David Gardner shares three principles he uses when evaluating potential rule-breaking investments -- plus several principles from our listeners.
Rule Breaker Investing
A Rule Breaker's Special Sauce
It's the Rule Breaker Investing Podcast with Motleyful Co-Founder, David Gardner. And welcome back to Rule Breaker Investing. I'm David Gardner. Very excited this week to go back over some of what I've been seeing on Twitter over the past week. Last week, as you'll recall, we talked about seven principles for investors, seven principles for those who do what we do for the long term. That is, we risk some capital and we pick carefully. We put a lot of effort in on the front end before we make a decision. And then we usually just let it go a lot of the time, just in the best frozen terms. We just let them go. And indeed, those are many of our best picks, the ones that we just allow to grow over time. But I asked at the end of that podcast, I bet you have some principles. I've given you seven, what's your eighth? And I just wanted to share back at the start of this week's podcast some of my favorite some of the ones that I've seen over the last week in no particular order. Scott answered eighth principle. Simple two words. He wrote fees matter. That's Scott who's at golfer 17 0 5 9 on Twitter and Scott, boy do I agree with that? You know, it's a wonder to me how few people realize what they are paying for their financial management every year. A lot of people just kind of check that box on their 401k plan, select a few funds. Don't really realize the fees that they're paying their funds. If you've got a good 401k plan, I hope you have good choice of funds, all of which should have low fees. It's called the expense ratio, the amount of money taken out of your holding each year as a percentage of what you hold. So for example, if you have $10,000 in your 401k plan and your fund manager took out $100 from that, that would be a 1% expense ratio. A lot of Americans don't even know what fees they're paying their funds. They don't know what an expense ratio is, it couldn't be simpler math again, just how much you paid them as a percentage of how much you have each year. And fees matter, fees matter, great deal. Next one up, Tobin Anthony at Tobin Anthony on Twitter, Tobin wrote, "A lot of times boring is better than buzz. May not get the same press as the hot ones, but will produce." That was Tobin's eighth principle. And here again, I agree, that's why I'm radiant on air. Good job, Tobin. Back in early monthly full days, we actually had a portfolio, one of those free online portfolios, back primarily when we were just in AOL site, that was called the boring portfolio. And the whole style and strategy of that portfolio, which was a good one, was to intentionally select incredibly boring companies. Now, I don't specifically target boring, but I have a lot of boring on both my stock advisor and rule-breaker scorecards, companies that just have acronyms as their name, like TDG, which is actually trans-dime industries, but those kinds of companies, or just what they do isn't that exciting. How about fact-set research systems? That's a pick from 2009, still an active pick today in rule-breakers, a company that really just kind of oversees lots of data, sometimes gets quoted in different financial articles. You'll see them opining about earnings, or they're keeping track of all the analysts. They're all about research and data, very boring company. We recommended a 52, it's about 175 today, a boring triple over the course of the last seven, six or seven years. Casey's general store is a recent pick I made in Motley Fool's Stock Advisor. That's a pretty boring company. It's convenience stores in the middle west. It doesn't sound like 3D printing, or the next magic thing, but it's been a wonderful stock, not just in the few months we've had it, but really in the decade or so of growth leading up. And I think in the next decade, so boring, I like boring. This one up, I'd like to highlight Huntau Financial at Huntau Financial on Twitter, eighth principle, always other fish in the sea don't cry over missing the big one. And I agree with that as well. You know Warren Buffett talks about how every time a stock comes down your pipe, it's like a pitch. It's like you're playing baseball and it's pitched at you and you don't have to swing. We don't have to swing every single time. And if we didn't swing and it was a beautiful pitch, we shouldn't spend too much time worrying about that going forward. A, right away, and the good news is this isn't baseball. You can go ahead and buy it even though you didn't have it the first time round or believe at first, or you could just not sweat that one because there's so many good stocks out there. And there are new companies coming public, some great businesses being born all the time. So I agree. I'm having fun, so I'm going to go with a few more here. Jason Newman, who I had an opportunity to highlight briefly last podcast and his 90 stock portfolio that he's built up over time using Motley Fool services and all the success that he's had. And he said, he said his eighth principle is be sure to share the experience with others. And I know Jason's not just a good guy and a good fool, but a father among other things as well. And a lot of us are parents. That's a clear way that we can share. But friends, co-workers, Thanksgiving's coming up here in the United States of America. You've got a lot of opportunity to share it out. And that's such a beautiful point. Oh, and by the way, Jason's Twitter handle is @jnew4. You can follow all these wonderful fools if you like. We do. Matt Moore at Moore Power In wrote rule number eight for him. It's fear-driven actions are almost always wrong. Flea burning building, but the building has to actually be on fire. And a lot is said about fear and greed in the market. Words I don't really like to use because they're kind of negative. I prefer, instead of fear, I like caution. Instead of greed, I like opportunity. But you're right. You're absolutely right, Matt, that a lot of our worst mistakes are made, not just with money, but often in life, driven by fear. And in my experience anyway, fear is often just because somebody doesn't know, wasn't taught, doesn't understand. As I've sometimes been one to do in speeches I've given over the years, I'll ask when medieval map makers hadn't been to a place, what did they write in that corner of their maps and they would write, "There be dragons." They didn't write, "I don't know, no one's ever gone there." No, the thing that they didn't know that they hadn't explored was a fearful thing to them. There be dragons, and we do there be dragons a lot, especially if we are new to investing or we don't understand the money world, it seems scary and we make some bad decisions. All right, one more. Deborah Gray, one of my favorite fools, a longtime Motley Fool member, and now staffer, one of those people who's risen through the ranks of our community to become part of our team and our staff here at the Motley Fool. Deborah wrote, "Rule number eight, pick companies that you want to learn more about." And there, too again, boy do I agree, one of the best ways to invest successfully over long periods of time is to ensure that you enjoy the process and one of the best ways to ensure that you enjoy the process is to pick companies that fascinate you. It might be that you work in that industry or it's your favorite hobby, or it might be just an interesting new frontier, something that as an intellectually curious person you'd like to know more about. I've often heard it said that everything we encounter over the course of our day or our lives either slightly attracts us or repels us, sometimes more than slightly, but we're either attracted or repelled by what we're encountering on a regular basis and when it comes to your stock market portfolio, I hope that you're attracted and that you pick stocks that give you energy, don't sap energy as you become a part owner and follow them over the course of time. One of the things we do at the Motley Fool is we've created risk ratings. I'll talk about that in another podcast, but we've actually put a number on each stock that we cover that estimates it's risk, the risk of holding at the risk of losing quite a bit of money in that particular holding versus any other holding and one of the questions we ask in our risk rating is in so many words what Debra's just said, it's will you enjoy following this company? It's actually about you, not about the stock, which shows us that risk is often subjective. It's not just an objective thing outside of you. You participate in this, if you enjoy following something, it's less risky for you because you're going to be learning, knowing, interested in it. If you're taking somebody else's tip, it's a company you don't really know about, but it sounds like a hot technology and you're not really following it, that's riskier for you than it would be for me if I were opposite. All right, so really fun and I'm going to do that in future podcasts. I enjoy asking our community, those fools who are listening in every week, I enjoy asking you things because you teach me a lot and I like to share it back, which is what I just did and that's the first half of this week's podcast. The second half is going to be to fulfill the promise I made last week and look at not just the seven principles for long-term investors that we covered last week, but to add in three more that are germane to me. So what I covered last week is really at the heart of Motley Fool's stock advisor and a lot of Motley Fool philosophy, but the three I'm going to cover this week are much more stylistic and much more my kind of thing, my brother might not agree, other staffers at the Motley Fool might not look for these things. These are my three additional personal principles, not so very different from the ones I just read that were yours. Now I'm giving you some of mine. I have three and for each of these, I'm going to give some examples of companies and stocks that I think fit within these. All right, let's get started. Number one, invest in companies with unquantifiable greatness. A secret sauce that gives them an edge. Now for consumer facing businesses, that means finding products that are sticky, products that fasten themselves to people's daily lives and me and my team at stock advisor, we often ask you know, how would consumers react if someone took that company off the face of the earth tomorrow? In fact, I did that in one of my early podcasts for Rule Breaker Investing. I call it the snap test. Snap your fingers. If you snapped your fingers and the company you're looking at disappeared instantly upon snapping your fingers the next morning, how many people would notice? How many people would care? And if you invest like I do, you want a lot of people to notice. You want a lot of people to be pretty upset that you snapped your fingers. You shouldn't have done that. And that kind of speaks to the greatness aspect of unquantifiable greatness, that phrase that I'm going to double underline for this point. Number one, let's talk briefly about unquantifiable. What does that mean? Well, that also harkens to an earlier point made in Rule Breaker Investing. I hope all of you have gone back and listened to all 18 or 19 of our podcasts so far and listen to them again, if you need to, or maybe especially those first five or six, which are kind of formative stuff, but I talked then about optionality, about how important it is for me to think, to like the multiplicity of possibilities that some of our companies, some of my favorite companies have. I love the companies that have 30 possible futures, not just one. That's the unquantifiable part. That's what confounds the stock market because when a company has that kind of possibility, it's really hard to put a number on that or especially highly numerically inclined investors. People who use screens to look for certain ratios and just pick stocks based on certain numbers, when you can't quantify things that are important, that confounds that style of investing. The computers with their algorithms have a hard time processing unquantifiable things, which is why I think as investors, we have special advantages when we find such companies. I'll give a couple quick examples. I think Zillow is a company that a lot of people would miss. Now, it's not universally known, but it is the company that puts property values on almost everything in the United States of America today. You can look at your house, you can click your block, look around your neighborhood. Increasingly, it's a tool used by real estate professionals to do their business and advertise themselves there. There's a lot of value. It's really hard to think about all the things Zillow can do with that. The businesses that they can enter into over the course of time at early days, people thought, "Hey, you know what? Zillow is actually trying to put those realtors out of business. They're just going to start saying sell your house directly online, just like you sell a product on eBay, why would you pay 6% sales commission to a realtor?" It's ended up that that has not been the case. Zillow has not really put realtors out of business. In fact, it's increasingly a best friend of many realtors, but it does have the possibility of doing that in some contexts in the future. That's just one example of what Zillow could do. Another company with unquantifiable greatness, and it's hard for me to talk about this one just because it's a stock that has performed so poorly, especially in 2015. It's been a loser's stock pick of mine, but I still like the company and I think it passes the snap test. That is if we snapped our fingers right now and Twitter disappeared overnight, I think a lot of people would notice and I think a lot of people would care. It's very unquantifiable and that's part of Twitter's problem right now is that people are asking, "Well, how are they going to make money or what are the ways they're going to make money?" Lots of people are using it, but how do they really monetize that with sufficient ad revenue? One of those questions remain and even management questions which have been recently solved. It's an example of a company that I'm talking about, but I wish every one of our companies were winners and every one of my principles led to a 100% success rate, but the truth is we're all venture capitalists, a point I'll be getting to very shortly, at least that's how I think about things. We're going to get it wrong from time to time. That's the nature of the game. We'll see you with Twitter. I like Twitter a lot here at this low depressed price though. Principle number two, again, two of three this week, choose companies that will benefit from undeniable long-term trends. A great example in our lifetimes has certainly been the internet as it came to the earth, as it started to rage this amazing new beast shaking the planet. The internet was clearly undeniably a long-term trend, creating all kinds of possibilities as it was adopted to disrupt existing brick and mortar retail to enable quicker payment, to allow people to connect with friends. There are so many aspects, of course, to the internet, undeniable long-term trend, undeniable is a key word. There was no question in my mind, I hope in years, that the internet was and is here to stay. I think next one coming down the pipe, I love it when new media are created. Simple reality, it's not really out there yet, but there is no question in my mind that it is a major new medium that will greatly change the world over the course of the next several decades and counting. We're still early on, and there's not a lot of obvious plays here for investors. I mean, a company like Facebook acquiring Oculus is one example, paying nine figures to buy early stage technology, Facebook has made it clear, Mark Zuckerberg agrees with us here on Rule Breaker Investing. I think it's undeniable, and I think it's a long-term trend, so we should be looking at these kinds of things. I'll just give two more quick examples of, to me, undeniable long-term trends. One is genomics, that we're going to get better and better at figuring out your genome and mine and learning from that creating personalized, customized solutions that work for you, that heal you, that improve your life, that are pertinent only to you, because of your unique DNA. To me, a company like Illumina, which has been a wonderful performer for us in Motleyful's Doc Advisor now for some years, benefits leads since it makes the machines that do a lot of that genomic decoding, but genomics is a big thing like the internet. There are a lot of players, and there will be a lot of beneficiaries, and especially you and me, because we, as individuals, will benefit. There'll be some lack of benefit, some loss of privacy, some questions about if you have a really bad gene, and I'm your insurer, what does that mean for our relationship together? These things are not easy to talk about or understand or predict exactly how it'll play out, but undeniably, this is a long-term trend, and one that is net-net, a great trend. And another one is the so-called, I kind of don't like this buzzword, but we'll go with it anyway, Internet of Things. There's just no doubt that we're putting chips in everything today. It seems like you might even have one in your ladder or in your light bulb, and we're using that to allow our devices to work more in concert with each other. And so, for me, an early example is just driving down the highway and in the Washington, D.C. area anyway, we have the easy pass, and this is just, rather than stop at the toll booth, you just blow right through. I bet you have this in your area. This is not new technology anymore, but, you know, there's basically a chip you have in your car, and it blows by the toll booth that has a chip, and it just could change charges, and it adds convenience to your life. It adds steady source of revenue for your local government, undeniable long-term trend, the Internet of Things, and companies like SkyWorks Solutions, which we have in Rulebreakers, or Sierra Wireless, which we have in Stock Advisor. These are all companies that will benefit from that. Are they all winners? Will they be? No. There will be a lot of losers, but 10 to favor companies that are in undeniable long-term trends. Finally, this week, number three, get in early on a great business and don't haggle on the price. Boy, have I learned this one over and over again, and most of my best investment moves, I was recommending a stock that had already done really well. This is hard for a lot of people because we here buy low, sell high, so we think we need to look for things that are beaten down or near their 52-week low, but when I recommended amazon.com in 1997, perhaps my longest-term recommendation at this point still in there, our cost is $3.21, Amazon had doubled in the six weeks leading up to that pick. It was hard to make that pick at the time. But I didn't haggle on price, AOL, certainly one of the great stocks that I'll ever pick, no longer a big world leader as it was in the 1990s, but in the 1990s, that was the decade that America came online benefiting from an undeniable long-term trend, and AOL, I had watched as a user go public in around 1992 and go up four times in value with me just sitting there on my hands going, "Ah, it's up again. I still haven't bought it. I use this. I believe in this, but now it's done so well." And finally, I decided, "You know what? I'm just going to go ahead now and buy." And the company went on from that point, again, having quadrupled in the two years that I was watching it with increasing frustration and went on from there to go up over a hundred times in value further over the next seven years. So get in early and don't haggle on price. Don't haggle on price to me means act like a venture capitalist. Not a lot of venture capitalists sit there and go, "What's the price to earnings ratio of this?" And what are some of the other traditional valuation metrics that people would apply that I'm going to apply to this early-stage situation? No, that's not how venture capitalists think. They basically ask things like, "What is the total addressable market of this? What could this grow up into?" That's why I prefer numbers like market cap, market capitalization as opposed to price to earnings ratios, I don't want to spend a lot of time haggling on price. Again, if we're getting in early, the price probably at that point almost doesn't matter. And certainly looking back at the Amazon.com cost basis, as I mentioned, I barely even remember it. It doesn't matter much to me. Instead, it's that we've found and that we bought Amazon.com, or maybe for you, Apple. Or how about Pixar in 2003? Pixar always looked expensive, but was a great company. And of course, eventually bought out by Disney. But these are all examples where we got in early and we didn't haggle on price. Okay, that's this week's Rule Breaker Investing. Next week, I'm going to scan the Rule Breaker service and I'm going to come up with five stocks that I think are typically overlooked or quiet, maybe harkening back to the good point made earlier by Tobin. Some of the more boring picks among Rule Breakers and five stocks that I'll like for the future. Thanks a lot for joining in with me this week. I'm David Carter. Talk to you next 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]