The Rule Breaker strategy is built upon the idea that experienced
investors should have at least a portion of their portfolio
dedicated to high-risk, high-reward stocks. Investing like a venture
capitalist is exciting, stomach churning, and potentially very
profitable. It's also intentionally very risky.
The strategy is appropriate for skilled and knowledgeable
investors prepared to take such risks -- and the disappointments
that inevitably come with such risks eventually. Among The Motley
Fool's online
portfolios, the Rule Breaker has had more bomb investments
perhaps than all the others combined. We have also outperformed all
the others over the long term.
The quintessential Rule Breaking company is one that has the
potential to change the world. We want our companies to be brand
names or have brand name products that are familiar to virtually
everybody. We believe that true sustainable advantages come
from brand and visionary management, not necessarily from
technological advantage.
We pay little to no attention to traditional valuation metrics,
and neither do we pay much attention to market history. Since we buy
young companies, we find far more value looking through the
windshield than the rear-view mirror.
We divide our criteria into two groups, business criteria and
stock criteria, to recognize that some businesses may well
be Rule Breaking, but that we would not invest in them due to one or
more restraints imposed by our stock criteria. Finding Rule
Breaking businesses is the most important part of our analysis,
however, since it will likely remain strong while the stock criteria
may fluctuate. We'll keep a Rule Breaking business on our radar
until it becomes an attractive buy.
Please note: These are criteria for buying long. We also short stocks that we
think are buzzard's bait, according to criteria laid out in several columns on
the Website.
Business Criteria: The business should...
- Be in an important, emerging industry
. A Rule
Breaker must be in an important, emerging industry, since those are
the areas with huge growth curves. Emergent industries come from
invention, reinvention, or adaptation of existing technologies. An
important industry has lasting relevance, deep consumer reach, and
expanding possibilities.
- Be the top dog and first-mover with gusto in
that industry
. Top dogs draw the best
talent, form the best partnerships, and have the best growth rates.
They do not always win, however. Companies that first realize the
industry's potential and attack the market with gusto, through
aggressive sales and marketing and smart partnerships, can claim
top-dog position.
- Have a sustainable advantage
. Rule Breakers
are usually too young to have demonstrated sustainable advantages,
but we look for short-term protections that can give the company an
early competitive boost. These advantages come in the form of
business momentum, patents, visionary leadership, and/or inept
competition.
- Have good management and smart backing
. Great
management is the key to success for a Rule Breaker. It must be
daring, visionary, flexible, savvy, accountable, communicative, and
adaptive. We pore over the company's mission statement, its
conference calls, in-depth news articles, and track records to try
to gain as much understanding of management as we can. We also look
for financial backing from smart investors or corporations.
- Have strong consumer appeal
. We look for
companies with strong consumer appeal. All else being equal, a
company that imprints its logo in the minds of the public stands a
better chance of surviving than one that does not. A strong brand
serves to attract, to habituate, to profit, and to protect.
Stock Criteria: The stock should...
- Have a relative strength of 90 or better
.
Contrary to conventional "buy low, sell high" market wisdom that
would have you searching for "beaten down" stocks, we like to find
Rule Breakers that have displayed strong price growth over the last
12 months, relative to the stock market as whole. When it comes to
Rule Breakers we think past market strength is a good indicator for
future strength, too.
- Have the potential to appreciate 10-fold in 5 years
. We take a lot of risk by investing in unproven,
often unprofitable companies, so we seek a high return -- 10 times
appreciation in 5 years. That's a very ambitious goal. It means that
we have to consider carefully the profitability potential of our
purchases. We won't be precise in our estimates, but we will form a
quantified vision of our expectations.
- Have been called overvalued by a significant
constituent of the financial media
. Great companies with
enormous potential do not often, if ever, look undervalued by
traditional measures. The market values companies by their future,
not their past. We try to exploit the financial media's tendency to
value companies by their past. To that end, we look for companies
that the market likes but the media calls overvalued.
