The Motley Fool's 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. You should be prepared for investments to bomb. That's why having more than 20% of a portfolio in Rule Breaker stocks is a lot, even for more experienced investors (unless, of course, one of your Rule Breakers succeeds and becomes a large part of your holdings).
Quintessential Rule Breaking companies have the potential to change the world. They are brand names, or have brand name products that are familiar to virtually everybody. They have true, sustainable advantages from brand and visionary management, not necessarily from technological advantage. Since they tend to be young companies, it's important to look through the windshield rather than the rear-view mirror of market history.
The investing criteria fall into two groups, business criteria and stock criteria, to recognize that some businesses may well be Rule Breaking, but that they may not be the right investments due to one or more restraints imposed by stock criteria. Finding Rule Breaking businesses is the most important part of the analysis, however, since it will likely remain strong while the stock criteria may fluctuate. Then you might keep a Rule Breaking business on your radar until it becomes an attractive buy.
Please note: These are criteria for buying long. The strategy also includes shorting stocks if they are buzzard's bait.
Briefly, here is what we look for in a Rule Breaker:
Business Criteria: The business should...
Be in an important, emerging industry. Those are the areas with huge growth curves. Emerging 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. Management 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. 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, habituate, profit, and 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 five years. We take a lot of risk by investing in unproven, often unprofitable companies, so we seek a high return -- 10 times appreciation in five 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 pasts. 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.
Want to learn more about the Rule Breaker strategy?
We discuss Rule Breaker stocks and investing on the Rule Breaker Strategy discussion board (30-day free trial to read; subscription required to post). You can meet others and have your questions answered there. No question's too "dumb"! You can also read David and Tom Gardner's book on the strategy, Rule Breakers, Rule Makers, keeping firmly in mind that the eight criteria above subsequently modified those in the book.
The Rule Breaker Portfolio (R.I.P.). From 1994 to early 2003, The Motley Fool ran an online real-money portfolio employing the Rule Breaker investing strategy. By cruising the following links, you can find all sorts of information about the portfolio -- including the trading history of specific stocks bought and sold, the portfolio's returns, and the many columns written about the portfolio.
Today, while we no longer have an online real-money Rule Breaker Portfolio, our very Foolish writers include the strategy and stocks meeting its criteria in their columns.
Principles: The five principles that guided the managers of the online Rule Breaker Portfolio.
Column Archives: Here you'll find not only Rule Breaker columns from 1998 to portfolio closing in February 2003, but also all the Fool Portfolio columns written since September 1995. Lots of oldies but goodies await you in the archives. Each column provides the portfolio's holdings and returns, as of publication date.
Trade History: Check the historical trades of the Fool Portfolio and the Rule Breaker Portfolio. The real-money Fool Portfolio began with $50,000 on Aug. 4, 1994. David Gardner renamed it the Rule Breaker Portfolio in October 1998. For a year beginning in July 2001, the portfolio added $12,500 each quarter to be invested shortly thereafter.
Please remember, this was a teaching portfolio; please don't mimic our trades. Do your own research and make your own decisions.
Stocks and Prospects: This page includes information about the portfolio's holdings, as of March 2003, when we closed the online portfolio.
FAQ: Answers to your common questions about Rule Breaker investing.
