Maintaining our new end-of-month tradition, David Gardner answers listeners’ investing questions submitted on Twitter (@RBIPodcast).
Rule Breaker Investing
December Mailbag
It's the Rule Breaker Investing Podcast with Motley Fool Co-Founder, David Gardner. And welcome back to Rule Breaker Investing, our final podcast of 2015. And yes, this is an original. We're not showing you best of or just replaying something we've done before. Nope, we're here hard at work at Fool HQ. Well, I admit we take this a couple of weeks ago. We're not actually in Fool HQ right now, but we did do this for you. And it's our mailbag. It's the last Wednesday of every month, and that's a new tradition we've started here on our podcast. We hit the mailbag on the final Wednesday, and here we are Wednesday, December 30th. And as usual, you had a lot of great questions more than I can speak to. Before I start, I want to mention one fun thing that came about from a couple of podcasts ago. You may remember Style Boxing, which was in early December. And I told the story of our former intern Igor, turns out I'd forgotten Igor's last name Igor Myerson, who was a Motleyful Intern. I told a story. If you don't remember it, you can go back and listen to Style Boxing. But a friend of a friend was listening to the podcast, let Igor know, and Igor reconnected with me via email and Twitter. And he's going to come by and go for a visit around Fool HQ sometime in the new year. So good to hear from you again, Igor, and good to know that the greater Rule Breaker Investing Podcasts family, the powerful network that you find yourself a part of continues to work and spin out magic. Okay. So we're going to come 10, count them 10 mailbag items this month. First one up. This is the longest read. This is a good question. This came from a few different people. Here's a short version from Mark W at these days on Twitter. Mark wrote, "I hear the idea that Rule Breaker Investing is more an art than science. What is trying to be conveyed? Art exists in science and vice versa. Or put in a little bit longer form, again, very thoughtful by @CCTopple, Craig Topple. Craig wrote, "Deegee, love in the podcast. I've heard thrown around the concept, are we investing more like art than a system or formula or investing as art? Not science. Could you expound on an episode? What is trying to be contrasted? Why oppose art in science? Are we talking art like an orchestra or a dance team or art like a Picasso? I suspect it would suggest creativity, Craig wrote. There's much creativity that exists within synchronization, which is quite systematic. Lots of creativity in science. RB Philosophy also talks a lot about regular consistent investing, which sounds quite systematic and somewhat scientific. You also use and analyze tons of data, which is very scientific. Thanks." As you might expect, that one actually came through by email that was more than 140 characters, but you hear the thread, you hear the theme, art and science. So what do I exactly mean? I guess I need to be fairly narrow with my answer, because I don't want to get into philosophical discussions about what art is and what science is. I'm not really qualified to play there, but I will tell you that I'm often reminded of a great passage in one of GK Chesterton's works, and I don't remember which work it was. It might have been the man who was Thursday, but Chesterton talks in one passage about poets and chess players. And here's paraphrased in so many words what he was saying. He was saying, "Why does the world always call poets mad? Why are poets always the mad ones?" And obviously he was somewhat of a poet, a writer himself, "Why are poets always mad? It's not the poets who are mad, it's the chess players. They're the ones whose entire world is bounded by an eight by eight grid, and everything is confined to this one universe, and a lot of them do go crazy over the course of their lives. It's the chess players who are crazy, not the poets. And so in some ways I think the same thing about art and science. Now listen, I love both art and sciences. I mentioned earlier, I'm not really not qualified to define the two against each other, but to me, investing our way is about the unknown. It's about placing some bets, trying to piece together where the future is headed. And for me, this is, as I said, unknown. The opposite of unknown for me in this context is, I'm going to say precise, precise, numbers, numerical, a very left brain approach to investing. Maybe we're talking left brain, right brain a little bit more, and maybe left brain's more science, and right brain's more art, I realize these are generalizations. But that's what I think about rule breaker investing. There are many people who screen for stocks, who just use simple numerical parameters or have a very rigorous numerical approach, maybe algorithmic driven. That's not what we're doing at rule breaker investing. We're really looking CEOs in the eye, we're looking the future in the eye as best we can, as best we can piece it together, and we know we're going to get it wrong, a substantial amount of the time. And so, yes, for me, that feels more like art. That feels more like splashing paint on a canvas than it does, coolly, sometimes even coldly calculating numbers. But by no means does that mean that you're only doing one, not the other. The truth is there's a real blend. But I think many people, most people tend to think of investing as very scientific, and in this case, again, precise and numerical. And I think what we're really bringing is an awareness of the whole other side, maybe of your brain or that other thing, art and bringing the creativity and guessing that comes with being a rule breaker. I hope I did a decent job at that. Thanks. That'll be my longest mailbag item this month. All right. Next one up is @HDGS, Hodges Bradbury, somebody who's a Motley Fool member and Hodges, hello, I remember you. You can't visit us a few years ago. Hope things are going well down in Georgia. Hodges wrote, "David, you prefer investing in winning stocks, under what conditions might you go bargain hunting?" Well, first of all, it's hard to generalize and give you a solid rule about when to bargain hunt. But I'll give you a couple examples or traits or instances. I will go bargain hunting when I have a high degree of knowledge about the company or stock that is now suddenly a bargain. By the way, I've had a lot of those this year. There are a number of companies, Amberella is an example of a company that is less than half the high it hit in July right now. It's been a wonderful winning stock for us in Motley Fool Rule Breakers over the years. But I have a much higher degree of confidence having studied and knowing Amberella. By no means an expert, a lot of you know more about Amberella. Some of you are speaking about real scientists, engineers who understand its business much better than I do. But when I use pattern recognition, I say that's a bargain right now and I'm happy to hunt that one. A second example, very quickly, the balance sheet is often, for a lot of us, a great way to gain confidence that a company can turn things around or is a bargain or the opposite is not. And when I say balance sheet, I realize not everybody is adept with financial statements listening to the podcast. But I'm really just talking about how much cash a company has in the bank. Just like I'm more willing to bet on you if you're down and out, if you have a large bank account than if you have nothing in your bank account. That's a lot more of a gamble. I have lower confidence, I probably wouldn't go bargain hunting in that case. So true of companies as well. So when companies have a large cash hoard on their balance sheet and little to no debt, that company is allowed to screw up, has permission to change things up, has time, time as money friend, has time in order to redress any past wrongs or improve itself or evolve into the future. And that's when I go bargain hunting. So those are a couple of times when I'll do that. Thanks Hodges. Next one up is at J Norman Yulich and Jeff, you and I have traded notes some over the years. Jeff, you asked and I hope I pronounced your last name correctly. On the technical front, do you have any screeners like PE and AV, that's net asset value. FCF, there are a lot of acronyms here. FCF, that would be free cash flow, debt, et cetera. When looking at new investments, in other words, do I tend to screen for certain numbers that I'm looking for when looking at new investments? And the answer is, Jeff, that I do not, I don't screen, I think screening is fine. It might be more dare I say this science than art. But for me anyway, I probably did screen stock sum in my early days, ages 18 to 24 or so, trying to figure out what would work or what would win in investing. But I haven't used screens for 20 years or so. We have some screening tools on the Motley full site. I wouldn't say we have the best screeners, and maybe that's partly because one of the co-founders doesn't use them that often, although we are always trying to improve our tools and make our site as useful for all of us as possible. I certainly think winning stocks can be found by screens, and I know some people use screens on a very regular basis, that's how they find stocks to invest in. But for me, I find stocks largely through my own experience, through our community, through reading and looking at things on the internet, watching videos, all of these different ways that we can come across ideas. I also try to think about the future, and that's something we do on this podcast. We talk about where the future is headed, and that guides some of my stock selection as well. Thanks for a good question. Next one up is @TimHuganin, and Tim wrote, "What are the top three long-term overarching and disruptive technology trends providing best investment opportunity?" Going for the jugular there, Tim. Not shy about asking the big question, well, because I'm doing this mailbag a little bit off the cuff this month, it is a very, very busy month. By no means can I bring you the definitive answer as to the three great trends of our time that we must all invest in, however, I will share some answers regardless. I think that the internet will remain, is and remains perhaps the number one long-term overarching disruptive technology of our time. It provides, has provided, will provide, many great investment opportunities. Many time you network the entire world into one great big brain, and enable people at a click of a button to make stuff pop up at their doorstep the next day, or maybe even the next hour. Any time you allow people the transparency of social media and the connectivity, so many things come from that, and I don't think we should ever forget that I think the internet is the great story of our time. I realize people say stuff like Generation X, or you Generation Y, or you a boomer. I don't like those kinds of ways of summing up whole generations, but I think history will look back and not say that this was Generation X, Y, or Z, or whatever we were saying these days. They'll say this was the internet generation. That's the generation that you and I, regardless of age, if you're hearing me today, that's the generation that you and I are living in, and it's really powerful and really important. A second trend, I think this is much more emerging, and certainly it may be getting up in the hype cycle right now, but it's got a lot of long-term play and it's virtual reality. No question that an entire new medium is being born, about to be born, and with the sales of some consumer-friendly headsets starting really in 2016 in earnest and all of the content creation that comes from everything from amazingly immersive video games to training videos, all kinds of social connectivity, this new medium, which you and I can't see yet, but come back and listen. I hope you're listening to this podcast 20 years from now, and remember that I was saying at the time, it's going to be big people. Plastics, that worked in 1960 or so in the 60s. Virtual reality definitely works in the 2000s teens, so it's going to be big, and then third, and these really aren't ordered in particular. I did say the internet is big and I went with that, but biotech and genomics clearly so, so important, so overarching, so disruptive, being able to map the human genome, and then in time we're not nearly there, we're not anywhere close right now, have personalized medicine, dramatically extending longevity, curing all kinds of horrendous things that will look back and say it's so sad that I had a friend or family member who was afflicted by or died of this or that, and 50 years from now we'll say that's not even around anymore. It'll look like ancient history, what a lot of us take for granted today, so biotech and genomics really big for me. Okay, number five. Number five comes from @Fameng1, F-E-I-M-E-N-G-1, and Fameng wrote, "David, how do you judge management quality beyond the indirect financial performance indicators like shares held?" And I'm going to do what I did last month's mailbag. I'm going to park this and say we're going to cover this on an upcoming podcast. I realize I haven't gotten to that one yet, but I predict early sometime in 2016 I will spend one week at least with you talking through what I look for in management. So great question, and I'm just going to park it and say, "Coming soon." Number six, @Hey_Men_4-1-2, John, you wrote, "Just had a miserable experience with a deep seed drilling stock, want to know the perspectives towards buying it back." Well, first of all, I hope it wasn't one of mine, but it could easily have been I have a deep seed drilling stock or two that I've recommended it, active recommendation of mine on the Motley Fool site, and it has been an ugly time, not just for deep seed drilling, but for anything it seems connected to oil and gas. The last 18 months have been most dispiriting, and a lot of us have lost quite a lot of money on any stocks that are in or even connected to that business. So it's obviously been disappointing, and I own some of them too, so I know what you mean. That said, sounds like you sold it because you're asking about perspective toward buying it back, so my natural question back to you and you can't answer, so it's rhetorical, is why did you sell it? And it sounds like you sold it because you became, and understandably so, very disappointed, dispirited, miserable experience you wrote. I'm not sure why you'd want to buy it back, frankly. I don't think that there's any requirement once you've exited a position at a loss to try to get it back into it so you can maybe get back to even, and some people continue to hold stocks with the idea, you know, if it could just get back to even. I think that's a losing mentality. I think that in general, we shouldn't be hoping that things would go back up or stick with something that has done very poorly for us. I think we should try to cut bait when we can for the things that aren't working, and probably with that capital and the capital that remains from that, the capital that you'll continue to save and earn, I hope, that you'll use that capital to diversify further, find more companies. I don't know the oil industry that well, obviously, otherwise, I wouldn't have had so many losers in the last 18 months. I would be smarter than that. I'm not smarter than that. And so I would tend to favor industries that you and I might know a little bit better. And so maybe there's a capital F foolish thought for you. Number seven. This one comes from @Andy_Laman, Andy, who's a talented musician. Andy, shout out to you. Thanks for your question. As a long-term investor, you wrote, "By the way, did you just write long-term investor? Have I not made it clear enough on this podcast that we never use long-term to modify investors? Because investor and investing is by nature long-term. I'm having some fun with this, not actually scolding you even though I'm using a scolding tone, but I'm half-scolding you because I am on a minor quest, lifelong, to get people to drop the phrase long-term from investing because when you say that word or you hear it in the media or invest or that should always mean long-term, the opposite is trading. That's short-term. But anyway, back to it. I'll rephrase Andy's question. David, as an investor, how do you ever know when to get out of a particular stock? Well, that falls on pretty nicely from the question I just addressed a little bit about selling out of something that's not working. But I think for the most part, there are two reasons that I sell stocks. The first one is good, the second one's bad. Here's the good one. I'm selling that stock either because A, I now want to use the money to do something like, I don't know, buy a house or put a child through school. That's why we invest. I talked about that a little bit last week, why we invest. That's a great reason, one A, that you actually want to do something with the money. That's often why I'll sell a stock. Then B is that sometimes I sell stocks because I have something that I like even more. Because we all have limited funds, we all have finite resources. If you have a stock outside your portfolio that you think would be great inside your portfolio, better than something else that's presently in your portfolio, that's a great reason to sell the stock. That's in many ways what I wrote in the very first chapter on selling. We ever wrote in our original book, The Motley Fool Investment Guide. Sometimes I still sign copies of that 1996 Simon Schuster publication. Perhaps you, dear, dear fool, have a dog-eared copy somewhere in your library, but the chapter on selling, which I wrote, I basically said, number one reason to sell is when you have a better place for that money. Sometimes that better place is you just have a stock that flat out you covet or envy being in other people's portfolios. You'd like that to be in your portfolio. You believe in that kind of a great reason to sell one of your other holdings. It gives you a portfolio-level mentality. That's really what I try to confer to people when we talk about selling. Think about your whole portfolio and ask, are you invested today optimally going forward? That's helpful for some people. They decide to sell some loser's stock they were hoping will get back to even and redeploy the money into a much more impressive company they've been wanting to own. So anyway, those are some good reasons to sell. Here's when things go badly when I sell, and that's answer number two. Answer number two is very simply when the company has failed to live up to my expectations of it, and not just my past expectations, but my expectations that I have going forward. What I hope for, what I think of the company no longer holds true in my mind. For example, we had a stock in the Rule Breaker service, X1, which was one of the 3D printers. It was focusing on metal, and we decided, you know what? We got that wrong. As it turns out, it's not a very easy business to run. It's not fulfilled. Our expectations. Usually these are stocks that are well down for us, and we just sell, and that's something that's hard for a lot of people to do, and it's even hard for me to do because I tend to be very inert and just allow my stocks to go, and that means I sometimes hold losers for a long time. But eventually, if you just decide, you know what, looking forward, I don't think this is going to work out. That's a great reason to sell. And those are really my two big reasons for selling. It certainly comes down to more than that. There's a far more nuance, but this is mailbag, so I'm never going to give a fully complete answer, and I probably even go on too long sometimes. Okay. Next one up is number eight. This one's from @PellerinPercy. And Percy writes, "Is it ever justifiable to use margin short-term until you can inject necessary dollars in order to take advantage of a great buying opportunity?" So an interesting question. So not everybody knows what margin is, let's define our terms here. Margin is when you borrow money from your broker against your brokerage account. You're just borrowing money, and you're paying an interest rate to hold that additional money. People use margin in order to buy even more stocks than they normally could afford. We generally counsel against it, generally strongly against it at the Motley Fool, because we don't like the idea that you are going to borrow more money than you have in order to put it in the stocks, because sometimes that's kind of a gambler's mentality. When that stock doesn't work out, you're really in trouble at that point, because now you don't have money to make it--you end up having to sell out some other good positions to pay back that margin loan if it doesn't work out. So in general, we are not fans of margin at the Motley Fool. That said, when it's used very maturely in a very low--for example, if your account is 100%, and you borrow an additional five or 10%, so that you're only actually not really borrowing that much against the assets of the value of the account, I think that can be okay if you're very experienced, and you're conservative. The question, as Percy phrased it, made me think it's not the best idea, because you're saying kind of short term in order to take advantage of a great buying opportunity. The language there is a little suspect in that it sounds a little possibly emotional or overexcited. That said, I want to make it really clear, I don't know you at all, and by no means am I suggesting that that is true of you. In fact, if you truly have identified a great buying opportunity, and you have funds coming in in a few weeks in your paycheck, and you're like, "Hey, I'd really like to buy it now," I think that you could, however, to close, I would ask you back, "Can't you just wait a couple of weeks? Why is the buying opportunity so urgent that you're thinking about borrowing in the short term?" So about, let's call it 89% of the time, and 89% of the people who ask me, I would say, "No, don't do that." But if you're one of the 11%, know what you're doing. Number nine, two final mailbag items this month. Number nine comes from @PaulJosephNolan, and Paul wrote, "Is short-term trading to fund long-term investing a good strategy?" Or to paraphrase, "Is doing something bad in order to achieve something good, a good strategy?" And I think that comes down to the old end justifies the means. I mean, what did you think of Machiavelli's "The Prince"? I'm going to have some fun with this, but I honestly don't know. I don't know whether you're going to succeed in trading the short term. That sounds like a coin flip to me. That's generally how trading comes across to me. So I think you're asking me, "Is flipping coins, if it works out for me, a viable strategy toward eventually succeeding?" And the answer is, I would say 50% of the time it's going to work. And finally, this month, mailbag item number 10, this one comes from @TeddyBeingTeddy. Thanks for this question. And this one speaks to my heart, which is why I close with it. Discuss how playing board games and reading books affects all things @DavidGFool within this age of immense media distraction @TeddyBeingTeddy asks. Yes, I do spend a lot of time playing teaching board games. I just played a board game earlier today at Fool HQ code names, by the way, highly recommended fun family party word game just out last couple of months, possibly overpriced a little bit, because lots of people try to put it under their tree for Christmas. I saw prices escalating. You shouldn't be paying much more than about 20 bucks for code names. Sometime in the New Year, I would recommend that to you and your family. That's just an example, but you see you get me started on this and I can start to digress. But let's get back to the main question. How does playing board games or reading books affect me or what does it do for me in this age of immense media distraction? Well, I think games allow me to test and learn. That's what I love about games. You're learning a new ruleset. You're basically studying a system that someone else designed. It's a system of rules that allows you, presumably with friends, cooperatively or competitively to have fun together, learn and try to win. You can try one strategy and if it didn't work out for you, that first game of Settlers of Gataan, you can try a different strategy. Good games generally have multiple paths to victory. You're having fun with others. That's something I love about games. That'll be in contrast to books, which I'll close with in a sec, but you're having fun with others. You're studying the great design, the great game designers and they are out there. There are some wonderful game designers. One of the great signs that we're in a golden age of board gaming, by the way, is that you see the designer's name on the box. That was never true for monopoly or part cheesy, but these days, just like great authors, the great game designers are prolific and they keep coming out with great stuff. So I love studying that great design. Of course, I enjoy the winning and the losing. I'm fine with losing. I do it a lot these days and ultimately I think you learn and so that's why I find time almost every day if I can to play a game, often a board or card game with a friend or family member, not every day, but at least you know what I'm aspiring to. And then just to speak to books briefly, I close with the word learn when I talk about games and I think that's especially what books are good at. Books give you that A to Z, a very logical, systematic approach. Somebody has thought through this chapter, then that chapter. Games don't do that. Games can be helter-sculptor. You're never quite sure what you're going to learn from a game. Books have a very intentional purpose, fiction or nonfiction, to teach and to convey messages and frameworks and thinking in, again, a very logical framework that I think is worth doing. I play a lot more games than I read books. Part of it is I play games faster and I read really slow. But the books that I read, I always underline, I write margin notes, I make the book my own as I was taught to do as an early young reader, but it also takes me longer to read books as a consequence. Anyway, obviously, I appreciate both. I bet you do too, which is maybe why you're asking me at Teddy being Teddy. And thank you for that question. And thank you all for another fun mailbag. This was the December mailbag. We'll be back next week with our first Rule Breaker Investing podcast of 2016. I want to thank you, again, season's greetings to all of you fools near and far. And thank you so much for listening and for your attention here at Rule Breaker Investing. I wish you a very capital F foolish New Year 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. 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