Invest Like a Venture Capitalist

Last week, Fool contributor Tim Beyers asked Motley Fool Rule Breakers chief David Gardner why investing like a banker -- focused on safe, steady, guaranteed returns -- is flawed. His answer? You'll miss the greatest money-making opportunities the stock market has to offer. Today, in part 2 of their interview, Tim puts David on the hot seat again and learns that stalking the multibagger means learning to invest like a venture capitalist.

Tim Beyers: I've heard you say that going for big stock returns demands that you invest like a venture capitalist (VC). Why? And why, specifically, a VC?

David Gardner: Venture capitalists -- especially the best ones -- often do not have tangible assets to look at, as bankers do. They have to assess people and opportunities. Remember when I told you that we had trouble getting a loan for equipment?

Tim Beyers: Yeah?

David Gardner: That's because we didn't have much in the way of tangible assets. But venture capitalists saw that we were drawing millions of visitors to Fool.com. They knew we were providing a valuable service by helping individual investors take control of their finances. Today, we're proud to count two top-notch VC firms -- Mayfield and Maveron -- as early investors. Maveron may even be a recognizable name to some of our readers; it was co-founded by former Starbucks CEO Howard Schultz!

Tim Beyers: Rule Breaker invests in Rule Breaker, in other words?

David Gardner: Yes, something like that.

Tim Beyers: OK, I get it, but let's get back to part 2 of my first question. Why, specifically, must I invest like a VC?

David Gardner: You've got to recognize that high-growth investing -- especially the Rule Breaking kind -- requires both science and art. It is an intellectual challenge, and it is sometimes remarkably difficult. And, let's face it, most investing is easy.

Tim Beyers: Wait. Easy? Let's not get silly, please. I don't think many readers would agree that investing is easy.

David Gardner: Maybe not, but I assure you it is -- especially if all we're talking about is running the numbers the way a banker does. For example, I can scour the key statistics for Coca-Cola (NYSE: KO  ) and conclude that it is trading at a discount to the market on a cash flow basis. Do enough math like that and you're bound to find underpriced stocks that offer a comfortable margin of safety.

High-growth companies, however, are rarely cheap, and so they are almost never obvious. In fact, the reverse is often true. Take Universal Display (Nasdaq: PANL  ) , which is a Motley Fool Rule Breakers pick that, thus far, lacks measurable earnings, making the shares appear remarkably expensive. But this company is fundamentally changing the way optical components are used to create displays. The market is only just now beginning to realize that. Getting in early has netted us a very rich gain in a short time.

Remember: eBay has never looked cheap. Google still doesn't. But each company has presented bold investors the opportunity to earn riches. And the boldest of them all -- the venture capitalists who offered funds when these firms were little more than business plans -- made hundreds of millions at the IPOs.

Tim Beyers: How do venture capitalists look beyond the numbers? And what do they see?

David Gardner: I think venture capitalists are excellent judges of human capital. Remember: In most instances all they are seeing is a business plan. They've got to evaluate the quality of the people before them and their capacity to execute grand visions. I'll bet John Doerr at Kleiner, Perkins, Caulfield & Byers invested in Amazon.com because he foresaw the potential for a multibillion-dollar market and figured Jeff Bezos could pull it off. A decade later we now know he was right.

Venture capitalists also study business models and the art of competitive advantage. They seek to understand not only how profits will be made but also how they will be protected. It's all very well to look promising in 2005. But what will your business and your industry-at-large look like by 2008? Not coincidentally, these are also the questions we ask of promising young firms in our search for Rule Breakers.

Tim Beyers: How can you differentiate between a fad and a real, live Rule Breaking opportunity?

David Gardner: Mindshare. It is one of the most powerful drivers of the best Rule Breaking businesses. Yet mindshare doesn't show up as an asset on corporate balance sheets. And there's no "price-to-mindshare ratio."

Still, there are a handful of examples where mindshare has preceded market success. These are the verb companies: TiVo (Nasdaq: TIVO  ) , Netflix (Nasdaq: NFLX  ) , FedEx (NYSE: FDX  ) , and Taser (Nasdaq: TASR  ) . Three of these four are members of our Rule Breaker Universe, and Taser is one of my earliest picks for the newsletter service. Legal tangles have made it a very tough year for Taser shareholders, but I'm as excited as ever about the company's long-term prospects.

Tim Beyers: You also own shares, yes? Does that mean you're holding your investment? You do realize that my Akamai (Nasdaq: AKAM  ) pick is absolutely destroying Taser on the Rule Breakers scorecard, right?

David Gardner:Hey. Did my brother put you up to that? Yeah, well, Akamai is also a great company. I'm glad to see it in our roster of Rule Breakers.

Now, getting back to the more relevant part of your question: Yes, I still hold Taser shares and expect to for some time. I think of Rule Breaker investing in terms of decades, not years. I encourage my fellow investors to do the same. Look to become a significant, committed owner of businesses, not a temporary lender hoping to make a few hundred basis points. You'll be better off intellectually and end up with a richer portfolio over the long run.

Tim Beyers: Thanks, David. This has been very helpful.

David Gardner: My pleasure.

Get the whole story. See part 1 of Tim and David's conversation here.

David Gardner is co-founder of The Motley Fool and the chief advisor ofMotley Fool Rule Breakers. He and his Foolish band of analysts are beating the market by 9 percentage points as of this writing. Get in on the action by taking a risk-free 30-day trial today.

Fool contributorTim Beyersknows a few venture capitalists. And he even dares to invest like one every now and again. Tim owns shares of Akamai. You can find out what else is in his portfolio by checking Tim's Fool profile, which ishere. Coca-Cola is a Motley Fool Inside Value recommendation. TiVo, Netflix, and FedEx are Motley Fool Stock Advisor recommendations. The Motley Fool has an ironcladdisclosure policy.


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