In this episode of Motley Fool Answers, hosts Alison Southwick and Robert Brokamp are joined by Motley Fool Co-founder and Chief Rule Breaker David Gardner as he shares his investing philosophy and the traits he looks for in a Rule Breaking company.
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This video was recorded on May 4, 2021.
Alison Southwick: This is Motley Fool Answers. I’m Alison Southwick, and I’m joined as always by Robert rules of order Brokamp, Personal Finance Expert here at The Motley Fool. Well listeners, get excited. I even skipped saying “Hi” to you. I’m so excited about today’s guest. Well, how are you?
Robert Brokamp: That’s OK. I’m fine, Alison. How are you?
Southwick: Okay, great. Get excited because the one and only, David Gardner, Co-founder and Chief Rule Breaker of The Motley Fool will be joining us for the next couple of episodes to share his guiding principles for investing success. This week will cover his six traits of a Rule Breaker stock. All that and more, on this week’s episode of Motley Fool Answers.
So Bro, what’s up?
Brokamp: Well, Alison, this past Saturday was the Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B) Annual Meeting and like the previous year, it was very different. Not a public gathering, but this year it was in L.A., so that Warren Buffett could do it with his partner, Charlie Munger. Munger being 97 years old, does not travel as much. Buffett however is a spray 90, so he was able to make the flight out there. They kicked it off and Buffett pointed out that they met 62 years ago, and at the time Munger was building a house, and just a few months before that Buffett had bought a house. 62 years later, they’re both in the same houses. I’ve never seen Munger’s house, but I’ve seen Buffett’s. I walked around the neighborhood when I went to one of the annual meetings. It’s definitely a nice house, nice neighborhood. Zillow values it as $1.3 million, don’t know how accurate that is. It is the nicest house in this neighborhood, but most of the other houses were like $500,000, $600,000. He’s not slumming it, but it’s probably not what most people would expect from one of the richest people in the world. I just think it’s one of the interesting things about Warren Buffett.
Buffett and Munger were joined by two other folks, Ajit Jain, who is the Vice President of Insurance Operations, and Greg Abel, who is the Vice President of everything but insurance and investments. Some news that came from the meeting today, a couple of days after the meeting, one of the questions during the meeting was whether there will be a point when Berkshire gets too large to manage. Charlie Munger replied that Berkshire can have all these different types of businesses because it’s uniquely decentralized, which only works if you have the right culture. He added, “Greg will keep the culture.” Well, some people thought that meant, “So, we finally identified who’s going to take over for Warren Buffett when he can’t do the job anymore.” CNBC called Warren Buffett on Monday, two days after the meeting and they confirmed that, “Yes, it is now official Greg Abel will take over for Warren Buffett, at least if Buffett were unable to do the job in the near future.” A lot of people expected that, but it’s interesting, especially for me as a Berkshire shareholder, to know officially who is going to take over for Warren Buffett.
Buffett kicked off the meeting with an investing lesson, and it was geared specifically to people who are new to investing. He thinks that probably there are more people who just started investing in this past year than probably at any point. He and Munger took some swipes at Robinhood and they wanted to make sure that people knew what investing was really about. He put on the slide, the 20 biggest publicly traded companies in the world as of the end of March. You probably could guess what these companies are. Biggest is Apple, second is actually […], I bet Microsoft, Amazon, Alphabet. Most of them are from the United States, 13 of them are in the United States, a few from China. There’s only one company that I actually have not heard of, I’m curious if you guys know about it, I’m not even sure I’m going to be able to pronounce it right, Kweichow Moutai. Have you guys ever heard of it?
Southwick: Not familiar, no.
Brokamp: Chinese companies.
Southwick: That’s on me.
Brokamp: It was the largest beverage company in the world, and it’s the largest distiller, and the most valuable spirit company even more valuable than Diageo. Anyways, I’ve never heard of it but regardless.
Southwick: Let’s get to know this company.
Brokamp: [laughs] Here’s the question that Buffett asked. “Taking a look at these companies, how many of these do you think 30 years from now are going to still be among the top 20?” Everyone can come up with their own idea of what some of these companies will be, whether they’ll still be the biggest. Then he said, “Well, to get an idea, let’s look back 30 or so years, a little bit more than 30 actually.” He put up a chart, or a table of the biggest companies in the world as of 1989. Do you want to take a guess on how many companies that were the biggest in ’89 are still among the 20 biggest?
Southwick: Five, I don’t know.
Brokamp: The answer is zero.
Southwick: Zero? Man, I thought there had to be some.
Brokamp: In fact, not only is it zero, but 13 of the top 20 were Japanese companies, the four biggest were Japanese banks, only six of them were American companies and they were Exxon, GE, IBM, AT&T, Philip Morris, and Merck, not known for being great investments these days. In fact, since 1989, the S&P 500 has returned almost 1,400%, Exxon 400%, and GE just 270%, and that’s just price return not including dividends. What were the lessons that Buffett was trying to impart? First of all, it’s just not easy to pick stocks. You might think that you know what’s going to be the most valuable company 10, 20, 30 years from now, but it’s actually very difficult to predict that. He actually pointed out during his presentation that there were more than 2,000 companies that entered the car business at some point in the 1900s, even companies like DuPont and Maytag and Allstate made cars, which I didn’t know about, but now of course there are just a handful of car companies and some of those have gone through bankruptcies.
Obviously, today in this episode and next week as well, we’re going to have full Co-Founder David Gardner talk about the criteria he looks for in a promising investment, and he has an outstanding record. But as he’ll explain, you have to be prepared for many of your investments to be disappointments, which is why diversification is important. Which gets to Buffett’s second point, something he emphasizes every year, and that is, for many people, you might as well just go with an S&P 500 index fund. As he said, the main thing to do is just be aboard the ship. He does express preference for the S&P 500 index fund, I think a total stock market index fund is a little bit better, it’s more diversified you get mid-cap stocks and small-cap stocks, which historically have better returns. At least that’s what I always say and then I’m like, “Am I right about this?” I look back at the returns for the oldest total stock market index fund, which is from Vanguard, came out in 1992, I’m like, “Has it outperformed the S&P 500 index fund?” The answer is yes, but not by so much.
So if you look back in 1992, if you invested $10,000 in the total stock market index fund, you’d have $174,000 today. In the S&P 500 Index fund, you’d have $168,000. So you’d definitely have a few thousand more. Then thirdly, I think this illustration brings up a question of international diversification. You could look at how things have changed over the last 30 years in one of two ways. You could look at this as evidence that you don’t need international stocks. Look what happened to people who invested outside the U.S. Or you could look at this and think whoever’s on top doesn’t stay on top forever. International stocks are great in the ’80s, U.S. stock great in the ’90s. International stocks did better in the first decade of the 2000s, U.S. stocks have done better the last decade. So who knows what’s going to happen over the next decade? Buffett didn’t really address this, he does express his preference for U.S. stocks, but Berkshire does own some international companies. As far as I’m concerned, I think it’s certainly worth considering having 15%, maybe even as high as 30% of your equity allocation in international stocks. Add that to your favorite stock picks, maybe add in some index funds for good measure, and 30 or more years from now, I think you’ll be a much wealthier person. That Alison, is what’s up.
Southwick: David Gardner, the man, the myth, the co-founder of The Motley Fool, thank you for joining us.
Gardner: It’s a delight to join you and if it’s a myth, which I don’t think it is, I hope it’s not scythian. Talking like an English major. Thank you.
Southwick: Hopefully, this episode won’t be like pushing a boulder up a hill. We want to be as easy as possible for you. We have gained a lot of new listeners to the show this year and so we thought this would be a great opportunity for them to get to know you and get to know your philosophy for investing, so that we can help set them up for success early. But before we get started, I wanted to take a brief trip on the way back machine, because it was right around this time of year, roughly 27 years ago, that The Motley Fool was being conceived in a backyard shed. Maybe six blocks from where I sit here in my living room. Can you take us back, David?
Gardner: Still brings these smiles in my face and sure I can, Alison. One job that I had before The Fool, I was writing for a financial newsletter. Louis Rukeyser was a personality on PBS. He had the longest-running show on PBS 30+ years. It was called Wall Street Week with Louis Rukeyser and I was writing for the financial newsletter. But this isn’t blaming Louis or anything, it just wasn’t a great job. It was creatively detonating. I would write pieces for the newsletter and they would come back edited with all the color and humor stripped out. I didn’t like the job. After only six months, now a married young person, but actually having not sought a job for the first year out of college, I’m now 25 with no prospects of getting hired by anybody because I couldn’t even hold one job with Louis Rukeyser for a year. It was time to start something and we started the Motley Fool. I pulled the name from Shakespeare Act 2, Scene 7, As you’d like it, “A fool, a fool, I see a fool in the forest, a Motley Fool.” It’s a rather nondescript quote except for the great phrase, The Motley Fool. Motley, of course, being the ragtag garments worn by court Jester.
What a delightful thought it was to think that we could challenge conventional wisdom as Fools have done for centuries. But in this case, focus it on money. We started the Motley Fool newsletter, it was for money, it was a $48 year subscription, and the only people who would be willing to pay us $48 a year back then, were not our friends and peers who probably didn’t trust us and we’re wondering what the heck we are doing, it was our parents’ friends who felt sorry for us and floated The Motley Fool through its first few months. The big moment for us was we pulled an April Fool’s joke. It was April 1st of 1994, Robert and Alison. At that time, a lot of people were starting to use this new medium, which wasn’t even called the Internet yet. The World Wide Web, that phrase wouldn’t show up for a couple of years. But they were starting to use it to pump and dump penny stocks. We saw this especially on prodigies, for those who remember that ill-fated long ago online service. We made up a penny stock and we got people excited about it through a fake account that was hyping it and we pulled a great joke online. The Wall Street Journal and Forbes picked that up, wrote us up. America Online came to us, at the time they were the big dog online. They said, “Hey, we think whatever your Motley Fool newsletters, let’s have lunch and let’s talk about maybe opening that on our new service, AOL,” which was still also in its near infancy. That was really how The Motley Fool started on August 4th of 1994, our first day on AOL. Alison, our first issue ever was July of 1993. Somewhere in April or May right around this time of year, we were coming up with these ideas and I think we were probably laid on our first couple deadlines, so it all got pushed into July and that’s when we launched.
Southwick: Now, your title is Chief Rule Breaker. You talk about the traits of a Rule Breaker stock. You lean into this phrase, Rule Breaker. Why is that?
Gardner: I think it’s because at the heart of Foolishness, if you think about it, it is going against conventional wisdom. I think in a lot of ways, Rule Breaking is consonant with being a Fool. In the context of investing, there are lots of ways to break the rules. But in the context of investing, I think I inherited a lot of the perceived truths of how to invest. I was taught those as a little kid, but I started to decide some of them aren’t actually right. I started to challenge some of those notions. A lot of people would say, a company has to have earnings before our investment club would ever think about that stock, or we would never pay over 25 times earnings of P/E, price to earnings ratio of 25, we would never overpay for any company that’s overvalued. A lot of people had those rules in their head, so I thought, I think the way to win this game, to beat the market, to beat the market averages and a lot of Wall Street’s wisdom is in fact to subvert these received truths is to break the rules and establish some new ones. I think we’re going to talk some today about what some of those new rules are, that indeed I’ve written about for more than 20 years and been guided by and still use the exact same set of traits. I think that we’re going to go over today in our book 23 years ago. Here I am, 23 years later, using them and they have beaten the market. I’m really happy to say, the song Shit I’ve been seeing off of has not changed and it has been wildly successful.
Southwick: All right. Well then, let’s go through the song lyric by lyric then. Shall we?
Gardner: You sing, I’ll just give the lyrics. You can sing. Bro can sing.
Southwick: Yeah, Bro is going to sing for us.
Gardner: Bro can dance, I’ll say that much. Our producer, Rick Engdahl, can sing and play instruments. If you want to post-produce something that really surprises me, I’m excited about that, but I’ll just do the talking part.
Southwick: That sounds fair enough. All right, David, then let’s get to it because you have six traits of a Rule Breaker stock that you are going to walk us through here today.
Gardner: Thank you. Yes. Trait No. 1 is, top dog and first mover in an important emerging industry. Now, a lot of those phrases are loaded and worth noting. Top dog, we’re talking about the companies that are the leaders. Sticking with our dog analogy, if you’re not the lead husky, the view never changes. We’ve often said that’s true in the Iditarod, it’s also true in business. I love to find the companies that are the lead huskies because they can take our sled off into crazy interesting places. If, on the other hand, you’re just following, it’s not nearly as interesting. The Rule Beakers are top dogs. They’re also usually first movers. They’re the companies that dreamed up Jeff Bezos, e-commerce before most people would realize it would be a thing and he was just selling books back in the day and things have changed since then. A lot of people, by the way, doubted that e-commerce would even work. They said, ”Who’s going to give their credit card over the Internet, that won’t work.” That was some of the skepticism we were greeted with when we picked Amazon at $3.21 a share in 1997 and still holding.
Then, an important emerging industry. We’re looking for the industries that are going to shape the future and the earlier we can figure that out together, the better. I’ve often applied something I call the snap test, which is, if you could snap your fingers overnight and the company you’re looking at or the industry you’re looking at disappeared, would anyone notice? Would anyone care? Now probably someone would notice in every case, if like Thanos from Avenger End Wars, you snapped your fingers and an entire company or industry disappeared, but how many people would really care? I don’t think a lot of people would miss their cable company very much. I’m not sure a lot of people would care, but if you snapped your fingers and Tesla disappeared, a lot of people would notice, and a lot of people would care. That’s the snap test and that helps me stay focused on making sure we’re looking at the important emerging industries and companies. In conclusion on this one, if there were only one trait that I could be guided by with all my investing of the six recovering today, this would be the one. I lead with it because I think it’s the most important. You are fishing in a stocked pond if you just focus your investing on these companies, and the remarkable thing about that stock pond is that not many other people are fishing there, which is part of the reason it’s magical and it works.
Southwick: Why aren’t people fishing there? What is the conventional wisdom counter to this one?
Gardner: I think for a lot of people, they think buy low, sell high. They think they have to find this obscure cryptocurrency or Penny stock that no one else knows about and it’s hidden and they found it and it’s going to go to the moon. Well, those things rarely ever do go to the moon. Once in a blue moon, they might. But I prefer to stay focused on the great companies. Again, ironically, since a lot of them look overvalued, wait am I stealing from a future trait? Since a lot of them look overvalued, people tend to think, well, I wouldn’t buy that one now, it’s already done it so well. They forget, in conclusion, that most of these important emerging industries are innovation-driven. The company that’s already the top dog is probably going to keep innovating. But because you can’t see that, because you’re taking it on faith, a lot of people are not willing to go fish in that risky-looking pond.
Southwick: Ironically. It’s the biggest stable companies that are like, ”I don’t want to go there.”
Gardner: It is. Especially, in context of these other five traits we’re going to cover. When you put those all together, you end up understanding why a lot of people never do buy the best companies of their time.
Southwick: Let’s move on to your next trait.
Gardner: Trait No. 2 is a sustainable competitive advantage. Now, that can be measured many different ways. Sometimes patent protection, if you’re thinking about pharmaceutical companies that come up with a great drug and then are protected for 20 years or so for what they’ve invented, but I also think about just having the visionary, having the smartest people in the room. That’s a great, sustainable competitive advantage. Mark Zuckerberg started our company, not your social media company, out of his Harvard dorm room, so I’m going to stick with Zuck. Now, I realize a lot of people are not big fans these days of Facebook in part because it’s gotten so big. That means it’s been an incredible investment from the outset or even from it being a public company. But that sustainable competitive advantage is so important because we’re investing for at least three years, if not three decades. In a world that’s gone trading where most mutual funds don’t own, on December 31st, the stocks they had at the start of the year on January 1st, 70%-100% of those positions have changed. You and I can break the rules by staying focused on the long term playing the long game, the only game that counts for me. Therefore, sustainable competitive advantage is so important.
Southwick: What is a company that really exemplifies this for you?
Gardner: So many of the companies that I have invested in. All of the companies we’re going to be talking about today through these six traits we’re covering, they’ve risen generally 10 times or more for me. I’d like to really learn from my winners, not learn too well from our losers. That’s another way to break the rules by the way, so many people think they should study what is lost for them. They should look at all the downsides of their life and learn lessons. As a Fool, I like to look at all the upsides and what’s working and let’s build from there. I can pull dozens of stocks to illustrate this. But how about Etsy? Etsy is a great example of a sustainable competitive advantage. You think, how could Etsy possibly survive in an Amazon lead world, and yet it is flourishing because it’s Amazon proof in a lot of ways. On Amazon, you can buy something that anyone else can buy on Amazon, and I love Amazon for that reason. On Etsy, you can buy something that you can’t find anywhere else but Etsy, and that is a sustainable competitive advantage.
Southwick: We’ll probably get into this more later in your future trait, but how do you tell if a leader is truly visionary but also strategic and smart about it? Because I could argue the founder of WeWork was pretty visionary, but then that ended up just collapsing. How do you evaluate vision?
Gardner: Yeah. First of all, I think time always goes to believing in the vision of people who’ve dreamed it and built it. Dream it, build it. That is the story of business. That is why so many jobs are created and so much innovation, especially in the U.S., has happened because somebody had a dream. Even the founder of WeWork, a stock that I would never have bought if it was public, maybe these days it’s worth looking at, if and when it does come public, it’s changed some. But even that company, you have to respect the scale that was achieved. There was a great idea there. It wasn’t a great business model. He might have gone a little crazy, but you know what? I’m also willing to lose and be wrong, and that’s also important here.
But to answer the question, I think that visionaries are usually identifiable because they have started with the seed of something, and think about all that it takes to bring them to become public companies one day. You have to find real customers with a real product or service that beat a lot of competition and you created forward momentum. You probably had a culture, I hope, that people loved to be part of as employees or as consumers. I think that these are often great signs of the visionaries of our time, and usually these are founder led companies. Usually, we recognize the names of the person who started this or that company as opposed to, sorry, to bash cable companies again, but Comcast or Spectrum these days. Who’s even running that? Who’s behind it? Who owns shares? At this point, they are often big institutional led companies that don’t have an evident visionary still working within that business.
Southwick: We’re actually in the process of getting rid of Comcast. We’re hoping this 5G works out for us.
Gardner: I still like my files, but I’m not saying I’m a huge fan of Verizon.
Southwick: Yeah. You’re not going to go buy a Verizon T-shirt and be really proud to be a Verizon customer.
Gardner: That’s right. I also want to say, Verizon employs hundreds of thousands of people. It is a very important company today, but that doesn’t mean you and I have to invest in it. I’d like to focus my investing on the real up and comers. Not the rule makers, if you will. I love the Rule Breakers who come along and disrupt the rule makers.
Southwick: Let’s move on to your next trait of a Rule Breaker stock.
Gardner: Trait No. 3. This is the first time that we really hit one that is about the stock, not the company, and that’s pretty controversial, which is in part, I think, why it works. Trait No. 3 is that the stock has strong past price appreciation. Now, you’d think again, in a world where so many people here buy low, sell high. Four of the most harmful words ever invented to misguide generations of mom-and-pop investors, individual investors like me. You think that you would never want to find a stock with strong past price appreciation. Why would you want to find something that’s already up? Before I picked Amazon, it had doubled in the six weeks leading up to me picking Amazon. That was rather painful at the time. I was researching it, I was writing it up, and the stock doubled, and yet it’s done pretty well since. I started to realize with older eyes looking backward that that was actually a great sign, a signal that we should pay attention to, because when a stock is doing really well, it tells you great things.
First of all, it tells you the market recognizes what’s happening. You’re not sitting there hoping that somebody will finally discover or think that the stock that you own is a great company. It’s already quite evident to a lot of people that it’s going up. The second thing that it tells you is the company is probably operating pretty effectively. They’re going through one quarterly earnings report after another where people might want to bash them or sell off their stock after hours because they didn’t quite hit their numbers. If a stock is consistently winning, that is an excellent sign. Instead of buying low, selling high, it has you buying high and trying not to sell, which is a much more successful approach to investing, and that is Rule Breaker investing.
Southwick: This one, I feel very strongly because it’s so easy to think I already missed it. I already missed the boat on Amazon. When I started at The Motley Fool, even 10 years ago, I had the same feelings, I already missed the boat on Amazon. Netflix, I’ve already missed my shot. I’ll just look around for something else. But of course, if I had and I did sometimes invest in these stocks, I would have still done very well in the last 10 years. But at the time I was like no. I had to just believe that it still had room to grow. This is one that personally, I had to learn to break the rule on.
Gardner: I’m glad that you have, Alison. I truly believe the most human beings, even those who love the stock still don’t get this. That leaves all the other human beings who haven’t even understood the stock market yet. Most people would never think that this would work, which is why it is Rule Breaker investing. Amazon looked overvalued in 1997 and 2002, 2007, 2012, 2017. People would still be saying it’s overpriced in 2022. For over 25 years, it was the best stock of our time. That is really instructive. But here’s another quick example. How about Lululemon Athletica? This is a stock that I first recommended in 2010. It’s up nine or more times in value. At the time, it was trading at 53 times earnings and people were saying, “Why would you overpay for yoga pants? I can get that much cheaper at X, Y, or Z,” and it’s up nine times in value. But at the time, it looked so overpriced. It had already done quite well as a public company, and that is a good sign.
Southwick: That provides a good segue to our next trait, because I feel like Lululemon has had its ups and downs on this next trait. I’ll let you share with our listeners what it is.
Gardner: Trait No. 4 is good management and smart backing. It’s about the people. Because after all, products and services change. The industry in which these companies work and their competitive sets will change over time, but what usually doesn’t change is what is responsible for all of the success or failure, and I think it’s you and me. It’s our fellow humans. It’s the management team. It’s the venture capitalists backing these early emerging companies. It is about the people. I mentioned earlier the importance of a sustainable competitive advantage. When you can have a founder who owns a lot of stock, it means a lot to him or her to actually own that company probably for their whole lives. That’s a great sign that not only do you have a sustainable competitive advantage, but you’ve probably found good management and smart backing.
In a world where so many people think the way to figure out the stock market is numerical, it’s about statistics, it’s algorithms, it’s big machines trading against each other, even as we’re speaking right now. How could I be a little investor possibly competing against this? Turns out you have a much bigger advantage because most of those machines don’t think about the people at all. They’re looking for zigs and zags on stock charts. They’re just hoping the next earnings report pops the stock. You and I are invested in the people and we’re looking for somebody like Jensen Huang, right in the eye, one of the more underrated CEOs of our time, the Founder and CEO of Nvidia, which has been a monster stock winner for us at Motley Fool Stock Advisor. Or Activision Blizzard‘s Bobby Kotick, who basically bought into Activision Blizzard when it was nearly bankrupt, and has brought the company into prominence as one of the great video game companies of our time. It’s about the people.
Southwick: This one reminds me of Buffett’s quote about investing in companies that are so great, even an idiot could run them, because eventually an idiot will, or something like that. I’m paraphrasing. I’m butchering the quote. It reminds me of that quote because well, if I can get a company that actually is so awesome, but then actually have great management, that’s exponential potential there to be an awesome stock.
Brokamp: The key with management is it usually stays in place. At bigger companies, let’s just go ahead and bash, I don’t know, Comcast, Spectrum.
Southwick: Let’s just pull the name from the sky.
Gardner: Let’s have Comcast, Spectrum, and Verizon all merged into mega Corp. Your cable company. Usually that person who rises to become CEO of that has worked his or her entire career to finally get to that point, let’s say in their early 60s. They are imagining a big pay package and they’re probably going to be there for how many years? I don’t know, maybe three. They’ll retire at 65 and somebody else will come on for his or her three or four year run, yet you and I can be invested in Jensen Huang for three decades or more. So yes, good management, smart backing, these things endure and that’s why we want to be invested in them.
Southwick: Let’s move onto our 5th trait of a Rule Breaker stock, David.
Gardner: Trait No. 5 is strong consumer appeal. We’re talking here about brands. Generally a strong consumer brand if possible, but even companies that sell to other companies, so called business-to-business. Businesses can have good brands. Ultimately, the brand is a promise that you make to your customers that you need to fulfill everyday. It’s really hard to do, especially at scale, when you think about a company like Apple, and think about how that brand has been created over the course of decades. Apple today is the No. 1 brand in the world by most surveys. It’s been a wonderful long term holding for so many Motley Fool members and a huge winner for Motley Fool Stock Advisor. It’s so instructive to me that the world’s No. 1 brand has also been one of the world’s best stocks, and the world’s No. 1 brand is also the largest market capitalization. It’s achieved the greatest size of all public companies worldwide. I hope all of us are studying and learning from that, but it doesn’t just have to be the biggest brands. Here’s a little brand that I loved back in the day, Marvel. Marvel, owned these days by another great brand, Disney, but stay focused on Marvel for a second.
Marvel had a whole fan base when it emerged out of near bankruptcy as a successful public company that was transitioning from comic books onto the silver screen. That first Spider-Man movie, a lot of people said, “That’s a fad. These superhero movies don’t have staying power, this is not a thing, don’t you remember Michael Keaton’s Batman back in the 90’s or 80’s or whatever it was, that’s not sustainable.” Yet as it turns out, Marvel has a great brand. Yeah, Marvel greater than […] DC, sorry. Marvel was and is a great brand. Now today, as I mentioned, Disney bought them out so we Marvel shareholders back in the day, today we’re Disney shareholders, but guess what, we just slid from one great brand to another.
Trait No. 5, we have to look at the brands and ask, what are the best known companies? What are the best loved brands in the world? So many of our best stocks are those companies. I’m reminded here of the original route, the Latin route for the word invest. It’s a beautiful word and I’m glad you’re here learning it from us if you didn’t already know. The word is investere. Investire is Latin for “to put on the clothes” or “to wear the clothes.” If you know a phrase like Priestly Vestments, well, it’s the same route, invest investments. It’s to put on the clothes. My mental picture has always been sports fans because they go to the games and what do they do? They wear the jerseys, they’ve got their favorite players number or name on their back. Whether their team wins or loses that day, whether their team has a good season or not, and there will be ups and downs, they’re going to keep that jersey on. That is exactly the same mental model that you and I should have. If we want to break the rules and beat Wall Street, we should stay focused on keeping the clothes on. You should love your stock, just like you love your home teams. You should be making your portfolio reflect your best vision for our future. Again, why is this breaking the rules when it seems like common sense? Well, as a wise man once said common sense ain’t actually that common. Most people think that they need to jump in and jump out, driven by phrases like buy low, sell high. The third word right away has been thinking about when they should sell, and we’ve been much more successful when we remember the original Latin route for the word investere, put on the clothes.
Southwick: Be proud of the companies that you invest in. Then you’re more likely to hold onto them, then you’re more likely to be excited when they do well, when you’re not yet financially invested, but you’re like, it’s more a reflection of you and how you want the world to be.
Gardner: Hell, yeah. As a friend of mine was recently reminding me since we’re all so busy in life and people ask us to do this thing or that thing. There’s so many choices we have to make, especially as adults. My friend said, “If it’s not a hell yeah, it’s a hell no.” Sometimes I like to throw the hell yeah out there to remember, let’s stay focused on the things that we really are most passionate about. Let’s say focus on the hell yeah companies too.
Southwick: Yeah. All right, let’s move on to our final trait.
Gardner: Trait No. 6, the secret sauce of Rule Breaker investing, especially in light of the other five. Trait No. 6 is that the stock be widely perceived as overvalued, especially by the financial media. Now for new investors in particular, this one seems crazy, which by the way is why it works. This one seems crazy because you would think if on the front cover of The Wall Street Journal or the news weekly Barron’s, or on CNBC, if they’re saying this stock is so overvalued, you would think, well that’s not the fishing pond, I’m going to be fishing in the overvalued stocks. But here’s the beauty of why this is the secret sauce for Rule Breaker investing. Because to review, if you can find the top dog and first mover in an important emerging industry with a sustainable competitive advantage, strong pass price appreciation, good management and smart backing, and strong consumer appeal, and everybody thinks that stock is so overvalued, you’re onto something special because yeah, it probably does look overvalued in the very near-term, but we’re not playing the near term game. If everybody thinks something is overvalued they’re on the sidelines. They’re like, “I would never buy Amazon, I would never buy Netflix. Do you realize that Netflix is mailing people DVDs? This is back in the day. Blockbusters going to crush Netflix. I could just drop off the movie at my local blockbuster.” People are going to think it’s overvalued, but as these companies go out and execute and win, all of those skeptics who stayed out of the stock, one by one, will all of a sudden have their Amazon Prime subscription.
Then a couple of years later, they’ll be like, “You know what, I am going to buy Amazon stock.” Warren Buffett just said a few years ago, one of those great regrets was he never bought Amazon. Well we’ve owned it for almost 25 years now because so many people thought it was overvalued all the way through. As those skeptics convert not just to believers, but to shareholders, that’s what drives the great walls of worry, which visually describe the ascent of these stock prices over time, as skeptics become not just believers, but shareholders.
Southwick: Not to keep harping on Amazon here. I’m not harping, but not to keep using Amazon as an example here. But it’s May of 1999 that Barron’s ran that famous Amazon.bomb cover. At the time they were saying that Amazon was worth a remarkable $36 billion. I don’t know what Amazon is worth today, [laughs] it’s off the top of my head, but I have a feeling it’s more than $36 billion. That was in 1999 that the media was saying that it’s over, it’s done.
Gardner: Amazon is worth $1.7 trillion today.
Southwick: A little more.
Gardner: These are all big numbers, but that is a huge huge win from $36 billion.
Southwick: Big number.
Gardner: It is worth pointing out in Barron’s favor that within a couple of years, Amazon would get torched, but it wasn’t Amazon’s fault. The entire stock market, and frankly, the world trade center all came down. That was a horrible time and a lot of the weak hands a lot of the second and third movers among the dot-bombs back then didn’t survive that era. Amazon sure did and so did some other great companies that we look back on as leaders today. I think about that a lot. I think it’s important to remember that when companies get called out in the cover of Barron’s as overvalued, Barron’s might even be right in the near-term and yet they’re writing for near term thinkers and near term actors. That’s what drives most of the financial media and even more of the trading that happens every day on the stock market. Simply by playing the on-game, by breaking the rules of how convection works here, we can win wildly.
Southwick: All right, David. Well, that covers it for the six traits of a Rule Breaker stock. But of course, it takes more than just identifying a great stock to be a successful investor, which is why next week, I believe you’ll be joining us to talk about your six habits of a Rule Breaker investor. Talking about what you as an investor need to do with your actions when you find these great stocks, when you identify these Rule Breaker stocks. That sound good?
Gardner: It sounds great, Alison, because it’s one thing to find these great companies, but if you don’t have the right mindset and the right habits then you might not do well with them. It’s so important to me not just to tell you six traits of Rule Breaker stocks, but the six habits you need to develop if you want to be a Rule Breaker investor. By the way, not everybody has to, if what we just covered sounds insane to you, good news, there are other approaches to prospering with the stock market. Companies pay dividends, etc. There are lots of ways to beat the market. You just asked me to describe mine.
Southwick: It’s worked pretty well for you. David, thank you so much for joining us and we’ll see you here next week.
Gardner: Fool on!
Southwick: Well, before we go, we should probably have a little bit of a disclaimer, a little bit of legal ease. As always, The Motley Fool may have formal recommendations for or against the stocks we talked about on the show, so don’t buy and sell stocks based solely on what you’ve heard here, although David Gardner is pretty good at it, but whatever. Our email is email@example.com. The show is edited Rule Breaking-ly by Rick Engdahl. For Robert Brokamp, I’m Alison Southwick, stay Foolish everybody!
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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