in the way that we thought they would be. Think of them as flags. The five are five green flags we're looking for. The three are three red flags we're hoping not to see. The reason we came up with this framework is because we wanted to make you as a Rule Breakers or Stock Advisor member a quick study. We wanted to give you a quick way to come back in and see our investment stratagem or thought our hypothesis about this stock and what we're looking for and I intentionally wanted to focus you on what's going to happen next or what we're looking for going forward. I want to make you a smart observer. In the armchair right there with us saying, "What do we think are really important future developments that we're hoping to see or not to see?" The other question you might be asking there is why five and three? Why not three and five or four and four? Well, in general these are stocks that we like that we're recommending them. Looking for what is positive, looking for what will work well makes a lot of sense for us, but it's also important to have those three red flags out there in your mind. I think as an investor at all times to know what could go wrong and what to be looking for that might be an early indicator of something not working out for that stock. Thanks for your question, Jonathan. I got him number three. This is from John and Robinson. He writes, "Love the risk podcasts isn't experience too much of a blanket. In many sectors today, old school leadership may be a huge negative." So John is reacting to from our risk series the second of the three and these were risk rating points 11 to 20. One of them labeled experience in which we're looking for at least 15 or more years of combined leadership of that company from the top three people in the company. And yes, we consider it to be safer when you have that kind of experience 15 plus years when you add up, let's say the CEO, maybe the chief operating officer, maybe the chief financial officer. Now John, you're right. Sometimes in many sectors today, especially fast moving or disruptive ones, the idea of having a CEO who's been there, let's just make it up 35 years, might not be the best sign. However, more often than not, and that's what we're doing here. There are always exceptional cases, but more often than not, I'm pretty sure that experience in an industry, especially when you think of the overall team itself and really the dynamics of working together, right? That's part of what those 15 combined years are, that you have people who are comfortable working with each other and are a good team. Pretty sure more often than not, that is an asset. And just to complete the answer, if you personally feel as you risk rate a company that you're looking at a team that has been around a little too long, maybe there's some hoarfrost over the headquarters, then what I would suggest you do is you ask yourself that question in questions number 23 and 24, the company specific ones that you write and you dream up. And one of the questions you could ask yourself is, is this company's management being around for so long in this industry an asset? And if you were to answer no, you would add risk to the company back and you would explain why, in your case, you think that these people have been around for too long, which certainly can be the case. So very good thought in your part, and I'll just say that for each of our risk rating points, there are always going to be exceptional cases. But I think most of them hit on the majority, the yes answer, the majority of the time is going to be the safe answer. And then mail back at him number four. This one comes from Tobin Anthony, Tobin writes, "Hi David, I had a question on risk ratings from earlier this month. You mentioned that one risk criterion called conscious capitalism assesses not just how a company treats its shareholders, but how it treats its stakeholders." That would be shareholders, employees, customers. Can you talk about how the Rule Breaker team developed this criterion? A company that cuts prices and raises salaries would certainly have happier customers and employees, but such behavior could erode margins, which might affect stock performance. I would very much want to work for such a company, by the way, who wouldn't? Raising salaries, just raising salaries and also lowering prices and making customers happy. It sounds great to me too, but it's not a given to open rights that I'd want to invest in it. Value stakeholders necessarily pose less risk to investors over those companies that put the interests of shareholders first. Thanks. I'm really enjoying the podcast, et cetera, at Tobin. Another fine question, Tobin. First of all, the framework that we're using here is not our own at Rule Breakers. You know, I wish I'd come up with conscious capitalism. I wish I'd written the book that John Mackie, the founder of Whole Foods and Raj Sasodia, is a very talented academic friend, the co-authors of that book. I wish I'd come up with those frameworks myself, but they're not our own. It's theirs. And of the four tenets of conscious capitalism, which I don't have time to summarize here, one of them is stakeholder orientation. That is companies that don't just take shareholders and say we're trying to maximize that stakeholder's value, but instead look across the organization and think about, you know, who really needs this company to succeed and certainly shareholders are one example, but how about employees? They would love the company to succeed. How about customers? They certainly would like the company to deliver good products and services and to do so consistently over time. And how about in some cases, local community might be a key stakeholder? Or how about the board of directors? And there are many others, depending on the business. So it's not our framework, but I do want to speak to the heart of your question, which is does this framework really work? Or between you and me is it actually just all about making money in the end and the shareholders that are going to get the benefits of that because they're going to get a price to earnings ratio of 30. So 30 times the earnings are going to be what this stock trades at and you and I are going to make money together. And my firm belief is that the companies that understand how to create win, win, win, in fact, Mackie and Caesodius say they call it a win to the sixth because they're thinking about six different shareholder groups. And so if you think about win to the sixth power, right, a win for everybody, yes, those are safer, stronger companies. I truly believe that companies that are only good at taking one or two of their stakeholder groups and creating real wins for those and not creating wins for the others, not creatively solving for those are riskier. They are less sustainable. And so a company like Whole Foods, which is really built on these principles, which has been around for 30 plus years, maybe 40 plus years now and thriving even if it hasn't been a great stock the last couple. These are the companies that I think are much safer bets going forward. So Tobin, that is their framework. But for Motley Fool's stock advisor, where that's one of our service specific questions we ask for risk ratings, I hope it makes it clearer why we do that and why I think it's a good question to ask of these kinds of companies. Mailbag item number five. This one comes from Lucas Coffee. Hey, Lucas, Lucas says prior to making a recommendation, do you think about the macro economy in any way? For instance, Lucas goes on when I listen to Ray Dalio speak about how he and Bridgewater Capital invest based on macro economic principles. It all sounds great, rational. It all makes sense. However, I then don't base any of my investment decisions on macro factors. I don't think Lucas says I have never consciously bought a stock based on interest rates, bond prices or currency fluctuations. Lucas, that makes two of us. I'm not here to suggest at all that macro economics doesn't matter. First of all, it's a great subject to study. One of my sons is presently studying in school and I'm like, you go, you go boy, because I think every one of us, frankly, should be almost required to take a course in economics before we call ourselves educated at the undergraduate level. This happens to be in high school. I'm really proud that the school that my son goes to teaches macro economics. It's a great subject. Understanding the basic laws of economics, there's no free lunch, supply and demand. All of those classic principles that will never change, that are timelessly true and important, is great. But then we start talking about things like what are interest rates right now or where do you think this or that currency is going to fluctuate? Or what about the price of oil, commodities, et cetera, which is where it starts to get a little bit more important, especially if you're buying an oil stock. I wish somebody had told me what was going to happen to the oil price three years ago. But the truth is that as investors, if you're really operating the way that I am, it isn't about those macroeconomic conditions which are usually near term considerations and tend to dominate the airwaves and thinking on the part of casual investors. The truth is you and I are getting on board with a company. We're boarding a train here and track has been laid down and we're going to stay on that train. We're going to go all the way across the country with that company if it keeps executing. If each of those places that we stop as we go from one depot to the next is still intact and still meets with our goals and what we thought of as we when we got on that journey, we're going to stay on that train and the weather is going to change all the time as we go across that country on that long trip together and frankly being over focused on whether it's going to snow in St. Louis or just how truly warm it's going to be as we go through Arizona isn't as important to me as the fundamental destination of where we're headed and what the train is that's taking us there. But knowing your companies, the trains that were on and knowing your destination or goals, for example, I'm hoping to hold this for 10 years and that's because I'm invested for my first house which I'd love to buy 10 years from now. Those kinds of things are much more important to me than macroeconomics. I realize in some ways it's kind of lazy. It's kind of a lazy answer because people who think deeply about macroeconomic conditions see things that I don't and they're very often, they're very smart and sometimes they work in the hedge fund world and they have really big bets in shorter term cycles on those conditions. But it's just not the game that I'm playing and so Lucas, you don't have to think too much about that. I think we should all have our eyes open and we should be thinking about the fabric of our country. I hope that we're a capitalist nation 20 years from now if we're not strongly so, if we're not a world leader there, we probably haven't had a great 20 years to invest in. These things matter but usually people are over focusing on where the oil price is right now or where the Dow Jones will be this fall or what interest rates will look like a year from now. There's no question those will be factors in terms of how the markets and your stocks do but we're invested past that cycle and I rarely see macroeconomics really taken out to a, well, where are we going to be in 10 or 20 years? Those are really the questions that would matter and are worth studying more probably than I do. Thanks Lucas. And last up this month, this one comes from Jacob Wesley, question for the next mailbag, Jason writes, as an Australian, so I'm going to start affecting my lame Aussie accent. As an Australian, should I invest in Australian companies to start with a jump into the US market? And in answer to that question, I'll give you two shots. Jacob, first of all, I'm delighted to know that you're listening all the way across the world to real breaker investing and I'm really proud that really all five of our Motleyful Podcasts have global listenerships and so naturally questions like this will occur from time to time because you're wondering, hey, wherever I am, what do I do based on what you're saying? I'm going to give my quick answer as the first part of this answer and that is I think that you should invest in companies that you know well to start with. If that means as an Australian, you feel like you know your companies and markets pretty well. I would say there too should be your funds. Warren Buffett has that great concept of circle of competence. Buffett says in so many words, all of us should draw a big circle around ourselves and everything inside that circle is what we know and your money should be inside that circle too. But many of us may not have a rich fabric of capitalism and good companies to pick from in our respective country. Maybe we know Apple even if we're not in America better than many of the companies that might be on our domestic exchanges. In that case, I would say keep your money there, stick with the companies that you have the most exposure to that you feel you can most easily research and get confidence in. There's also a consideration about the implications sometimes of investing outside your country. There might be tax concerns. Some countries require you to keep certain amounts of funds or have in the past within that country. So these are the questions that you're going to have to answer for yourself. That said, I would be remiss if I did not mention that the Motleyful has Motleyful Premium Services in Australia. And in that regard, I'd like to introduce you to my friend Scott Phillips, Scott, take it away. Good day, David. Thank you. And thank you to Jagan for a great question. David, I can only assume that accent was maybe cockney Londoner. I'm not quite sure of it in the Australians who have that exact accent, but I do like the effort. So cut us to you for trying a really good go, even if it's not immediately recognizable as Australia. Jacob, I'm also very pleased that you're checking out the Rule Breaker Investing podcast. It's a must listen for me as one I never miss. David, I'm happy to say that we do have a plethora of wonderful companies here in Australia, not quite the same breadth of industries and sectors as you do in the US. And so that does raise some potential opportunities for Jacob. And again, quite frankly, and unfortunately for us, not as many Rule Breaker type businesses here in Australia. In terms of where to invest, I would suggest that there's a good opportunity to do a bit of both, quite frankly. I think, as David's already mentioned, there's a great opportunity to invest in the companies you know well and exchange you know well and in currency you know well. In other words, investing in Australian companies is simply less complex and if you're just getting started and investing, you may be able to find a half a dozen or a dozen great companies in your local exchanges that have the sorts of attributes that David's talked about, which give you the opportunity to get your feet wet in investing. To start building a portfolio quickly, as David's mentioned in previous podcasts, to build out your foolish investment portfolio if you like. And then what I would suggest is then start to dip your toe into overseas markets, particularly in the United States. For me personally, I have about half of my invested wealth in the US and about half here in Australia, but that's a nice ratio for me. It gives you currency diversification, it gives you industry diversification, and it gives you geographic diversification. And all those three things are really, really useful, particularly when Australia's only 2% of the world's equity markets, the US I think represents something like 40 or 45%. So the gap is dramatic and the range of investment opportunities in the United States, obviously a market the size of the US, both in terms of sheer number of people, but also the size of the economy and GDP terms and others. The US tends to be great opportunity for rural breaking companies to be burnt over there. So I was saying in conclusion, David, thank you again for the opportunity to answer this question. I think it's a great idea to start investing in your home country and overseas, and if you're invested outside the US and the US is the natural overseas place to go for the broader diversification. But I would suggest maybe start here at home, have a look at some great opportunities that exist on the ASX or if you're somewhere else around the world on your local exchange, build a portfolio quickly without the complications of international investing, but then give international investing a go. It's easier than you believe, particularly if you're Australia, but I imagine for others around the world, the brokerage isn't too expensive, but you do have to shop around for great brokerage. You get the opportunities of investing in what you know and what you can easily buy. And then as you start to feel more comfortable, branch out and buy some of those companies that simply aren't available on your exchange than your markets. Again, David, thanks again, and everyone, full on. And what a delight it is to have an extra voice here in our mailbag this month. And maybe that's a model for future. You know, I have a lot of foolish friends all around our company, some of whom don't even work in Alexandria, Virginia, and occasionally they know a lot more about your questions than I do. So maybe we'll try that again in future. In the meantime, I hope you've enjoyed this edition of Rule Breaker Investing and our March Mailbag. If you didn't have your question answered this time or your thought shared, remember you'll have a chance this time next month. In the meantime, I'm looking forward to what April will bring us all as investors and fools. We're listening. Have a great week. Fool on. 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] [BLANK_AUDIO]