It's the Rule Breaker Investing Podcast with Motley Fool Co-Founder, David Gardner. And welcome back to Rule Breaker Investing, I'm David Gardner and it's Mailbag Week. This is our fourth Mailbag, so we do it the final week of every month. And this is our fourth and I think it's an experiment that's working. I really enjoy your questions. I have fun with this format, in fact I'm not going to do this again, but last month I ask myself a question this month, I'll be pulling in a few things that aren't questions from around our site and including those, so it's a creative and fun format. And if you enjoy it, let me know. In fact, if you ever want to review this podcast and let other people on iTunes know about Rule Breaker Investing and your thoughts about it, and specifically this week, if you want to say what you think of our Mailbags, that would be helpful. And so looking over our roster, I see 12 items, 12 items. Now, I'm definitely going to bring this in under 30 minutes. I commit to that sometimes with Mailbag, it's been a challenge. But I like to enumerate my numbers, my titles, my points ahead of time, so you know what we're working towards. Some of these are quick, some of these are a little longer. Let's get started. Mailbag item number one this month is just a mention of Berea College. This is not anything that was mailed to me. I just want to mention how I spent a portion of last week. I went to the heart of Kentucky to Berea College to speak to 900 students and faculty, mostly students, about financial literacy. It was a pleasure to be invited to Berea. If you've never heard of Berea, you should know three things about it. The first is that this school is one of the few in America that is a tuition-free college. Yes, they do exist. In fact, some of the international students I met, including Harry from Ghana, who introduced me in my talk last week, found the school by googling tuition-free American college. And so that's a remarkable truth. And they get away with that in two ways, a great endowment, number one and number two. Students, every student at Berea, works part-time in order to support themselves through that school. Two other cool things about Berea. The first is that in 1855, it incorporated as a college, it became the first interracial and co-educational college in the South. So that's right, pre-civil war, African-American and female students right there in the heart of Kentucky. And the third and final thing you should know about it, for those of you who know, Motley Fool Supernova and my colleague David Kretzmann, T.M.F. Pencils, he was student body president at Berea for his final two years there. He graduated just a few years ago, is now a great and wonderful act of contributor to the Motley Fool. So it was partly through David's invitation, but a very foolish group of people. And I highly recommend if you're not familiar with Berea, B-E-R-E-A.edu. Now back, item number two, I really enjoyed this note from Eric Eason. Eric is a longtime Motley Fool member. And sometimes we've even interviewed Eric on, I remember my old supernova podcast. Anyway, Eric wrote, "Thank you, Eric." He wrote, "I was delighted by your podcast a few weeks ago on diction and the many poor choices of words used in investing. I would like to introduce the word I currently have on my own wordsmith pedestal for the next one that must go, or at least be severely curtailed. And his word is the word, potentially." Eric writes, "Over the past couple of years, potentially has become the investing journalists, you know, word like you know, you know, you know, potentially. It shows up everywhere, cluttering the expository landscape of even the best authors. Once it's on your own radar, you're going to soon discover how overused, misused, even abused this word has become a once valuable word, has lost its luster, and now usually serves only to distract and interrupt the reader. It also, more basically, is getting used as a cover the author's booty word. Just in case their assertion doesn't pan out, Eric goes on to list some examples. I'll provide just a few. He lists quite a number. And specifically, these all come from the Motley Fool site, which I have to chuckle and say that's a pretty capital F Foolish thing to do, Eric. So probably one or two of these are mine. He doesn't identify the authors or the articles, but he categorizes these in three categories, the misuse of the word, where you should just omit the word altogether. Then there's the poor use of the word. You could have chosen a better word. And then there's the appropriate use of the word, and we'll close with that one. So just a few examples, again, a wonderful note. And because I recall Eric works in astronomy or astrophysics, I'm pretty sure he wasn't an English major, but he is really channeling the English major inside all of us here with this note. And you know I love this, Eric. So here are a couple of examples of where we didn't even need potentially at all. Quote, company XYZ could potentially end quote. He says that's a double conditional could suffices quite nicely, you're right. You don't have to say could potentially do you? Another example, projected a potential rebound in quotes. Well projections are already conditional. They projected a rebound, you don't project a potential rebound. You see where this is headed. How about just a better word? How about XYZ still had the potential to deliver Eric writes XYZ still had the ability to deliver. So many other choices aren't there. We believe in the potential of our companies. Some Motley Fool writer must have written. I hope it wasn't me. Eric says, how about we believe in the prospects of our companies? Dido. Finally, the appropriate use of the word quote, we've earned about one fourth of the full potential profit end quote, yay, Eric writes, this is an appropriate use. So addiction hunters be on the lookout for the completely unnecessary overuse of the word potential, potentially be on the lookout. Mailbag item number three, Matt Marr wrote, David and fools. My question is this, are buybacks counterproductive to the market at large when many companies are doing them? I often hear the 17 price to earnings ratio cited as an average. And when that average creeps above 17 to 19 pundits point to that indication saying it's an expensive market, expensive market, Matt goes on to write, in turn becomes fodder for all of the top callers, the fear mongers, seems like most repurchase plans are poorly executed, et cetera. And Matt's note, very understandable, very good question. So yeah, let's be clear on this. Companies can buy back their stock, it happens all the time, just like you can buy a stock or you can sell a stock, companies do that with their own stock. And a lot of companies sometimes fall in love with their own stock, they purchase their stock at the top, they make all the mistakes that you and I might make and do sometimes make as investors. A lot of companies are buying back shares merely to retire shares that they're going to be giving to their employees. And others do it as a matter of a more efficient use of capital. For example, if you are a slower growth, more mature company and you have a ton of cash because you're making a lot of cash flow, but you can't reinvest that in your own business at a good enough rate of return. Maybe your business just isn't growing that fast, instead you can buy back shares. And when you buy back shares, if you and I are shareholders and the companies buying back their shares, it's reducing the number of shares, right? So when the company reports earnings per share, all of a sudden that goes up, right? Because there are fewer shares and so the EPS or earnings per share of that company is higher and that'll cause the stock usually to do better thanks to a good trading multiple off of that rising earnings per share. So companies are doing it, they could have paid dividends with that money, they could have reinvested in their business, but some companies just buy back shares. So overall, Matt, my view of this is it's a perfectly fair use of capital when done properly. The two key conditions we're looking for here are, number one, if companies are egregiously giving away lots of options and shares to employees, this is a way just to keep things under control by buying back shares in the open market. But number two, especially if it's a more mature company as I just mentioned, it's an okay way to use capital assuming that the management team is making good decisions on when to buy and sell stock. You and I can see what this kind of activity looks like. For example, I just saw the earnings report for Texas Roadhouse, a Motleyful Stock Advisor picked this week and the company listed the number of shares it had bought in the market over the last quarter and paid, I did the math about $35, about 35 and a half for those shares, the stock as I do the podcast days, about 41. So I guess you and I would say that was smart, right? The company bought low and the share price is higher today. But of course, that's a short term measure. But I want you to know that I don't use buybacks overall as a big indicator of where the markets headed and there's no magic price to earnings ratio. I'm foreshadowing a later mailbag item we'll be speaking to, but there's no magic price to earnings ratio that I'm looking for to see when companies do the most kinds of buybacks. I do think it could be interesting if you have an overall market view of the number of buybacks and you have a historical appreciation for that. I think that can be fruitful, not part of my own approach, but I think it's legit. Thanks for a good question. Mailbag item number four, this one's from Mark de Blassie at Mark de Blassie on Twitter. Mark wrote, "I don't trim my winners to rebalance my portfolio. Why would I want to sell my top performers? Is this small F foolish or capital F foolish?" Well, Mark, I hope you've been listening to the podcast over the last four to six months or so or maybe you've been a Motley Fool member for longer than that. I think you're giving me a nice fat pitch here to swing at because this is in fact one of my cardinal points and that is that in general, I don't look to sell my winners. In fact, most of my best investments and most of my net worth is tied up in companies that I allowed to keep winning over long periods of time for me as an investor. The classic line, why are you watering the weeds and trimming your flowers is a helpful metaphor for a lot of us. Even the tendency is, if you're thinking buy low, sell high, a lot of people just start selling anything that's doing well and then sometimes redeploy that capital back and things that aren't doing so well. That's a really bad mistake to recuringly make over long periods of time so always have that flowers and weeds metaphor in your mind. But I do want to close that by saying that there can certainly be a reason sometimes to sell some winners. I don't trim by habit but we've talked about this in the past. If a single position or a number of positions become greatly overweighted in your portfolio overall or any single stock holding for you represents more money than you feel comfortable sitting in that stock from one day to the next. If you're losing any sleep over your portfolio, then that might be a reason to sell some winners. But for the most part in my experience, too many people are, in fact, sadly watering their weeds and trimming their flowers. Thanks for the question. Now back at number five, I mentioned this earlier. This was not technically submitted for this podcast. I found this on Motleyful Caps. It was in response to something on my caps page. It starts this way from Riley. Riley writes, "Dave, I heard this on your RBI podcast recently, had a few comments on the stock." This is about, by the way, planet fitness. This is one of the companies I mentioned, five stocks to buy in the teeth of a bear market, planet fitness, a recent rule breaker recommendation. He said, "I'm a paying member of planet fitness. I've been for about five years now. I'm from a small town in Vermont where your only gym options are planet fitness or paying above $35 a month for the other gyms that offer more than just your basic equipment needed for the average gym goer." But as a college student, with no income for the majority of the year, Riley writes, "I can't complain one bit about the pricing model that this company's established, and I have little to no complaints about the PLNT." That's the ticker symbol I attend. When looking at the stock, Riley goes on, "I can't see this company being able to expand their business beyond North America. I lived in and explored Europe for four months last year, and while it wasn't by any means and extraordinary amount of time, I noticed how fit everyone seemed to be compared to America, which should be of no surprise. For that reason, I think this sort of concept can only exist in North America." And the post goes on from there. All I wanted to do was highlight two things. First of all, Riley, this is exactly what the Motley Fool's about. You are sharing your viewpoint, you're adding to our community intelligence when you provide your insights, and whether you are, as you said, a lower income college student just starting out investing, or in fact the CEO of Planet Fitness, or somebody who is actively leading or using technology someplace in our world from a more executive level, all viewpoints are welcome. And we have, in fact, from early on, really, from the first day the Motley Fool started on America online in August 4th of 1994. We have welcomed this kind of community intelligence, and it's a pleasure for me to find that on my caps page, just you responding to my PLNT green thumb, which leads to my second point, which is just, that's something that I do a lot, and I hope you, dear listener, do as well, which is when you have a hunch, or a thought about a stock in its direction, I go to Motley Fool caps, I put my green thumb if I think it's going to beat the market, or my red thumb if I think it's going to lose, we score all of those positions. You can type in why, for example, Riley's sharing his or her viewpoint there. It's a wonderful learning tool, and indeed has helped guide me a lot as an investor over the years when I see comments like Riley's. So, Riley, sorry to pull you in from my caps page onto the mailbag of the Rule Breaker Investing Podcast, but you can see it's really all the same fabric, it's all of the piece. Oh, and I guess I should mention, in closing, Riley does feel good about planet fitness, but over the next five years or so, as it builds itself out domestically, not necessarily as bullish the five years or so after that, but as Riley concludes, as I said, I'm just a college student majoring in finance, long-time listener of the Motley Fool podcast. Thanks, Riley. Mailbag item number six. The question, I will leave the Twitter person nameless here. The question simply, are we currently experiencing a bubble in any area? All I want to say is, if you listen to my addiction podcast, you'll know I don't use the word bubble, nor do I think in terms of bubble, so sorry to burst your bubble. Number seven comes from Ken Hart at Fool Hart with a P, of course, on Twitter, Ken writes, "Advice for a Tesla fanatic, 50% of portfolio and want more. As a hundred times more a believer than next company, Ken concludes going to hell?" Well, it's a funny question, Ken, so I think what you're conveying is that you have 50% of your portfolio in Tesla, so you probably are going to know where I'm headed with my answer, but that sounds like a lot for any one stock. Unless your portfolio is something that you can allow truly to make dramatic movements over time, and if Tesla doesn't work out, which could, by the way, happen, Tesla may not work out from here, that could happen. I would say the same of any single company or stock. If it doesn't, how badly would you be hurt by that? If you have a gigantic portfolio, easily enough to retire on, and so if you lost your top position equaling 50%, it wouldn't hurt that much for your family's future, then sure, if you feel that much more strongly about that one company than any other, I guess you could allow a huge percentage, but I think 99% of us would be better served to make sure that we are better diversified. Now, I have to admit some hypocrisy here because back in the day when I owned America Online stock and it went up 150 times in value in five years or so, and I just left it in there, but stock was probably more than that for me, so those of us who are comfortable with risk and have something that we really believe in, I guess you could go a larger percentage like that, but I think it's almost fiscally irresponsible for me on my podcast to suggest anything other than making sure you diversify away from a 50% position, however much you love a company or a stock, and I do love the company. Number eight, number eight comes from Sarah Wilson at My Smart Puppy, that's a good Twitter handle. Sarah, I like your question, made me think a lot this week, not sure I even have a great answer, but you wrote what are two metrics that you look at, David, you look at first when assessing a company's financials, two metrics, so yes, I did think about this one. I slightly reframed the question, but I hope this is still helpful, Sarah, I think the way that I phrased in my mind is pretend that I could only know two data points, two numbers for any stock, and then I had to make a decision about whether I wanted to continue researching that company, maybe to buy it, or just kick it away. What would those two bits of data be? And I think I've settled on this. The first number that I'd like to know is the cash flow of the company. So I'd like to know if I'm allowed to know what next year's projection would be, or if you would sneakily tell me what the next five years of cash flow would be, I would take that number, or we could just look backwards one year as the financial statements do and show where cash flow, what cash flow has been. That's number one. I'd like to know, is this company pulling in $10 million of cash flow this year, or are we flat, or is the company losing $100 million of cash flow each year? So knowing where the cash is moving, and then the second number would be the amount of cash on the balance sheet. So to give a couple quick examples, let's take the example of an development stage biotech company. So this is a company that's going to have negative cash flow. Let's pretend that it lost $35 million in cash flow, negative cash flow last year, presumably because it doesn't have a product in the market yet, it's trying to get FDA clearance and it's spending a lot on scientists and labs in order to find a good solution. So that's a typical situation. So minus 35 million sounds bad, but if I then find out that on the balance sheet, in the company's checking account, if you will, it has $350 million, then I can project that forward and say, okay, so these guys are going to be around a while, minus 35 might sound bad, but we have 350 sitting there on the balance sheet. And I feel just fine about that. On the other hand, if we have a company that is generating just $2 million of cash flow, which is a number two, and on their balance sheet, they have $8 million of cash overall. Then I start worrying a little bit because that my first example was a company with negative cash flow, which sounds bad, but they had a lot on their balance sheet. This is a company with small positive cash flow, but one without that much cash. Now, there's no way I would ever allow myself to only have two financial metrics and really the third that really makes this have a little bit more structural integrity is knowing the amount of debt that a company has. So, in both of those examples I just gave, the amount of debt a company might have or not would affect this. But if you boil down business just to the generation of cash, is it plus or minus right now and how much do we have in the bank? I think you largely have a pretty good quick financial framework to know what kinds of companies and stocks you might want to pick and what you're looking for. Thanks for your question. Now, bag item number nine, this one comes from Kate Lambert at Theo Philo SWO on Twitter. What do you consider before re-recommending a company in a Motley Fool service? How does this differ from the original recommendation? Well, one of our most valuable acts over the years, if you look at Motley Fool premium services like Stock Advisor or Rule Breakers or Supernova, all of which I work on, one of our most valuable acts has been, as it turns out, to re-recommend companies. So, for example, I might have picked Netflix in 2004 or Priceline in 2002, but all of a sudden in 2010, in the case of Priceline, I decide, "Hey, I'd like to re-recommend that again." And the reason it's been a very valuable act is because I think our internal numbers show, and anybody who's a member can just look at our scorecards because everything we're doing is transparent on those services, you'll notice that we have an unusually good habit of re-recommending companies that go on to do well. So, for example, in the case of Priceline, after it had already risen eight times in value, I, for whatever reason, got it in my Fool head to re-recommend Priceline again. And just to be clear on that, it was, in fact, June 18 of 2010. A lot of people said, "David's already up eight times. What are you re-recommending that stock now? I'm happy to say that Priceline, since June 18 of 2010, is up another 553%, so it's gone up six times from there, which means that first position is up a lot at this point. By the way, I don't always get this right. I re-recommended the Container Store last year, and that has badly hurt. So, it doesn't always work, but we do have a pretty good habit of doing well with our re-recommendations. So, what am I looking at? There are a couple of things I'm looking at. One is just that the company is doing well, and it is fulfilling whatever we said in our original recommendations, and that's something that's really important to us. A growing confidence in that company, its business, usually because we're re-recommending once a fair amount of time has passed, in most cases, we've been able to witness, does this management live up to what it's saying? Does its competitive advantage in its industry loom larger today than it did when we first recommended it, whether it was last year or eight years ago? And so, it is, I think, adding to our winners that is the critical lesson for re-recommendations. And so, yes, I tend to look at the companies that are doing really well and ignore the other ones when I make my re-recommendations. There is no hard and fast rule here, and there are going to be exceptions to any rule we ever make here on the Rule Breaker Investing podcast. So, occasionally, I have re-recommended a stock when it was down. Activision Blizzard worked out quite well once. Companies that have a large balance sheet, we just talked about that earlier. If you have a lot of cash on hand and your stock's down, I feel better about you than if you don't have much cash on hand because cash is really permission to evolve into the future. If you have a lot of cash, you can screw up all day long as long as you're starting to realize you're screwing up and redeploying that money in R&D and getting ready for the future. So, that's a big factor for me. The few times I recommend stocks that are down, but usually the winners keep on winning and our re-recommendations reflect that. Mailbag out him number 10. This one comes from Lucas Coffee. He emailed it in. Lucas said, "Hey, he's been recently reading a lot of investing books, everything from Intelligent Investor, The Intelligent Investor," by Ben Graham, and some Buffett books, Education of a Value Investor, The Little Book of Value Investing. There's a theme emerging in some of these titles. He said, "David, I feel like Benjamin Graham, despite your long history of beating the market, might label you or your style as, quotes, speculation." So, my question is, how do you personally, technically, value rule-breaker stocks? You already mentioned several times you don't worry about PE ratios, et cetera, so how do you do what you do? Great question. I've been asked this many times over the years. I think I've written a lot about this over the years, trying to be succinct here and keep this particular podcast inside of my defined goal of 30 minutes or less. I just want you to know a few things. First of all, I think the markets are pretty efficient. So, the prices that you're seeing on stocks today are generally pretty reflective of where those stocks should be trading, which may sound crazy from somebody who thinks that you and I should invest in stocks because we'll beat the market. You just heard me say, I think that they're generally fairly priced in the near term, but here's the key. The markets have a real hard time pricing for the long term. So, in my experience, the pricing is efficient if you're looking inside six months or so, but that's the real fault of the markets. They're so short term oriented. So, I'm generally okay with taking the prices that are being offered every day on the market. Certainly, I do use some ratios. I look, especially at price to sales, as a simple measure. We can talk about that in another podcast. I don't want to get too technical here, but certainly the price earnings to growth ratio. So, if the company has a PE ratio of 17 but is growing by 50% a year, that's better than if a company has a price earnings ratio of 17 and is growing 10% a year. So, these things all influence me, but I don't make valuation per se the way that we gain an edge as investors. I think we gain an edge, at least as rule breaker investors, by looking at the excellence of the company, the importance of the industry, and all kinds of other factors. Many of them, not numerical, things like, can the company innovate? What's the company culture like? Who is actually running this company? What is their competitive advantage? None of these things are found on financial statements. And so, for this reason, I think we have an edge, and this is why we beat the market over the long term, not because we look for a certain PE ratio or because we screen for certain numbers and have some magic list of screen stocks that we just buy regardless of the company because they meet a numerical goal. If that does sound speculative, and maybe it would to Ben Graham a century ago or so, then I say some of us are speculating, but since I've been doing it 23 years or so, and we're often speculating our ways into some of the best companies in America, from Apple to Amazon.com, along with some losers too, we've talked about that other podcasts. I feel comfortable with that. I hope you do too. And if I'm challenging some of what you've read in books like the little book of value investing and the education of a value investor, I'm happy to do so. And if you end up favoring those more than our own approach, totally understand. It takes two to make a market. All right, and just two more mailbag items this month as we close out. Steve Hunter wrote us by email, too cheap to sell was the subject. Dear David, I've been a happy stock advisor member for many years. However, not every recommendation I've invested in his worked out, which is okay, of course. Steve kindly writes, he even kindly then goes on to talk about some of my biggest losers in recent years. But some he writes, see drill, Westport have so little value, really just a few hundred dollars that I wonder if it's foolish to sell them. That would be with a capital F. The good kind of foolish is it foolish to sell them even though I'm pessimistic about their future. There's a small but not zero chance they'll bounce back. If I sell, the money I can reinvest is small. Your thoughts? Well, Steve, thank you very much for writing. And yes, I have some big losers I always will in my services in my own portfolio. And here's my general advice for big losers. At the point at which if you're down with a stock 80% or more and you've maintained a fairly balanced portfolio, then that position has simply shrunk relative to all the other positions in your portfolio. And you're right, it becomes almost a needless distraction to see something with a big red number in terms of percentage drop, but a fairly small number in terms of the dollars you have invested at that point. That's why I think of those primarily as just tax decisions at the point at which you find yourself. Usually what I look to do is I look to sell that position unless I have a really strong confidence that I come to going forward and I match it up against another stock whose capital gains I'm cashing for whatever reason that year. So you can reduce your capital gains. You can use losers like that to reduce capital gains of winners as you redeploy that winning money somewhere else. So for me, they become a tax decision more than anything. And by the way, for some of these winners, they do come back and that can be really good news for those of us who hold on. I think in general, whether it's my stock advisor or losers or my rule breaker losers, I think it's fair to say that I tend to hold losers too long. But that's all in service of holding my winners too long as well. If you do the math, it's a good numerical fault to have because your winners you hold too long, that is for a long time, are going to end up wiping out of my experience what you lose on your losers. And that's why I think of them more as a tax decision as opposed to something to get excited about or to reinvest in. I also finally want to admit that there's also a little psychic energy for all of us, which is just consumed by the presence of additional losers just sitting there on our scorecard. And so sometimes just cutting bait can be the psychologically healthy thing to do as well. Now back item number 12. This is from Warren Kiesel at W. Kiesel on Twitter. He writes, "Mollyful income investor uses low, medium and high for risk ratings. Why not use the same risk descriptions for all of the services?" Well, two answers to Warren. First of all, every one of our services of the Motley Fool is unique. We have different viewpoints, different approaches. What I do with my risk ratings might not be what income investor wants to do with its. And as co-founder of the company, we created a Motley company on purpose. So we don't have any standard that everybody has to adhere to and we all have different ways of viewing things. I personally prefer a number to just a label like medium. We talked about this podcast or two ago. I also talked about, and this is a preview for next month, in fact for next podcast, I talked about how I wanted to go over risk and talk more about risk and the risk ratings that we've developed at the Motley Fool. In fact, we put a single number from zero to 25 on every stock we recommend, the higher the number, the higher the risk. And these ratings are very useful for members who are trying to figure out relatively how risky is this pick versus that one as you decide which one you want for your portfolio. So I named March Risk Ratings Month, and we're going to spend a few podcasts in March a short series going over the 25 questions. We won't do them all at once. The questions that make up our 25 point risk rating framework. It's an opportunity to talk and discover together what kinds of questions do we ask that causes to think this stock is risky or not. And again, there'll be 25 of them and starting next week, we'll do a short series kicking off with the risk ratings. Warren, thank you very much for your question. Well, thus much for February Mailbag. I hope March is a better market month than January and February. I hope you enjoyed this edition. I look forward to talking about risk with you next week. Fool on. As always, people on this program may have interest in the stocks they talk about, and the Motley 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]
