Mixing it up this holiday week, David Gardner answers listeners’ investing questions that were submitted on Twitter (@RBIPodcast).
Rule Breaker Investing
November Mailbag
It's the Rule Breaker Investing Podcast with Motley Fool Co-Founder, David Gardner. And welcome back to Rule Breaker Investing, delighted that you're joining me this week. Here in the United States of America, it is Thanksgiving Week. In fact, I taped this last week because I'm away with my family and if you're an American, I hope you're somewhere with yours. And I hope you have a wonderful week. It's been an interesting year for the stock market. However, not that far from where we started a year ago, just about breakeven, which is kind of interesting, although a few stocks have really propelled the market and kept it up. I read an article in the last week or so that on the S&P 500, there are only five stocks, Amazon, Google are now alphabet, of course, Facebook, Microsoft, and General Electric. Those five stocks, their gains, make up for all the other 495 combined. So there are a lot of stocks that are down or haven't done much, but when you have a stock like Amazon.com that has more than doubled, that really brings up the whole S&P 500. But otherwise, kind of an unexceptional year and yet still a year to give thanks. Certainly if you're an Amazon shareholder, you can give thanks or if you're a Netflix shareholder, which is the number one performer on the S&P 500 over this past year, it didn't count since the S&P 500 is market cap-weighted, that is, if you're a really big company, you move the index more than if you're a small company. So since Netflix is smaller than those five companies, it wasn't included in that list, but it's been, for some stocks, a really remarkable year. But just giving thanks is important in life. I think that the more that we give thanks, the more thankful we become and the less thankless our lives are and our work reminds me of an old preacher in New York City, Morris Boyd, one of my favorites back in the day. He used to say this is sort of the opposite point, but the dangerous thing about being a liar, he would say, in his Northern Irish accent, the dangerous thing about being a liar is you start thinking everyone else is lying to you. And I think Boyd was right about that. If you start lying, it changes who you are and you start to worry that life and the world is lying to you. And I think it's the exact opposite in a great way with thanking. So thanksgiving is just a great holiday in the United States of America because the act of giving thanks of feeling gratitude isn't just great for the thing that you're expressing gratitude toward. It's great for you. Well, I hope it's going to be great for us this week, this experiment, which is our first mailbag segment with this podcast. So I've got a lot of good questions in over the last week, a lot to respond to. I picked 10 of my favorites. I'm going to see if I can take through all 10 of these in this week's podcast. And in contrast to most of our 20 plus podcasts leading up to this one where I kind of programmed something that I was going to say and there's usually a theme or a list and we're going to go down that. This one is whatever is on your mind. So I'm just a catcher's mitt in baseball terms. I'm just a catcher's mitt for whatever you, my fellow rule breaker, is thinking about. So this is going to be a very motley list, questions coming from all kinds of different places on the internet, different mentalities. And I'm just going to do my best to go down the list here and give some thoughts. So thank you each and everyone who reached out. Sorry, we can't include everyone's question, but maybe we'll do mailbag again, especially if you tell me you like it later on. All right. First up this week is a tweet that came in from @DaveBartrum. Dave wrote, "I keep telling myself that when I find a stock to invest in, I should start investing a set amount per month," Dave wrote. Thoughts? And he also further colored that with another tweet when he basically said, similarly, he said, "When I find a stock, should I invest one-off lump sums in it or a set amount?" So it's kind of a question about, you know, how much should you invest in a stock that you found? I want to say two things back, Dave. First of all, great that you're finding stocks and that you want to invest. For a lot of people, those are the biggest blockers. They either don't know what stock to invest in or they don't even have capital or the will to invest. So I love that you already have your feelers up, you got your capital ready, and then the only question is, you know, how much should you put in it? And I think, especially if you're starting out, and I'll pretend that you are, I don't really know your situation, but I think that you should have a goal of maybe at 10 stocks or so for your initial portfolio. So if you have $1,000, I would suggest your first 100 go in one of 10 different stocks. Now maybe you feel like you don't know which 10 stocks, you don't have 10 stocks yet, but I think that's a good goal. The best thing we can do, especially when we're starting either ourselves or maybe there's a child that you're getting started investing in your life or a grandchild, the best thing we can do is just getting them going. Building that first stock, buying that second stock, but making it not about just the first ticker symbol or company that you find, which might be a winner or a loser. Investing isn't about making a good call in a single stock. It's about really the rhythm of building out a portfolio and making it a lifetime endeavor. And so the more that we're focused that way, the better. So I like set amounts, you know, just, I gave an example, 100 bucks in 10 different stocks to get started. I don't like to overload one position versus another. I'm not good enough to think that I can predict the future and know that this stock, not that one, is going to outperform. I didn't know that Netflix was going to more than double this year. And I didn't know that some of my other stocks were going to lose half their value, which happens to every single year to some of my rule breakers. So I prefer that kind of set amount, build a portfolio to get started. Thank you for your question. Next up, at Arzabrodski, actually going to feature two from Arzabrodski this week. The first one was my small business therapist wife loves Square for billing, the company Square, transformative. Should she buy the IPO of a product she loves? Well, again, I want to praise the question and also the question, I thank you for the question, but I want to praise the question. I wish everyone were asking questions like that. We would be a stronger world if more people thought to match a new company that's going to be born on the public markets through an IPO. You can finally become a shareholder of it if they would do that with the things that they like and/or are connected to. That's just a great question to be asking. Well, Square did in fact come public last week. Arzabrodski sent this to me before it actually went public, but now history shows that the stock IPO had successfully. Let's talk just a little bit about IPOs and then I'll answer your question directly. First of all, most of the excitement you hear about IPOs is about the move they make on their first day. I think this misleads a lot of investors, especially newer investors, because it creates a sense that IPOs are exciting and events that you want to be a part of on day one. What happens is the stock usually will be underpriced on purpose by the brokerage firms and banks that are bringing that company out. They want to underprice it so that that first trade represents a big gain because that's excitement. That's what you want. You want to have a sense that that IPO is up 40% or so, which is what Square was able to report on day one, but the only people who really make money, and I hope we're clear on this, are not you and I who are buying on day one. It's the people selling to us as we buy on day one. It's the people who've owned the private shares for the years leading up to that day when it IPOs. They might start owning the stock at eight, and the first price, the first buy might be at 12, so you and I have just bought it for 12, so the people who owned it at eight just the day before made a lot of money, they did great. More power to them. I'm not cynical about that. That's the way that markets should work. They've taken a risk as private investors, and now they're selling some of those shares out in the open market, and you and I might want to own it, and so we pay up for it. That's what happens. But don't ever get confused into thinking that IPOs are really exciting for you and me. I'd say the mom and pop investors, those of us who are not the institutional players who had all the shares the day before. With that clear, and remembering that these are underpriced on purpose, you should also know that typically the average IPO is lower six months later than it was on that first day, and so that's, I'll give a quick example, Shake Shack was a very exciting IPO within the last year. Shake Shack came public in early 2015, and it rose from a low of 38 to as high as 96, and today where is it? It's at about 43 as I taped this podcast, so it has dramatically dropped from its high of the summer, and that's not true of every IPO, but that's true of enough IPOs that I don't spend a lot of time targeting them as where I want to put my investment dollars. So, again, the average IPO six months later is trading below where it was that first day. And now finally to square and to your actual question, a very good one, and you might think I'm about to say you shouldn't buy square, but I actually kind of like it. If somebody is a partner of a business, a customer of a business, they love that business, you just said she's presumably using Square for her own business, and you said the word transformative, and for those I say more power to you, sure, buy a little square. Not only do you have some passion around that, you'll study it and learn it, you'll be more interested in following it, it may well do well for you. After all, IPOs ultimately happen because some of these are great companies. Some of these end up being Amazon.com or Netflix, or many of the companies that we talk about as great successes for us as investors, that those all came public at one point, and they're much, much higher than they were on that first day. So I am a fan when you have a direct connection to a company of getting in early on the stock. Just realize that those first six months might be a little turbulent. Take a look at Shake Shack's chart. By the way, on caps, I'm very happy to say I thumbed Shake Shack down at 75 this summer. It did zoom up, as I mentioned, to 96, but it is now down at 43, making my red thumb the prediction that it would underperform the S&P 500. The reason I mentioned it here on the podcast, it's done pretty well for me. But anyway, realize that you might get Shake Shack, but if you're pursuing a diversified investment strategy where this is just another stock, I think it's exciting to find those businesses. And I like it when they come public. After all, without good IPOs, we wouldn't even have interesting companies to invest in. So I hope that's a somewhat roundabout that ultimately direct answer. Thanks for a great question. Your other question, though, number three this week, was about investing biases. And you wrote me, "We all have investing biases that can get us into trouble. Is buying at the top of the hype cycle one of yours?" And thank you for that question. Thank you for tapping into one of our previous podcasts on the hype cycle a few weeks back. And my goal is to buy early for any company. So what I'm really trying to do is buy in the initial phases leading up to when a company inevitably hits that peak of inflated expectations. So our best stocks have been ones where we were in very early and very patiently held them all the way into that peak. And then through that peak, yes, stocks often do sell off as the hype gives out. But then if the company is for real, it's excellent. If it's product or service is relevant in the world, it will come back and it will persist. And it will end up being, for the best ones, a really great investment. So I definitely see that I have sometimes looking back bought at the very top, the very wrong, worst time to buy, again, last week's podcast entitled Meet the World's Worst Investor. I know what it's like to make really bad mistakes and I'm going to continue making them from time to time. And especially because we believe when we find a stock that we like, that you should just keep adding to it on a regular basis. If you are finding something early and you keep adding to it, at some point you're going to be adding to it at a high point and you look back and go, "Wow, I wish I hadn't bought that day." But I think net, net, you're going to be well rewarded for just systematically investing regularly into great companies wherever we are in the hype cycle. Number four this week, number four comes from @DavidPervis22 and David wrote, "Could you discuss or comment on dividend investing versus growth investing long-term?" Well, I think really dividend investing is the process of finding companies that pay a dividend. That's when they take a portion generally of their profits that they've made in the year and they pay it back out, straight cash to you, the shareholder. And people who like dividends generally have income needs. They generally want to have their stocks paying them to hold the stock over the course of time. And these are usually larger, more mature companies that can afford to pay these regular dividends. And therefore, especially for people who are in the latter half of their lives or as investors, we often like these kinds of companies because we get that regular dividend. There are benefits beyond just being paid directly by your stock to hold it, though. For example, usually companies that can pay dividends, it means that they have real cash flow and cash to pay from versus the ones that don't. So that can be a sign of more stability. It is possible, and some companies certainly do this, borrow money to pay dividends, not as strong a move. So knowing what percentage was paid to you from company profits, the payout ratio is a good concept to look up. You can look it up on wiki.full.com if you don't know what the payout ratio is. You should, if you're a dividend investor. Knowing how much relatively a company is paying from its profits in the form of dividends is helpful because if it's paying way more than it can afford, that would be a bad thing if it's a very low payout ratio, that's a good thing. So anyway, it's about for companies more than just the dividend and for you the shareholder, there are certain traits of the companies that do this that are admirable. All that said, I am pretty dividend agnostic. Many of our stocks that I cover in Motley Fool's stock advisor and some end rule breakers do pay dividends and many others don't and some great companies like Netflix don't pay any dividend at all. Usually companies that are growing, if you have an extra hundred bucks left over at the end of the day and you're the chief financial officer of a company, do you want to pay that out to shareholders or do you want to reinvest that in another shop or another technology or buy another movie to put it on Netflix streaming, right? The question is yours, your call. If you choose to pay it out to shareholders, it usually implies that you probably don't have a better way to invest it in your business. You might be a more mature business. You're kind of in the cash flow generation stage of the business, whereas if you're a dynamic grower, it's kind of dumb to pay that money out to shareholders when you can reinvest it back in your business at much, much higher rates of return that will achieve better overall stock market returns for your shareholders than if you'd paid it out at that stage in dividends. So hope I did a decent job kind of covering how dividends work and to answer your question directly. I think that it's not a big deal to me whether a company pays a dividend or not, but many of our listeners and many Motleyful members are focused on those kinds of companies and the ones that do so year in and year out are often very admirable. Number five this week. This one comes from @SullyBully, that's Brian Buckholtz and Brian Rowe just read the Motley Full Investment Guide. Do you still abide by all the same rules 20 years later, like doubling the doubt? My answer back is no, I do not. I certainly am glad that we wrote the book and there's a lot in there and if you've gotten to know the Motley Full in the 20 years since and if you've listened to this podcast, you probably know kind of what I like or how I think about things, but I don't think there's any investment book that I or anyone else could write 20 years before, but then they say yes, everything in there, nothing's changed. So I would say that certainly there's a big focus in the early editions of that book on the so-called dogs of the Dow approach and that's not an approach we use anymore. But then again, there's a lot in there about being long-term when you're an investor and buying companies, not tickers and of course we do agree with all of that. So that's been a wonderful book. It was the way that the Motley Full really reached a lot of people in our first few years as an early startup just on AOL because the worldwide web wasn't even around yet. So the book was a wonderful thing and I'm proud of it, but it's definitely not something that I can read today, even later editions, still maybe 10 plus years old and say yes, that's how I think about investing. I'd say about 85% of it is though. Next one up is from Frank D. Pietro at FR Dip and I recognize Frank as a longtime Motley Full member. Thanks for listening to the podcast, Frank. You asked what is an appropriate initial portfolio allocation to a rule breaker? What percentage should one initially invest? And my answer back is generally, I already talked earlier about how if you're starting, I like the idea of starting with 10 stocks, not one stock, but really I think for most of us we should be trying to get to maybe around 25 stocks and straight math would suggest that each of those stocks would be allocated at about 4%, 4 times 25 equaling 100% of the pie. So I like even increments and I like somewhere between 2 to 5% depending on how many stocks that you'd like to own in your portfolio going forward. For me, that's what I've done over the course of my life as an investor. However, if you were to see my portfolio today, you'd see that it's highly imbalanced. I have some very large holdings, Netflix being one of them, for example, and then some very small holdings that are well less than 1% because they were bad picks. I didn't add to them, but they declined in value. And if you play that forward, just 25 stocks from a standing start, 4% each. If you play that forward, you're going to have some big winners, some big losers, lots in between, the big winners aren't going to end up being large percentages of your portfolio. Maybe 10% or more of your overall portfolio and your losers are going to decline to irrelevance as they become less than 1/2 of 1% of your portfolio. And so realize that however you set things up, if you allow our approach to investing to take hold and let your winners run and tend to add to those over time, you're going to end up with an imbalanced portfolio. Some people are totally comfortable with that, Frank, you and I might be those people. But many people don't want to have so much in just a few stocks where a lot of their financial destiny is being tied to decisions made by Bob Iger or Reed Hastings. And if that's you, you're somebody who's more conservative, then I'd be the first to say, feel free to sell off some of that winning stock. I would never sell all my winners and add to my losers systematically that's a bad approach to investing, but I certainly am fine if you're losing sleep at night, selling off a portion of a big winner in order to reinvest it. Typically, I'd reinvest that in new companies. I generally don't like to add to my losers, but wait, I should stop there because I'm foreshadowing another answer. I'm going to give thank you, Frank, for a good question. That was number six, number seven. And I'm going to start flying now because we're running out of time. Number seven comes from @theofylo SWO, Kate Lambert, who wrote, "What resources or books do you recommend for new investors that are friendly to the rule breaker and/or fool philosophy of investing?" Quickly, I will say, speaking of books written 10 years ago, I still take a lot of pride in that first half of the book, Rule Breakers, Rule Makers, which my brother and I wrote at the end of the 1990s, and that first section is Rule Breakers, and that's where I really lay out the six traits, many of which, much of which I've talked about throughout this year in this podcast. So if you've been a longtime listener, you already know a lot of what I've written in that book, but I've spent a lot of time writing and writing carefully and thinking and illustrating in that book. And while it is about companies that, in many cases, have changed a lot since we wrote the book 15 years ago, I take a lot of pride in that book. So if you're looking for a good read from me about my stuff, circa 1998, Rule Breakers, Rule Makers, the first half of that book is a good start. Obviously, I'm going to mention our Rule Breakers service. It's a premium service here at the Motley Fool. For many of you, I hope it would be affordable. It is Motley Fool Rule Breakers, and that's a great example of a resource where we put out not just the Rule Breaker and Fool Philosophy, but we actually pick stocks, some of which I mentioned on this podcast. We're invested in these companies. We're causing our members to become investors in these companies. We talk a lot about the approach. I write a monthly intro every week. The service has been published since October 2004. It's probably the best repository of all things Rule Breaker. And then finally, I'll just mention this podcast. You've already found me. If you don't want to spend any money, you just want to enjoy stuff for free as long as possible. At the Motley Fool, as business people, we always hope that you will want to join Motley Fool services and benefit from being a member, which I think is a substantial thing, but no question that you can just skate for free on this podcast and learn a lot about what I think about Rule Breaker investing and Fool Philosophy. So thank you for a good question. Number eight comes from @goodoldbenji. That is Ben Thomas' Twitter handle. Ben wrote, "We always hear about how important leadership is in a quality business. How do you evaluate a management team?" Next used. And you know what? I'm going to do a future podcast on that topic. It's a great question. Thank you, Ben. So I'm going to flag that in the next three or four weeks. Let's talk about evaluating management on this podcast and maybe some traits or things that we're looking for. Whether I can actually boil it to a metric or not, we'll see. But great question and more to come. Number nine at ragtag Chris. Question. Chris wrote, "How exactly do investors benefit when a company initiates a stock buyback?" There's a simple answer to that. So companies with money at the end of the day or the year, we've already talked about a few things they can do. They can reinvest in their business. They can pay a dividend to you and me as shareholders. A third thing they can do is they can buy back their own stock. So when a company buys back its own shares, it's going out to you and to me as shareholders. It's just a buyer in the market just like anybody else in the market and it's just buying our shares from us. And when it does that, those shares are retired. So if the company had 20 million shares to start the year and it bought back a million shares from people like you and me over the course of the year, now it has only 19 million shares left and at the end of the year when you want to calculate the earnings per share, the denominator shares is a lower number, which means that the earnings per share are going to be higher. The value of a single share is now going to be richer. It's going to be a better thing because there are fewer shares spread around the same amount of earnings. So we each own a slightly larger piece of the pie when companies buy back stock. And traditionally, the companies that do that do gain value over the course of time. It's a smart thing to do. A lot of Warren Buffett companies do this. They don't like to pay dividends. Buffett doesn't really pay dividends. They think it's an inefficient use of capital. They say, why do you want to pay a dividend when you have to first pay the federal government so that is a tax? And then you and I as the shareholders also have to pay a dividend income tax. It's a double tax. It's not a good use of capital. So what Buffett and many of his ilk have done is instead they take that money that they could have paid out as dividends and they just buy back their own shares. And so if you and I are shareholders, they're making the individual value of each of our shares a little bit richer by doing that. So that's how investors benefit when a company initiates stock buybacks. The last thing I want to say about that is some companies don't do this well. If they've overpaid for their stock, if at the top of the stock market, they've spent a ton of money buying back their stock and then their stock loses value subsequently. That was a poor use of capital. So investors don't always benefit from stock buybacks. If companies just like you and me make a really ill timed buy, that's not a great use of capital that hurts all of us as shareholders. So one thing I've never really seen is a good scorecard of which companies do this best and which don't. If you know of a resource that shows that or gives us a top 20 list or something, share it out with @RBI podcast and I'll mention a future podcast. So that's a little bit of my thinking on your good question. Chris, in the last one this week, this one actually didn't come out on Twitter. It came out through email. You emailed us directly, Carrie and Cheryl, and you asked, "When do you stop adding to a stock on dips?" You said, "I like to add to a stock on dips, but what if it keeps dipping?" And I want to close with that one. And remind you, I hope you may have already encountered this either through this podcast or many things I've written on our site in years past, I typically don't like to buy on dips. One of my favorite personal slogans, I developed this one myself. This is a homebrew, dips buy on dips. And I'm not meaning to be too harsh, I'm having some fun with it there, but I don't see why when you have some money and you're waiting to invest it, why you want to wait for something to drop. What if it doesn't? Well, if it didn't, that was a mistake you made. You should have just bought the stock then because if it never dipped and just kept going, you left a lot of money on the table by not just simply acting on your instinct to add more shares or to become a part owner of that company in the first place. So why people want to buy on dips is unclear to me. I realize there's a natural human thing. We want to feel like it's a 20% sale. We love that in the store windows, so we want to feel the same for our stocks. So some people just sit there waiting for stuff to fall. But sometimes, you saw the stock at 15, you're waiting for it to drop 20%, which means you love it to drop to 12, but it doesn't. It goes from 15 to 25 to 30 and then it drops 20%. And that means it just dropped from 30 to 24. And so now you finally buy at 24, but you know what? You dip. You could have bought at 15 if you just acted on your initial instinct. Of course, I'm going to have fun with that. I don't mean to be insulting to anybody, but given my dips buy on dips mentality, carrying Cheryl, I don't like to add to things on dips. And often, especially for rule breaker emergent companies, some of the companies we talk about on this podcast, some of our riskier stocks, when they start falling apart, that's not a good time to be adding. And if they fall about further, which sometimes they will, you really don't want to continue adding. That's why in general, if I have extra money left over to add to my portfolio, I add it to my winners. I don't typically add it to my losers. I like to say, don't throw good money after bad. Your initial stock, if it didn't work out well for you, that's bad money. Why throw good money at that? Admit that you were maybe wrong. Now, the only thing that I'd like to say in support of your question and your point is if a company is very financially strong, if it has lots of cash on its balance sheet, very little debt, that gives it permission to screw up and to make mistakes from time to time. And when you buy those companies on dips, that can be very well timed. So I think of Chipotle recently with the E. coli scare has dipped and Chipotle is a very strong company. So that one might be one that you think about buying on a dip. But overall, I don't really think about dips or gains too much. I just think about, if I have extra money, what do I want to invest that in that I think will be well invested? Okay, that was one of our longer rule breaker investing podcasts. I think it's because I'm an enthusiast for your questions. I love fielding them and I enjoy thinking and helping you think about them. So I hope this was a good one for you. Next week, we're going to do something different once again. We may or may not revisit Mailbag in future. I probably think I will, especially if you tell me we should do this periodically. But next week, I'm going to be a little bit more business oriented as opposed to investing oriented. We're going to step out of investing just for one week. One thing I'm really proud to say about the Motley Fool is that we have perennially been honored on Glassdoor and other sites for the quality of our workplace culture. And so I'm going to go over 10 culture tips. If you're a small business person, if you're an entrepreneur, if you're working in business, really for profit or not for profit and workplace corporate culture matters to you, I'm going to feature 10 of our, I might even say some of our secrets, some of our tricks of the trade that we do and make part of the Motley Fool's culture here. So we're going to have some fun just stepping out next week, talking a little bit about business culture. It does connect back to investing, by the way, because this is also what I look for in companies. I like to find companies that have great workplace culture. So it does all tie back, but I hope you'll look forward to that. In the meantime, have a great week. Great time with your family, 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] (upbeat music)