Our Philosophy_ 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

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10/7/2017

Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

Our Philosophy: 6 Signs of a Rule Breaker authorId: [1589]; byline: [Motley Fool Staff]

Investing in great companies early in their highgrowth stages and then holding them for the long term will provide the highest possible returns. Period. We call these companies Rule Breakers, and the Motley Fool Rule Breakers team is on a mission to bring you the great growth stocks of tomorrow before the Street catches on. Why Buy Growth? When we talk about growth, we’re essentially talking about a company selling more goods and

THE 6 SIGNS

services this year than it did last year — and expecting to sell even more the following year. But you shouldn’t just search out hot companies or high growth rates in isolation.

1. Top Dog and First Mover 2. Sustainable Advantage 3. Past Price Appreciation

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Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

Rule Breakers investing is about identifying companies that are likely to turn a high growth rate — or an anticipated high growth rate — into a sustainable force for driving cash flow for a very long time to come. With the right principles and

4. Good Management 5. Strong Consumer Appeal 6. Overvalued, According to the Media

a little discipline, you can be a successful growthstock investor — and the payoff can be huge.

Why It Works Rapid growth can lead you to some of the biggest returns you’ll ever find as an investor. Yet at the same time, chasing growth by itself is a ticket to mediocre performance … or worse. So how can you find the companies that will lead to superior returns and avoid the mistakes that will drag down your performance? We look at six criteria to help identify a Rule Breaker. Not every great growth investment has all these traits, and not every company we recommend is a Rule Breaker. But the companies that exhibit all these characteristics deserve special attention. They’re most likely to be the ones that sustain extraordinary growth over a long period of time.

1. Top Dog and First Mover in an Important, Emerging Industry A top dog holds the dominant market share in its industry; usually it’s the largest by market capitalization. The first mover is the innovator that first exploits a niche — essentially creating its market. And finally, that niche must actually be worth dominating. Who has put all of this together? Think of Microsoft in software, Starbucks in coffee, Whole Foods in natural and organic groceries. Starbucks didn’t invent the coffee shop, and Whole Foods wasn’t the first natural food store. But these companies were the first to conceive of these businesses on a national and ultimately international scale, when others didn’t see growth opportunities. Rule Breakers aren’t hidden; they’re right there before our eyes, bringing disruptive technology, clever and effective marketing, or a brand-new business model.

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Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

2. Sustainable Advantage Gained Through Business Momentum, Patent Protection, Visionary Leadership, or Inept Competitors Successful businesses attract competition. The critical question is how well a company can fend off that competition. In some businesses, like the pharmaceutical industry, patents can enforce a lasting competitive advantage. On the other hand, patent protection can be problematic in the software industry, where protected inventions can often be worked around. Luckily, there are other ways of protecting a competitive advantage. Companies have trade secrets (the formula for Coke isn’t patented; it’s a well-guarded secret known to only a few employees), and they can build expertise that others find hard to duplicate. Some businesses require daunting levels of capital investment to establish, while others invest in their reputations and brand names. Sometimes a company’s leaders are just smarter than the competition — and sometimes competitors find they just can’t adapt to a changing world. The key is to find what we call a company’s moat — its bulwark against inevitable competitors — and figure out how many alligators are in it.

3. Strong Past Price Appreciation Consider an investor’s take on Newton's law of inertia: A stock on the rise tends to remain on the rise unless an outside force disrupts its path. The best growth stocks continue rising, because their advantages allow them to sustain remarkable earnings and cash flow growth and to continuously win new converts among the ranks of both customers and investors. Don’t count on momentum to save your bacon in the absence of other strong fundamentals. But a strong company firing on all cylinders can sustain a remarkably extended run.

4. Good Management and Smart Backing Good management trumps almost all other concerns. Think of a company like Target: At its core, it’s just another discount retailer with few structural advantages over its rivals. Yet by dint of good management, it’s been very successful and returned a lot of value to shareholders. https://www.fool.com/premium/rule-breakers/coverage/1069/about/6-signs-of-a-rule-breaker.aspx

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Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

Better a mediocre business with great management than a great business with mediocre management. Over time, those latter guys will screw up a free lunch. Now imagine adding great management to a great company — it’s a powerful force. Judging the quality of a management team is a bit subjective, but that’s because it’s human beings who head these companies. Luckily, we’re human beings, too, and most of us are equipped with skills to assess the more subjective aspects. Listen to conference calls and investor presentations. Even if you can’t talk to management directly, the Internet makes it easy to hear how the top brass thinks and how they interact with investors. Are they smart? Visionary? Inspiring? The heads of Rule Breaking companies are often career entrepreneurs with a track record of business formation you can look to. Even if you can’t put a number on it, you can certainly get some idea of whom you’re dealing with.

5. Strong Consumer Appeal It’s almost impossible to overstate the power of a strong brand. If a business has mass consumer appeal, sustaining extraordinary growth is that much easier. A brand eventually reinforces itself — that’s why a company like Starbucks has never really had to advertise. A brand also becomes associated with an experience. We’re creatures of habit, and when we have to think less, it makes our lives seem easier. The habit that comes from a strong brand — knowing where your next cup of coffee is coming from — immeasurably strengthens a company against its competitors. It also gives a company pricing power over rivals — you expect to pay more for a brand name, right? Of course, some great companies work in specialty businesses that simply don’t have mass consumer appeal. That’s OK, but we want to know that the company’s product, name, and reputation constitute a brand among the people who matter. If you’re looking at an esoteric software business, ask yourself this question: Could this company price its product 5% or 10% higher than its competitors and still maintain market share because of its reputation and loyal customers?

6. Grossly Overvalued According to the Financial Media This might sound like an odd factor. Who wants to buy a stock that those wise financial commentators say is too expensive and poised for a tumble?

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Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

In fact, being derided as overvalued is a trait shared by many Rule Breakers that supposedly smart investors avoid … stocks that go on to double, triple, quintuple, and more over the years. The “too expensive” label comes from underestimating how a Rule Breaker can disrupt its industry, displace competitors, and grow over a relatively short time. Investors’ fears leave many on the sidelines, only to come in later and drive the stock up further as the writing on the wall becomes more apparent. These six criteria aren’t guaranteed to weed out every dog or to point you to every winner. But they offer a framework for evaluating fast-growing companies. We think they can focus your attention on the characteristics most likely to be shared by companies that turn growth into extraordinary performance over a long period.

Is Rule Breakers Right for You? Are you ready to go out and discover the ultimate growth companies? That’s great. You should. But keep a few things in mind when you do. Every investor, no matter what style or strategy he chooses to pursue, makes mistakes. Everyone, the Rule Breakers team included. We can make reasonable assumptions and sensible inferences about the future, but we can’t predict it with unfailing accuracy. When it comes to growth stocks, your mistakes are likely to cost you. You’re buying companies that are priced with the expectation that tomorrow is going to be a lot better than today. That new technology is going to work, that product is going to reach the market, that demand is going to climb. If it turns out that tomorrow is only a little bit better than today, you’ll pay. If tomorrow turns out to be worse than today, you’ll really pay. Rule Breakers tend to be volatile because necessarily rough predictions of the future are constantly being reevaluated. Both good news and bad news get amplified. For that reason, you’ve got to have the stomach for some volatility if you’re going to invest in Rule Breakers. If the very idea that an investment might lose 30% or more of its value in a single day gives you a stomachache, this might not be the approach for you. Buy Rule Breakers as part of a broader portfolio. If you own equal amounts of 10 stocks and one drops 50%, your portfolio goes down 5%. If you own equal amounts of 10 stocks and one goes up 500%, your whole portfolio increases in value by 50% — from just one stock.

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Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

If you apply the Rule Breakers approach with diligence and patience, you will find stocks that go up 500% and more. You will also pick some that go down 90% — we have. The secret to coping with that is knowing that your Rule Breaking investments are part of a broader approach to wealth creation.

The Foolish Bottom Line Where are the creative disruptions happening today? Some are undoubtedly just bubbling up now, invisible to all but a few eyes. But others have matured enough to become apparent to investors willing to break a few rules. Are those opportunities in solar power? In robotics? In the new world of cloud computing? Maybe all of the above? Finding these companies will challenge to your sleuthing abilities. Buying them will challenge to your well-honed impulses as a cautious investor. Just remember this: Rule Breakers investing isn’t about taking giant gambles on unproven, blue-sky ideas. It’s about recognizing the companies that are already succeeding in creating a new niche — and identifying the ones that are going to keep succeeding tomorrow. In other words, it's the ultimate in growth investing. See the team's and David and Tom Gardner's holdings here. The Motley Fool owns shares of Microsoft, Starbucks, and Whole Foods Market. Take the guesswork out of building your stock portfolio. Here's how. There's nothing quite as gratifying as investing in individual companies - not to mention the returns that can be made from them. Our sister company The Motley Fool prides itself on the quality of its research that can give its subscribers that extra edge. But sometimes acting on research, no matter how good it is, can be difficult and time consuming, especially with a large portfolio to diversify. That's where we at Motley Fool Wealth Management can help in ways that The Motley Fool can't. You own the account and the stocks, while our expert portfolio managers pick the companies. You just sit back and watch it happen. Click here for your custom plan. Motley Fool Wealth Management, an affiliate of The Motley Fool, is a separate entity that is registered with the U.S. SEC, and all investment decisions for client portfolios are made independently by the asset managers at MFWM.

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Our Philosophy: 6 Signs of a Rule Breaker - Motley Fool Rule Breakers

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