Rule Breaker Portfolio
Rule Breaker Information and Principles
Principle 4

By David Gardner
updated March 20, 2001

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Rule Breaker Principles

Our fourth principle concisely lists the attributes we're looking for in locating a Rule Breaker, as well as our sell strategy.

To pick our growth stocks, we are using the Rule-Breaking criteria laid out in The Motley Fool's Rule Breakers, Rule Makers, with periodic modification.

We offer here an abbreviated version of our criteria. It is quite superficial compared to the full definition, exploration, and illustrations that we provide in Rule Breakers, Rule Makers, as well as the commentary that we present in our regular column and during annual seminars. Still, we'd be remiss if we didn't identify and share what those attributes are as part of our portfolio management principles. So here we provide a short list -- a preview, if you will -- of the attributes shared by all true Rule Breaker stocks.

Business Criteria: The business must...

  1. Be in an important and emerging industry.
  2. Be the top dog and first-mover with gusto in that industry.
  3. Have a sustainable advantage.
  4. Have good management and smart backing.
  5. Have strong consumer appeal.

Stock Criteria: The stock must...

  1. Have a relative strength of 90 or better.
  2. Have the potential to appreciate ten times in five years.
  3. Have been called overvalued by a significant constituent of the financial media.

Note that many of these criteria are qualitative, not quantitative... subjective, not objective. This is consistent with our wish to really get into the thinking of investing, which is this portfolio's goal. Indeed, we believe that those who struggle with answering whether a given company truly fulfills the attributes listed above will not only improve their investing results, they'll improve their understanding of investing, in general.

Our true Rule Breakers have been our best stocks. By studying them, anatomizing them, and locating others like them, we hope to further increase our lead over the stock market from now till kingdom come.

Why, When, and What to Sell

One question we feel the need to address -- one that is difficult to answer -- is when do we sell?

The chapter in The Motley Fool Investment Guide entitled "When To Sell" remains the definitive answer to the question. If you own the book, go back and read that because it tells you most of what you need to know about how we think about managing our portfolio. Essentially, we do NOT set target prices for our stocks, contrary to what so many commentators recommend.

Instead, when we see a new investment that we like quite a bit -- so much, in fact, that we want to sell part or all of a current holding in order to buy it -- then we make our sell decision. Decisions to sell stocks are therefore not usually made on their own merit, but rather on a "demand" basis; when a new investment strikes us as sufficiently attractive that it "demands" to be bought, we sell something in order to buy it.

Then the question becomes: What do we sell? Simple. We sell whatever we like least. In that regard, we are simply moving money from things we don't like as much to new things that we like a good deal more. This is our portfolio management approach.

We are constantly being told by one or another person that if we're smart, we'll sell this or that stock because it's overpriced. These suggestions, right or wrong, do not address how we think about investing. We simply don't pick numbers out of the air and say, "I'll sell when it hits $100." To do so is fundamentally unFoolish, because it often fails to account for the changes -- the bullish changes -- in a company's story that occur in between your purchase price and your target price.

As you can see, our decision of when to sell any of our stocks comes down not to picking the proverbial number out of the air, but rather, waiting till we find something we like more. The only exception to this rule is if we get way, way, way overweighted in a given stock. If that happens, we may sell a portion of that stock in order to move the money elsewhere (as we did with AOL and Iomega in 1997 -- some of that money, by the way, made our purchase of Amazon possible).

There you have an account of our method for buying and selling stocks. We discuss it in hopes of educating our Foolish readers and contributors worldwide -- that's our mission. Whether you choose to agree or to disagree is your business -- in fact, our whole goal is to help you to think for yourself about investing.

Next: Rule Breaker Principle 5 »