Rule Breaker Investing: Inside the June Mailbag

Motley Fool co-founder David Gardner kicks off the summer by dipping into the Rule Breaker Investing mailbag.

In addition to sharing some of the Warren Buffett quotes sent to him, he also talks about what he sees as the greatest horror story he regularly hears. It doesn't involve a bogeyman hiding under the bed or in a closet. Instead, it's the one thing he hates to see new investors do.

He also shares his feelings from the first time he heard of a company that's become bigger than anyone could have imagined. When the company was conceived, the idea sounded a little preposterous, and it was hard to see how the company would be able to change the world in the major way it did.

A full transcript follows the video.

This podcast was recorded on June 29, 2016.

David Gardner: Welcome back to Rule Breaker Investing. It is the final Wednesday of the month of June, and therefore it is time for our June 2016 Mailbag. And, as usual, I have a wonderful, motley collection of emails and tweets to react to. Since this is the summer, and technically I'm away at the time this is broadcast -- I'm on summer break -- this will be a little bit quicker, a little bit easier, and a little bit less work on my part, since it is, after all, the end of June, not, I don't know, when I'm really productive, maybe at the end of September.

So if you think I'm blowing it off a little bit this week by reading more of your stuff rather than reacting to it myself, you might be right, but I'm really looking forward to sharing some Foolishness that's come through the internet to us this week, through your wonderful tweets and emails.

And before I start it off, this month, let me mention, when I have more things to select from than I can choose, some of the factors that cause me to select this one, not that one, for Mailbag, one of them is when you're reacting to something we've done that month. That's my first few here, this particular Mailbag. You sent me a couple of Buffett quotes that you like. You also included a quote reacting to one of my campfire stories earlier this month. So, yes, I'm a little bit of a sucker for tweets reacting to what we did that particular month for Mailbag.

Therefore, let's start if off with Troy Springer, @TSprings11, on Twitter. A friend of mine. Troy, I got to know you, as you'll well remember, at the University of Richmond, where I spoke this spring, and you were a very wonderful host to me. I hope you're having a great summer. And Troy, your Buffett quote, I thought, was great.

I don't know if it's verbatim, and before I read this one and the few that follow, let me say I have not double-checked that Buffett actually said this, but if you heard my Buffett "Great Quotes" podcast, you'll note that it's almost kind of funny -- that's almost in the spirit of what we're doing. It almost doesn't matter whether Buffett said this or not; it's just so Buffett and so worth listening to.

Troy, your favorite Buffett quote for the week: "Wall Street is the only place where people ride to in a Rolls Royce to get advice from those who rode the subway." That's pretty funny, and I like it.

And Ahmed Alawami -- and on Twitter Ahmed is, in fact, @Ahmed_Awami -- Ahmed, you sent your Buffett quote: "Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing." Provocative, as many Buffett quotes are.

And in particular, thinking about those two quotes, the first one I think we can all chuckle at a little bit. The second one -- I can come down on both sides of this one, and I hope you can, too. I hope you can see both sides of either being highly diversified or less diversified.

For many beginning investors, often when people show up at Fool.com for the first time -- maybe they joined Motley Fool Stock Advisor -- they often don't have many stocks at all, so our goal for our newer members is to get them invested and diversified.

Our horror stories are to think that somebody joins Motley Fool Stock Advisor, buys one of the stocks, it doesn't work out for him or her, they judge our service based on that bad pick that I might have made and they're like, "Not only am I going to cancel Stock Advisor, but I don't even think stock market investing is for me."

So the horror story is that it's a sample size of one that somebody gave him- or herself as a way to judge whether or not we are worthy, or investing, period, is worthwhile. So really getting investors from zero to 15 as quickly as possible is what we're trying to do at Motley Fool Stock Advisor.

Now, for some people 15 sounds like a lot, especially if you're starting at zero, but for others, 15 might not sound that diversified. Are you really going to pin your financial fortunes to 15 different companies? Why not 25 or 50? And so everybody has different minds about this.

The Buffett quote that Ahmed is sharing with reminds us that for experienced investors -- I would say people who do know what they're doing -- and I think we have a lot of Fools who are that way; certainly Warren Buffett is one such, if I may say so, Fool who thinks that way -- it's a protection against ignorance, Buffett says. You should be more focused. You shouldn't have so many different stocks. After all, Buffett's asking, in effect, "Are you just buying a lot of stuff because you don't really know which ones are going to work out and what you should even own?" So we'll leave that question rhetorical.

Our third quote -- and the last of the quotes we'll be doing this June's Mailbag -- was from Kurt Elia, @KurtElia on Twitter. Kurt, you were reacting to one of the campfire stories that I told in the middle of this month. And talking about -- the lessons, for those who listened, will remember the lessons of the red 6 of Spades, and also the five monkeys story.

Kurt, reflecting on both of those, included this greatest quote from, in effect, @GreatestQuotes is the Twitter handle. I don't follow @GreatestQuotes. Perhaps I should. This one comes from P.B. Medawar, and he said, apparently, I'm quoting, "The human mind treats a new idea the same way the body treats a strange protein: It rejects it."

And I do think that it is fairly natural for us with our immune systems to reject foreign bodies. And it's not just true -- as you're pointing out, Kurt, as P.B. Medawar's pointing out -- of physical substances. Often it is those mental substances that try to enter our minds. Some new disruptive thought. And what I've learned to do, as an investor, is realize that that's just how my mind works, and how yours works, and it's really based on our biology. Maybe our evolved biology.

But that first reaction doesn't need to be your eventual conclusion. At least I, anyway, can look back on my life as not just an investor but a person and say, "You know, that seemed crazy at the time, but then it started to work its way in on me and I started to realize that is the way of things." And if you do have that ability, when you can do that -- it doesn't always work -- you'll have some of your best investments.

Certainly for me, Netflix is a good example of a company. I thought it was crazy the first time I heard that Netflix back in the day -- this is circa 2004 -- that instead of renting a video right from your nearby Blockbuster, you would actually send it off through the mail and have to wait for a movie three days before you could watch it. That you would have this thing called a queue. It sounded preposterous to me, at the time, and it ended up being a pretty smart idea, and I'm glad that I figured that out in time.

So I think that's a really good reflection on the human mind, and we should all remember that about ourselves and just recognize that sometimes -- while that might be your first thought, it does not need to be your final thought. And especially if you want to be a Rule Breaker investor, you need to be very used to things disrupting not just what you thought before, but also what's been happening in the world. Disrupting that. Changing it. Of course, if it works out, changing it for the better, which is what leads to great stocks.

The next one up this month is TeddyBeingTeddy. That's @TeddyBeingTeddy on Twitter. And Teddy, you asked: "What kind of person would you recommend only invest in the S&P, and conversely, who should be a stock picker?"

That's a fun question. I like those kinds of provocative questions. I can't think of Teddy not being Teddy Roosevelt. I've read a couple of his biographies in the last year and really enjoyed them. I really appreciate Teddy Roosevelt and the character of the man. And looking for character in our leaders is something that I think is so important for me as an investor, and I know for those of us in the United States of America, we probably want that of our presidential candidates.

Maybe it's not as much in evidence these days. I'm not trying to be too nostalgic, as it was clearly in evidence in some of our presidents of the past. That's not an American comment. That's an "Anywheresville" comment. You want to be able to look at the character of the people that you are following, or that are your leaders, and be deeply admirable of that. I'll say, anyway, Teddy Roosevelt would have been that for me had I been alive about a century ago.

But speaking of TeddyBeingTeddy, you were asking, again, Teddy, what kind of person should maybe just invest in index funds versus pick stocks.

Two quick factors. The first is how much interest somebody has in this topic. I think most people who just aren't that interested aren't listening to our podcast, don't tune in every week to this or any other Motley Fool podcast. Those people -- I think I'll say it -- are slightly less cool people who don't really care, obviously. I think factor No. 1, they should be investing in index funds. Even getting some of them to understand what an index fund is, is sometimes hard. Not everybody has an interest, at all, in this subject.

But those who have just a forced interest are compelled to fill out something on their 401(k) plan. I think index funds are a great answer for them. A lot of times they're not picking index funds. They're picking managed funds. They're picking sometimes less efficient, more expensive funds with not as good performance.

That's why The Motley Fool, for 20-plus years now, has been a champion for Vanguard. It's been an unpaid relationship pretty much all the way through. We're also big Jack Bogle fans. He's become a friend of my brother's and mine. We're big fans of Vanguard because they keep it cheap. And when you buy an index fund from Vanguard, very low turnover, very low cost. Very customer-centric company. We like that a lot. It's a rare bird in financial services that operates that way. So I think that's an answer for most people, even those who come to Fool.com. I think it's an answer for most people if they just don't have that much, factor one, that much interest.

Factor No. 2 I'm going to say is the other obvious one. It's your time. It's how much time you have or that you want to commit to the subject of investing. Again, for those of us who are very time starved, or don't want to spend time on this, because in the end we all choose how we spend our time, we're not creatures of our own busyness. We choose what we want to be busy with. So if you don't want to spend time this way, then again, I think index funds are great.

Let me close by looking at the opposite. I think I spoke to those who don't have either one of those two things, but now let me speak to those who have both of those things. So if you do have an interest -- and darn it, you're listening to me right now, so I think you do -- and if you want to make time for this, I think you should be picking stocks. Is everybody who can check both of those boxes going to be a stock picker or a good stock picker? Probably not.

I'll say this. I think everybody should try. I've said 20-plus years now, whenever I put on my Fool cap and speak to audiences, I think everyone -- usually it's been in America, so everyone in America should own one stock. But I have a lot of non-American listeners. We're proud of that at the Fool. We have a lot of Fools around the globe listening to our five Motley Fool podcasts, and I think every one of us should own one stock.

Even if it's just a tiny percentage of what you have, it's just a way to dip your toe in. See that there's something beyond index funds. And if you find that you picked a good stock, you might start getting a sense that maybe you could beat your index funds. This is our goal for almost anybody who comes to The Motley Fool, whether they want to use one of our passive services or some of our more active solutions that we have at the Fool.

Maybe I've gone on too long on this one, Teddy, but I hope that's pretty clear. I think the majority of the world should just be in index funds. I think a significant part of the world should be stock pickers far more than are today, just because I don't think people have awakened to this. I think everybody, if they have capital, should own at least one stock, just partly to have fun and partly to measure their funds against their own stock picking. Thanks for a good question.

No. 5 this month comes from Jake Versluis, and that's @rawkerv on Twitter. Jake, you said: "It hit me hard today, in a good way, that we'd all have more money if we bought into good companies and never sold our positions." It hit you hard on a recent day that we would all have more money if we bought into good companies and never sold our positions.

I agree with you, Jake. I'm glad that hit you. I wish it hit everybody. Now, it's not going to be true of everybody. Sometimes what you think is a good company wasn't a good company. If you just hold out forever, you'll underperform the market dramatically as the market keeps rising and your poor choice, if you made one, doesn't. But when we're talking about not just a single stock, but a portfolio or a philosophy of investing -- which is what I'm here to propound every week to as many people as will listen -- yes, I do think we would all have more money if we traded less.

You may remember me having said in the past, Jake -- I said it this month on this podcast -- that our Motley Fool Stock Advisor scorecard would be even better than it is today, a strong market beater. I'm very proud of the work I've done for 14 years now in Motley Fool Stock Advisor beating the market. I would be higher had I not sold a single position, picking one stock a month, every single month, for 14 years. I would be higher today had I not ever said "sell."

We'd have some horrendous dogs. We'd have companies that are well down and never going to catch back up to the market, and I'd still be holding it, following this approach, but some of the ones that we've sold -- from Electronic Arts, to ARM Holdings, Biogen Idec -- a number of these have gone on to multiply. And when you don't hold on to stocks that go up five, six, seven, eight times in value, it turns out it's going to look better at the end of the day if you had held on to such companies than if you'd not.

I do want to mention. I was doing a little research this week. I was inspired by the Motley Fool MarketFoolery podcast I heard last week that was looking at LinkedIn's list of the 40 most attractive employers in America, according to LinkedIn. It was called the "Top Attractors List." And what I saw there was pretty stark.

So the top 10 employers -- speaking of, by the way, investing in good companies, Jake, your point, here. I'm just going to list them off real fast. This is in order, so No. 1, Alphabet. No. 2, [salesforce.com]. No. 3, Facebook. Then Apple, then [Amazon.com ] rounds out the top five. Then Uber is No. 6. Seven is Microsoft. Eight, [Tesla Motors]. Nine, Twitter. Ten, Airbnb. I'll mention, by the way, Netflix was No. 11.

Now the reason I think this is particularly fun is because I have owned a lot and recommended all of those stocks, in most cases for years, really quickly. Google in 2008 was our first pick. Salesforce in 2009. Facebook in 2012. Apple in 2008. Amazon in 2002. Couldn't recommend Uber. Couldn't recommend Airbnb. Have never recommended Microsoft. The other two in the top 10 -- Tesla in 2011; Twitter in 2013.

So, yes, if you're a Rule Breakers member, if you're a Stock Advisor member, if you're a long-term member, I bet you own at least one of these companies. I'm pretty proud to say that for our scorecards -- and you can just look right down the Supernova Universe page if you're a Supernova member and see -- we've had all these stocks, just about, and we've had them for years.

And to close out this answer, let's see briefly how they've done. Google is up 158% for us. Salesforce is 1,088% for us. Facebook is up 289% for us. Apple is up 353% for us. Amazon is up 4,569% for us. Never did recommend Microsoft. Tesla is up 604% for us, and Twitter, the odd duck, here, is down 70% for us. It's the most recent pick on this list of all the companies. We've had it for only about three years, and it has been a very poor-performing investment.

But to go back to your question, Jake, or your point, of what hit you over the head -- yes, it should hit us all hard that we'd all have more money if we bought into good companies and never sold our positions. And to close it out on this answer, sometimes I think about The Motley Fool and what our company and our membership, our community is doing in the world. I think we're causing people to allocate capital more intelligently.

I think we're causing good capital to find its way to good companies and there's a really nice, almost global effect that's happening there as kind of an unintended consequence of the advice that we've been giving for almost 25 years now. When good money finds good companies, great things happen in the world at large. When good money finds bad companies, that's not good -- and when bad money finds good companies, that's also not so good. So that's sometimes one of the things that I think and reflect on when I think of The Motley Fool.

And the last two this week. The first is from Ken Hart. Ken, you are @Pfoolhart with a "P." I do appreciate that. If you're a P.G. Wodehouse fan, you may know his character Psmith, which of course did start with a "P" as well. So @Pfoolhart on Twitter. Ken, you ask: "Is there a Fool scorecard for reinvestments? Re-recommendations that we make, specifically for Rule Breakers or for Stock Advisor. Guessing they'd be amazing."

Well, thank you for that good question, Ken. We have not, actually, purposed that in Stock Advisor or Rule Breakers. Whenever we re-recommend a stock, it just shows up for that month and that row on the scorecard. But internally, we've sometimes looked at this. We haven't really framed this up in a big way to face our members. It's not a consumer-facing thing on our site, but we do run data and studies, and we do see that we have a higher-than-average hit rate with some of our best investments when we re-recommend that stock.

Earlier I was mentioning some of my favorite and some of our best picks, and the beauty of it is that we didn't just buy Apple once, or Amazon once, or Google-Alphabet once or Salesforce, frankly. We've re-recommended them multiple times, and those show that we have more confidence in them, and I think our members have more confidence when we re-recommend companies.

Because after all, part of what you're doing when you buy a stock a second time, for you, whoever you are, in your portfolio, probably you know it better than when you first bought that stock. So not only does your own confidence grow, I think, as you buy a stock a second time, but your familiarity with that company is higher than if you picked a different stock. We found that in some of our numbers and results.

The last one this month comes from Seth Bertram. Seth, you are @F0rtunateS0n. That's with zeroes, not "Os," you leet-speaking guy on Twitter. @F0rtunateS0n, Seth, you said: "Sometimes great companies decline. What criteria should a Rule Breaker investor use to evaluate when to exit a stock?"

Well, it's one of those million-dollar questions. If I had a great answer, I'd be putting it into play all the time, and if it were a great answer, I would have much better results than I've generated to date. But I still feel pretty good about my results, and that's one way of my saying -- and I hope you feel the same way, Seth -- that we don't always have to get it right on the exit side.

In fact, I've talked about this before on our podcasts. I'm always humored by the phrase "sell discipline." Some people will say, "What's your sell discipline?" and I always love that, because no one ever asks, "What's your buy discipline?" I think for some reason in a lot of people's minds selling is more important than buying, and darn it, you should have discipline around knowing when to sell. But as I am a Motley Fool and often favor the contrary approach, and I like to invert things, I think your buy discipline, whatever that is, is far more important than when to sell.

The only way you're really going to make a lot of money in the stock market is not by really knowing when to sell. I think it's by specifically knowing what to buy. Not even so much when to buy, but what to buy. The only way you're going to have 10-baggers is to actually pick the stocks that do go up 10 times in value, whether you managed to hold on to them all the way through or not. So a quick word, then, about knowing when to buy or specifically what to buy, and if I were to express it in simple mathematical terms: What to buy > when to sell.

But since you asked me the sell question, I'll give a quick thought as we close. For me, there are three common criteria that most frequently cause me, eventually, to exit a stock. And by the way, when I do exit a stock, usually, I've been late, anyway, and it's a loser. So these are not criteria that help me know ahead of time when something's going to decline. These are more me throwing up my hands going, "OK, I'm out."

No. 1 is when I have lost faith in the management of the company. After all, most important to me is who's running these companies. What's the culture of that company? If I feel like something toxic, or strange, or something different than what I saw or thought would happen initially -- like, yes, I did once own shares in Enron. At the time it looked like a great company, and I liked Ken Lay, the CEO. We had him on our radio show back in the day. But if all of a sudden I decide things have changed or I got it wrong, that's No. 1 why I would sell.

No. 2 is when a company is no longer fulfilling the initial expectation I had for it. I try to write down -- in fact, with every stock pick that I make on Rule Breakers and Stock Advisor, we put our thesis right out there in front of you. That gives me a great thing to refer back to later on, saying, "Is that thesis being fulfilled or not?" If it's not, that's a great reason to sell. It's easier for me, since I have to publicly write up my stock picks, but for you, if you keep a journal -- talking about something else we've talked about this month on Rule Breaker Investing -- then you'll have notes you can refer back to and ask yourself whether this company is fulfilling the thesis.

Finally, No. 3 is, it's not always about management failing or about the thesis not working out. Sometimes it's that something else came in from nowhere. Like that company is all of a sudden being disrupted by something you never thought of before, and that can be a great reason. If you no longer see that company being relevant, or as relevant, or truly leading the world forward, you see something else. that's a great reason to sell the stock.

This was a fun Mailbag. I really appreciate all your questions. I hope your summer is proceeding most Foolishly. Thank you very much for joining me this week, and we'll start July's Rule Breaker Investing next week. Fool on!

As always, people on this program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker Investing at RBI.fool.com.