Please ensure Javascript is enabled for purposes of website accessibility

Why Strong Stock Price Appreciation Shouldn't Scare Investors Away

By Motley Fool Staff - Updated Oct 13, 2019 at 1:17PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

If you’re waiting for winning stocks to drop into what the experts think of as bargain territory, you may wait forever.

In the stock market, it's tough to find consistency. Great companies may profit investors over the long term, but even the best of them will have months when they miss the mark and lose ground. But if you need a bit of consistency, look no further than the Rule Breaker Investing podcast, which always ends the month with a win for its listeners: a mailbag episode.

In this segment from the podcast, listener Michael poses a question that cuts to the core of The Motley Fool's investing philosophy: How did he and brother Tom develop the criteria they use to spot Rule Breakers, particularly the idea that they shouldn't avoid companies that have already delivered big share-price run-ups, even to the point where the pundits call them grossly overvalued? To answer, David harks back to some of his earliest investing decisions, discusses lessons he learned from a terrible and excellent book -- yes, it's both -- and offers his own contrarian "special sauce."

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Sept. 25, 2019.

David Gardner: Rule Breaker mailbag item No. 2. This comes from Michael Hannon. Mike he wrote, "Hi, David. Could you please explain how you came to develop the Rule Breaker criteria, especially not avoiding fast-growing companies because of strong past price appreciation, and the related criteria of grossly overvalued according to the financial media? I do believe you are correct about these, but this thinking goes against a lot of conventional wisdom, such as Ben Graham style value investing. I'm curious about how you came to develop and recommend this type of bold investing style. Any history about the evolution of your thinking that led to the Rule Breaker methods would be greatly appreciated. Thanks, Mike."

Well, thank you, Mike. Like most lessons earned over the course of our lives, especially the ones that we earned and learned ourselves based on our experience, not just book learning from somebody else -- though I greatly respect that -- this one came at a personal price. I think the iconic story that I've told, the moment where I made a decision to shift how I was thinking -- because previously, I had been a "buy low, sell high" investor. I was raised that way. But, I remember picking stocks on America Online. This is even pre-Web, back when it was keyword FOOL on AOL. We had a real money portfolio that I was helping to manage. And at the time, I thought, "Yahoo! looks like a good stock." And indeed, it really was. This was the golden age of Yahoo!, pre-Google, when Yahoo! was an early titan. And I calculated, using my valuation approaches at the time, that it was worth $25 and change. And the stock at the time was around $29. So I said, "Well, it's overvalued. Based on what I'm seeing, I think this is worth $25 and change. I'm going to wait for it to get down to $25 and change before I would buy it or recommend buying it," because that's what we were doing over our site, showing people what we were doing with our own real money; follow us along, if you will.

Here's what happened with Yahoo! From $29, it never went down to $25 and change. It went to the split-adjusted equivalent of $1,000. So, I missed a stock that went up over 30 times in value because I thought it was worth a few dollars less than it was trading for at the time. And at that point, I decided, "I am going to unblock my thinking and take away this notion of a target price or a valuation leading me to," I love the ones that are out to a decimal place or two. Nope, I am going to ask myself, "What's going to win over the only term that counts, the long term?" And I felt empowered, then, to go after and by the best companies of our time. And that's helped me ever since.

Missing Yahoo!'s 30-bagger because I decided that was worth a few bucks less was not the only time that had happened. That was the straw that broke the camel's back. I'd already seen that and done that before. But that's the one I remember. There's no substitute for having thousands back then, or these days hundreds of thousands, or millions of people watching what you're doing, and drawing conclusions appropriately. I was still a young investor in my 20s. That was very impressionable for me to change my mind and reverse what I was doing so that I could start winning on behalf of my fellow Fools, our subscribers, today our members. That was a really important moment for me.

I want to highlight two other quick things before we move onto the next one. The first is that even just being in and around AOL in the early days was so helpful for me, not just as an investor, but also as a businessperson, as an entrepreneur. I'll always remember, in the early days, AOL decided at one point raise its rates. You'll remember, back then, you had to pay an hourly fee to be online. This is really early days of the internet, like $3 an hour. And at one point, AOL raised its rates. And I was at a partner conference for AOL Partners, and I saw the CEO, Steve Case, that evening. And I was reading all the headlines coming out of The New York Times and others the next day, "AOL makes a horrible decision, it's raising rates." Steve Case very calmly explained to me, he said something to the effect of, "Don't you think we've already market tested this for the last six months or so? Don't you think we already know exactly what's going to happen with these numbers? Do you think this is a bad decision we're making?" Again, this was early days of AOL, but, it was so impressionable for me to see the entrepreneur himself and the whole team that's working on the business and their perspective versus the journalists criticizing the company that ended up being a great move for AOL. Again, things didn't end great for AOL years later, but not before the stock returned 150 times its value from our original recommendation. That was a very impressionable thing for me, to realize that sometimes, great companies and winners -- you've heard this before -- win, and if you just stick with them, you can win wildly well, too. That was also very helpful for me.

The last thing I'd like to mention is William O'Neil's book, How To Make Money in Stocks. I've mentioned it before in the same context on Rule Breaker Investing. It's in some ways the worst investment book ever written, because it talks about market timing and reading graphs and it's very short-term oriented; and it's in some ways the best investment book ever written, because William O'Neil is looking at what wins empirically over time. He identifies traits of those companies. And usually, it's the ones hitting new 52-week highs, which made it easier for me to be, in your words, Mike, bold, as I changed my investing style and started to realize that we should be looking for a strong past price appreciation, not afraid of it.

My own special sauce, my own contribution to the oeuvre, if you will, is this idea that when the media calls something grossly overvalued, that is our ultimate Rule Breaker buy sign. Again, if your company is a top dog and first mover in an important, emerging industry with excellent management, smart backing, a good brand, and a number of other attributes, and somebody in the media is telling you it's dramatically overvalued and puts that on the cover of Barron's, that's actually a great sign, not a bad one.

Thank you, Mike, for encouraging me to look back into history and see where these ideas came from and how they were formed. It's something I enjoy doing myself. I also want to make it clear, before we go to No. 3 here, that I'm continuing to learn every year. It's not like Rule Breaker Investing hasn't changed or never will change again. I'm always trying to be guided by my best ideas and whatever I'm learning. We'll change our thinking whenever we feel like we need to win.

The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
394%
 
S&P 500 Returns
127%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/18/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.