'Buy low, sell high,' huh? Maybe not! Revealing two more key Rule Breaker traits, David takes down this classic piece of conventional wisdom.
Rule Breaker Investing
Buy High?
It's the Rule Breaker Investing Podcast with Motleyful Co-Founder, David Gardner. Welcome back to Rule Breaker Investing. I'm your host, David Gardner. Pleasure to have you with us. We've been covering in recent podcasts our Rule Breaker principles, doing some deeper dives along those six signs of a Rule Breaker. Last time we covered the first two, now we're up to numbers three and four, and let's just put them out there right up front, and then let's talk about them a little bit today. Number three is strong past price appreciation. We're looking for companies that are doing really well with their stocks. Number four is good management and smart backing. Let's take them in order, and really, I'm going to probably front load my comments on the first one more so than the second, because I think it's a little bit more interesting and counterintuitive, but both are really key Rule Breaker principles. Strong past price appreciation. That goes contrary to what most people think of when they think about investing, especially people who aren't that experienced and investing in my experience. They think that the way to make money as the old saw goes is to buy low and sell high. What I consider to be a very harmful forward phrase imprints itself on the mentalities of so many people who are beginning investing. The first thing they think about is buying low. Buying low means two bad things, sometimes in concert which would be really bad. The first of those bad things is buy low price stocks. A lot of people think about penny stocks, or they don't want to buy a stock like Apple that's at $125 to share because that sounds like it won't make nearly as much money as if they find a stock at $1.25 because if that stock at $1.25 per share just goes up, another dollar you've doubled your money. Whereas it sounds like a lot for Apple to go from $125 to $250 in order to double your money. A lot of people start thinking about buying low and they think penny stocks. As I often have asked rhetorically of my penny stock loving novice friends, how do you think it got down to $0.37 a share? What do you think was the journey for that stock to get down to $1.25 that you're thinking about purchasing? The answer is often that it's not really a great story. Usually, these are companies that are well down for good reasons. Reasons that you and I should be running from when we think about our own capital and where we want to invest. Buying low, again, means two bad things. The first bad thing it means is people think low price, bad thinking. Second bad thing is they think they're looking for stocks that have been crushed. They think the magic to good successful investing is to catch stuff on the rebound. It's looking for discounts just as we do when we're shopping. We're looking for sales all the time. Often, this kind of mentality is looking for things that are doing poorly and deciding, if I buy low, if they turn it around or the stock market changes its perception here, I'm going to make some money. That is a way, again, a lot of people think about investing. Buy low, sell high. Maybe we'll talk about sell high some other day, but just fastening down once again on buy low. If you do those things in concert, you're looking for penny stocks that have been crushed. That's probably the fastest way to lose money in the stock market of all. We're reversing that at Rule Breakers. The Rule Breaker philosophy here is to go against the conventional wisdom. The conventional wisdom is buying low. We like to buy high. Again, it goes against so much of what we either have been taught or psychologically deemed to be true when we're buying something that's already done well. Yet, I'm going to give some examples, but my 30-year investing history is replete with examples where the stock had already doubled, I finally bought, and then it kept going and became one of my best stocks ever. When America Online, speaking of one of my best stocks ever, back in the day, two decades ago, when America Online came public, I was an AOL user, an early adopter, way back at the time. It was 1990, I think, or '91. The stock had gone up four times in value over the course of its first year of being a public company. It was only then that I was like, "What a knucklehead, I can't believe I'm a user. I believe in this medium. The stock, it keeps going up and it's making me angry. I haven't bought, but you know what? I am finally just going to buy this stock." From there, America Online went on to rise over about 150 times in value in the succeeding eight years. You can imagine that I was very pleased that I decided, finally, I would stop chasing the idea that the stock would dip and that I would actually buy it. In so doing, it led me to one of my great early investments. But more recently, Priceline has been a wonderful stock for us at the Motley Fool. I first recommended it in 2004, went up eight times in value, and I decided in 2010, you know what? I like this stock. This is going to be my new recommendation at this price. So I re-recommended it for stock advisor. I'm really happy to say that the stock's up about five times from there, which means the initial position is up much closer to 40-45 times since we first bought. The key operative principle underlying all this goes really back to Sir Isaac Newton, his first law of motion. Every object in the state of uniform motion tends to remain in that state of motion unless an external force is applied to it. Stocks that go up generally keep going up. Winners in life, in my experience, generally keep on winning. A phrase that's often made to sound like a bad or wrong thing, the rich get richer, is actually true of investing. That's what happens, the more money you make, the more money you're going to make. These are really positive, very natural things that you should expect. The best baseball player generally is going to have the MVP career. He's going to, whether or not he gets better, you and I want to invest in excellence. We want to find the winners because in general, Isaac Newton reminds us, things are going to continue in their present state unless acted upon by external forces. Now that can happen. Many companies can have the rug pulled out from under them as new technologies show up. We're going to get into shortly with our next principle, good management and smart backing. When you find really good people and a really good situation, expect that it will continue. Don't think that the stock market is a parabola. Don't be parabolic in your thinking and think, "Well, as soon as it goes up, it's going to come back down again." That's not how the world works. That's not how the stock market works, usually the winners keep on winning. Before I ever recommended Amazon, which has been one of my best investments, I think my cost is $3.21, and I still hold the position today, it had doubled in the six weeks leading up to that recommendation in 1997. It was painful watching it at the time, watching it double, and yet now I look back 200 times our money later and realize that was probably a good indicator. Strong past price appreciation, I hope I've made a good argument for it. There are more examples I could bore you with, but let me just say in closing on this one that the average Rule Breaker pick on our Rule Breaker service scorecard is beating the market by about 44% points, up about 90% the market up about 46%. That's across more than 200 recommendations over the course of the history of that service. We're about doubling the market, and almost every one of those stocks was picked on an upward trajectory, a stock that had done really well, rarely if ever are we picking so-called Rule Breakers that are on really hard times. That's not how we invest, and that's not the story of our success. Let's now next go to good management and smart backing, and the reason I can give this one short-trip is because it's pretty obvious. There's not a lot of, we're not going against conventional wisdom here. What we're asserting with this fourth Rule Breaker principle is that the people who are running a company and the people who are investing in that company really matter. In fact, at the end of the day, it's not about finding the best product, the best service, the best competitive set, certain ratios you might be screening for using stock market screening software. Really, if you're an investor, by definition, you are thinking long-term, you are becoming a part owner of companies with your money over long periods of time. It's obvious that who you're investing, who makes all those decisions, the products, the services, the competitive decision strategies, that person is going to make more difference for you for better or for worse than any other single aspect of your investment. Good management, we're obviously looking for visionary managers. The world, I'm happy to say, celebrates these people. We've already mentioned some of these names before in our podcast, and I grow tired of saying names like Reed Hastings of Netflix, or Elon Musk of Tesla, or Jeff Bezos of Amazon, or Steve Jobs of Apple, and there are many other examples of people who aren't as well known, but who are really great, great people of great character who make wonderful decisions on behalf of all the stakeholders that they oversee with their for-profit enterprises. One of those stakeholders, you and me, the shareholder, we are well rewarded by really good people. I also include smart backing, because especially since we tend to look at earlier stage companies and rule breakers as rule breaker investors, we like to know where is the capital that's come to fund those companies, because when you have somebody really savvy on your board, somebody like, let's say Mark Andreessen, or the folks at Kleiner Perkins, these are really talented venture capitalists, and before a company comes public, I love to think that their money and often their influence is in that organization versus somebody else who's not as smart, not as good a backer, not as great a track record. Again, I think the winners keep on winning, and there's a self-reinforcing aspect to this that happens in venture capital, where once you become well regarded as venture capitalists, the best deals come to you, you keep adding more value to those best deals, and really great upward spirals are created from there. I hope you see the key human dynamic here in good management and smart backing, and when you combine that with our previous principle of strong past price appreciation, you can see why we often find our way into some of the best companies of our time, because the stocks are really doing well, because they're very well run by people with a lot of money behind them, and they just keep rolling up to higher and higher highs, even when they make missteps sometimes in drop, which they always do, and when the market absent any misstep by coming when the market drops, which it always will from time to time, those are the only times that these upward trajectories aren't maintained, but for the most part if you just step away from it all and look at a graph of a stock or the Dow Jones over any meaningful period of time, you're going to see it go upward, and that's largely because of these two key factors helping us find these kinds of companies. I hope you've enjoyed this edition of Rule Breaker Investing. 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]