Companies with strong customer appeal that are, paradoxically, perceived to be "overvalued" by the financial media are often Rule Breakers in the making. David Gardner explains why.
Rule Breaker Investing
Buy What You Like - And What the Financial Media Doesn't
It's the Rule Breaker Investing Podcast with Motley Fool co-founder, David Gardner. Welcome back to Rule Breaker Investing. I'm David Gardner. Thanks so much for joining us. This is the fourth podcast. So we've already published our first three. Went out on iTunes this week, very exciting to see some new listeners, new members joining. And of course, many existing Motley Fool members, and this is for you too. Whether you're a long time fool, or whether you have only started to discover a little bit of capital F foolishness in you, I'm here for you. And that's what this podcast is for to encourage you to think in a Rule Breaker like manner about not just investing, but business and maybe sometimes life. Well this week, we're going to talk about the final two attributes that most Rule Breakers share. I think I've mentioned in previous podcasts that of the six Rule Breaker attributes, I don't expect to see all six of them present in any company. It does happen from time to time. But at least you're seeing the six traits that we really value, that we look for, and we love to see some companies that exhibit more than one of them, and certainly some of our best DocPix have exhibited all six of them. So without being too hardcore about any one of them, I did want to spend this time, and we're going to do this again this week, just looking a little bit more deeply at each of the six, and we're up to numbers five. And six, number five is strong consumer appeal. Number six, possibly the most Rule Breaker-y of all, documented proof that the stock is overvalued, in quotes according to the financial media. We love to find stocks that are overvalued, I'll talk about that in a little while. But let's first talk about strong consumer appeal. So I think the word that comes to most people's minds when they think about this fifth Rule Breaker attribute is brand, and brand is a beautiful word, it's a word that can be used to mean many things, but my favorite definition of brand is a promise that you make and that you have to fulfill on every day, in this case to consumers. So those are the great brands, the companies that make a promise and then deliver on that promise every single time, it's very hard to do in business. The companies that truly do, over the course of time, consistently deliver, become among our favorite things to buy from and buy as consumers, and that's really powerful for stock market returns. Now when we talk about brand, there are many definitions as I mentioned, another one that I like a lot from businessman and author Roy Spence, one of our favorite people here at the Motley Fool, the head of GSD&M, one of the co-founders in Austin, Texas, the marketing and branding firm. And Roy has a book called It's Not What You Sell, It's What You Stand For. And that's another great way of thinking about brand. So ask yourself, what are the companies that I buy from as a consumer, where I feel like they stand for something? And as I buy their product or service, I'm participating in that, I'm helping grow that a little bit by spending some money their way, not somebody else's way. What are the products or services in your life that stand out as standing for something, as opposed to the many that don't or don't quite well enough? So there are two definitions of brand and both of those create strong consumer appeal. And one of my favorite things about the reason this works in business and the stock market is because when you do that, when you develop a brand that people want to buy from, especially if it's a repeat purchase business like an everyday thing and we'll give a couple examples in a sec, these are really wonderful, powerful businesses over the course of time because what you're doing for me as a consumer is you're making my choice brainless. Not long ago I was in some random New York City cafe and I was going to buy juice so I flipped open their big fridge there at the 7-Elevenor cafe where I was and I just grabbed Tropicana and bought that orange juice and then I kind of checked myself after having bought it and I went back to the fridge, the attractive glass door and the several brand choices that I had essentially ignored because Tropicana is just something that I'm used to, I trust it and I looked at another of the brands and it was just picked which maybe some of you know, P-I-K-T and it was easy for me to quickly gloss over and not even think twice about which orange juice I was going to buy. Now that might be true of me and orange juice in you for something else but when companies do this, they create a convenience in a time-starved world, an info-rich world where constant choices are being thrown at us all the time, if you can just say I trust your product, you save people a lot of time and time is our dearest commodity. So that's why strong consumer appeal works, not just in business but for investors and investing. And when I think about companies that do this really well, they are legion, at least when you look up and down Motley Fool scorecards in our services. So in my rule-breaker service, I think about Under Armour, there's a company that really I feel does stand for something. If you ask me what does Under Armour stand for, which you can't because this is a one way podcast but if you were to do so, I would probably say something like in contrast to Nike, I would say edge. I think Nike has kind of owned the market for high performance, that concept but Under Armour brings a little bit of edge to that and they're very similar but they're both great brands in that same space. Any other brands within apparel, footwear, but those are two great brands that stand out to a lot of us. Guess what, those have also been two wonderful companies to own. In fact, rule-breakers, I recommended Under Armour about seven or eight years ago and the stock is up about seven or eight times. So it's been an outstanding company to own and it has strong consumer appeal. Starbucks obviously comes to mind for many people, a brainless quick choice. You could go to the cafe across the street or the Starbucks, maybe you're out of town. You don't have your favorite local spot so you go to Starbucks. When you walk inside Starbucks, please know that they have very carefully mapped every aspect of your experience from the smell outside the door to how the door feels as you push it open and closed to where the stools are and where they're not. If there's a bar even which some Starbucks have, they've very carefully mapped through your experience and not only is that important to them for that store, but they have thousands of stores. So when you really get great at delivering a consistent experience, you're going to get repeat business. So again, strong consumer appeal, another quick example, Apple. Apple probably has the greatest brand in the world and Apple doesn't have a ton of products, but the promise that it makes, that depending on how you look at things, it just works. That would be one or a sense that with an Apple product, you can give it to somebody very old or very young and they'll know how to use it. The Apple operating system is a convenient, easy, little bit fun relative to the other choices in the market. Apple has done a beautiful job managing its brand and has created the most valuable brand of our time. Another reason that I love strong consumer appeal and brand when I'm stock picking is because brand is not represented on the financial statements of companies. So we have a world where people are aiming their computer algorithms and their screening methods at financial statements all the time looking for certain ratios. The net profit margin or the price to earnings ratio are these different, and I know a lot of you are investors and you know these and others of you aren't and you'll come to learn them, but people are using computers all the time to screen the market today, but when brand, something so key, so important and powerful, you can't do that with your computer. There isn't a number that values a company's brand. There are independent assessments and you can take a look at that, but nobody has ever done the market cap to brand ratio, for example. So that's another reason that I love it as a stock picker because I think a lot of the market, especially Wall Street types, don't recognize or even care or know about the brand, don't score it, don't value it and therefore these kinds of stocks are undervalued because the number isn't there for people's computers to see cap. All right, enough for strong consumer appeal. Let's now go to overvalued. Overvalued is probably my own special sauce. The previous five attributes are all concepts that you probably can or should have learned, especially if you went to business school or learn some about investing. You should have valued things like strong consumer appeal or finding a top dog and first mover in an important emerging industry, but the idea that the sixth and final rule breaker attribute would be that specifically you want the financial media. You want prominent spokesman to say that stock is overvalued and that is a good thing. That is a buy signal for you. You like that. You want that. That is probably the most, as we sometimes say around these parts, rule breakery of all. So the sixth attribute, I want to say two things about it. The first is the reason that it works. The reason that it works is because if you think about the other five attributes, again, you found a top dog and first mover in an important emerging industry that has a sustainable advantage, that has strong past price appreciation, that has good management and smart backing and strong consumer appeal and somebody from the financial media or somebody on television is telling you that's overvalued, I'm going to bet all day long that that is a stock worth buying because of those first five attributes and specifically the reason this works is because if everybody has this idea that a stock is overvalued, then it makes even more sense for you to buy it because presumably everybody's money is sitting on the sideline because it's "overvalued" and so you have a lot of the market that is not willing to pay up or buy that stock and those first five attributes, if a company is operating brilliantly, which many of these companies do, not every time and not as perfectly sustained way but overall, you're going to have great companies and over the course of time those companies will convert their skeptics and the people who are calling them overvalued and not buying from them or not buying their stock convert them into shareholders eventually and as that money comes into stocks over time, that's what drives up the value of a share price. So that's why it actually works and the second thing I want to say in closing about overvalued is that usually what people are thinking about when they say a stock is overvalued is they're just looking at let's say the price to earnings ratio, some very simple metrics in terms of how you would value a stock and I know many of my podcast listeners may not yet know what a price to earnings ratio is, we could talk about that another time but let me just say there are simple basic metrics that the number of times above a company's earnings that you're paying for their stock, for example, if a company makes a hundred million a year and the stock is worth a billion, that's a ten times price to earnings ratio, the price is ten times what they're earning this year, very simple ratios like that but what's being missed by those very simple ratios are most of the important things in business. For example, we just covered it, the brand is not being scored. How about this, one CEO versus another CEO, there are CEOs that add incredible valued enterprises and CEOs who subtract value from enterprises and that is not being captured in the price to earnings ratio, can this company innovate? The value of companies that can innovate is well beyond, is a large multiple of the value of companies that cannot innovate, that is also not being scored. So there are a number of things that are not being traditionally valued or scored by very conventional players, conventional wisdom around the stock market and so when you and I are instead focused on the things that can't be scored as well and we know the importance of them and we see them proliferating or predominating in a given company or industry, that's why this works and when other people call it overvalued, I look back on my career so far and I can say many of my best stocks were all considered overvalued throughout and to close. Part of the reason is because first rate things are going to have first rate valuations. That doesn't mean we should be avoiding the first rate and always looking for the tenth rate, looking for cheap stuff or buying low. The truth is as long term investors we're going to be much better served by finding excellence and so the first rate things are almost always going to be priced first rate and if you're just waiting for them to drop or look reasonable, they probably never will. The companies I mentioned earlier, Apple, Starbucks, Under Armour, these are perennially missed by people. Even though they're great companies we all buy from, they're unwilling to buy the stock because they saw it went up three times and died the last five years so you feel like you missed it but the truth is you just need to buy and hold for a long period of time and if you found excellence, you will be well rewarded I have as well and you'll be being told at the time by the media or friends over the water cooler that that stock looks overvalued and so with a smile on our faces we say as rule breakers that this is often exactly what we're looking for and not what we're shunning. I hope you've enjoyed this edition of Rule Breaker Investing. I'm David Gardner, I'm looking forward to next week. Until then, 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]