[In March 2003, we stopped running a real-money portfolio using the Rule Breaker strategy, because our current stock-picking content competes with it and we were soon to unveil new content plans. The Rule Breaker strategy lives on in our articles and investing. We are editing all Rule Breaker information pages to reflect the change, but it may be a while until that's done. You can check out our reasoning here and our last words on the portfolio's stocks here.]
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.