Two weeks ago I had the privilege of authoring my first official Rule Breaker report. In it, I revealed up front that I'm a zealot when it comes to the Fool's preference for business-focused investing. Were it not for The Motley Fool, I might still be wandering in the alluring -- but ultimately empty -- bazaar of buy low, sell high, market-focused trading strategies.

As is usually the case, though, moving from the halls of philosophical conviction into the arena of practical decisions has a way of exposing trouble spots, regardless of how sound the underlying strategy. For Rule Breaker investing -- the variant of the business-focused approach that we write about here -- this Achilles heel has always been market price. On one hand, the fact that our Breakers distinguish themselves, in the first place, through their defiance of traditional valuation metrics renders us Fools even more obstinate than usual about our lack interest in market price. On the other hand, our unconventional Rule Breakers, by nature, pose the greatest potential for complete disconnect between objective business potential and market price and, as such, demand that we occasionally take on that nasty "p-word."

Tonight is one of these occasions. Now that I'm drinking The Fool Kool-aid, it's logical that I stop just short of Breaker nirvana and double-check my bearings. Are we misleading our readers by ignoring value? Are we setting them up for painful awakenings? These are important questions. So I want to step back and address this pesky thorn, the dreaded topic of market value. My partner in Breaker break-in, TMF Tardior, kicked off the topic in his Monday report. This will be my own personal reckoning.

A Breaker Branch and Its Vine -- A Useful Metaphor

When I think about the business-focused approach, I imagine the company's business results -- represented by its discounted future cash flows -- plotted versus time. Since business results are little subject to market speculation and because unusual, one-time charges usually don't matter much over the long-term, I tend to think of this plot as a reasonably smooth curve, free of market jitters.

The business value curve for our typical Breaker candidate resembles a mutant tree branch, growing out at an unusually steep angle. As long as our Breaker's business model, and the general economy, remain healthy, cash flow -- er, the branch -- grows steadily upward. And so it goes over the years, with the general economic ebb and flow affecting our tree like the cycles of good rain and bad, creating bends and crooks in our Rule Breaking branch as it makes its stunning ascent.

Wrapped around this smooth cash flow trend -- like a two-dimensional vine climbing the angled tree branch -- is the company's stock price (suitably normalized). The vine rises and falls more dramatically, but it is anchored by the branch. Initially, a Breaker's stock price will lead its business value and the vine will arc over the branch. Later, when hyper-speculation collapses for a time, the vine might drop down for a twist below the branch.

But what happens if the vine takes off on its own, leaving behind the safe platform of the steady branch and heading downward toward the grubby ground? Well, in terms of the folksy metaphor that I'm building here, the branch will always pull the vine back home. Like the insistent pull of gravity -- in reverse -- the market won't allow a company that is generating real cash from operations to go broke. If this is your Breaker, don't fret. The vine will be back.

"Yes, but the branch might break!"

No doubt about it. The tree branch itself may break and fall. In fact these thin, rapidly growing Breaker branches are indeed the most likely to crack and find the earth. Their destiny will be organic decomposition into the loam of capitalism. This 100% authentic, no-argument, business-focused risk is a hallmark of the Rule Breaker approach (see Principle #1). The approach recognizes that only a few Breaker branches will sustain their growth, but assumes that these rare but stunning winners will grow high enough to dominate losses from the more common, earthbound, broken Breakers.

So, let's make it crystal clear. Everyone recognizes that branch-picking is risky. No controversy here. Let's call this selection risk.

What kicks off the controversy, usually, is a change in focus from the Breaker branch to its creeping vine -- from a business to its market price. Now we're talking about market risk, a different animal. This market risk is the exclusive focus of this article.

In our discussion above, we were about to reach the most important scenario. What if the vine takes off upward, skipping from one over-hanging branch to the next, leaving its original branch so far below that it's nearly impossible to even trace the connection? Do we worry now? After all, this wayward vine is no illusion. It represents the potential for cold hard cash, and lots of it, in our pockets. Doesn't it make sense to sell, cash in, and buy again when the vine finds its way back to the branch? If we have more cash to invest, does it still make sense to consider the branch and its wayward vine?

My Solution: The Rule Breaker YGBFKM Valuation Method

To start with, let's agree that pricing a potential Rule Breaker has nothing to do with assessing a fair value. No way. We picked the stock with the idea that it might be one of those rare companies that makes a mockery of early fair-value assessments. Of course its price will exceed its fair value. That's the point!

So pricing a potential Rule Breaker is not a fair-value check. So what is it? Well, I think of it as a reality check. I want to think in the most optimistic terms to ensure that I don't undercut my selection talent by selling too soon. In this light, I propose the Rule Breaker's patented You Gotta Be Freakin' Kidding Me! (YGBFKM) method of valuing Rule Breakers. If the price is too rich by this metric, then we have to admit that the vine has reached a height to which we just can't ever see the branch catching up. The religion will have broken down. We'll have to devise a special dispensation, like fish on Fridays.

But I'm out of time for the nitty-gritty of the YGBFKM. It'll have to wait for next time. As a teaser, though, I'll shock you by revealing that I plan to unveil the technique on Surprise! In the meantime, I highly recommend sorting our Amazon discussion board by number of recommendations, especially if you are not a regular. You will find a richness of Amazon valuation arguments to whet your appetite.

Until next time...