Learning Investing Lingo With The Motley Fool

Today the podcast is joined by a ship of top-notch Fools to review some simple and not-so-simple terms that will make you a smarter investor, Motley Fool-style!

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 May 10, 2023.

David Gardner: Burn rate, asset location, inventory turnover, customer acquisition cost, spiffy pop. Each of these represents intermediate level terms that most serious, Foolish investors capital F know, and most people who are not serious investors do not know. This week we bring you the latest installment of our got to know the lingo series, one part teaching and yeah, why not one part quiz show. I'm welcoming back three Motley Fool advisors and analysts to help teach me and you, the rest of us some new terms, terms like the ones I led off with, some simple, some more advanced all terms we think you need to know drawn from investing in business. Understanding these terms and the concepts behind them will enable you to become smarter about the game of investing. Smarter, which in my experience leads to happier and richer over time or maybe you already know these terms, in which case, I've got to scoring system. You can score yourself along with us this week. Six new terms, five of us to sort through them, me, my three analysts, and you. You ready? Only on this week's Rule Breaker Investing. 

Welcome back to Rule Breaker Investing. It's got to know the lingo Volume 4. It's amazing to me that the last episode in this series was more than five years ago. I really enjoy and have enjoyed this series, but it's been five long years since we revisited, got to know the lingo. Again, the purpose of the series is to look at some of the terms that you might hear about, and not always fully understand from business, accounting, investing, and sometimes technology as well. Some new oncoming terms to get you thinking about the language of investing, business, and sometimes life to get you smarter about these concepts. The last time we did this was February 21st, 2018, and somewhat, ironically, this was not planned the week before that podcast five years ago, I had just interviewed Kevin Kelly, the Co-founder of Wired and indeed that's exactly what happened on this podcast last week. I hope you had, at least, half as good a time as I did listening to and learning from Kevin last week. Because if you did, that means you had a wonderful hour-and-a-half for so, much longer podcasts than usual, but that one is still feels a little too short to me when we're engaging, forward-thinking conversation with an engaging forward thinking person and friend of the Fool. A delight to be with Kevin last week. Yes, five-years ago, this time, right after I had Kevin Kelly talked about the inevitable, we did got another lingo, Volume 3. We're about to do Volume 4, I'm going to be welcoming on Bill Barker, Jason Moser, and Tom King to share three simple terms and three advanced terms and I'll talk about the scoring system for that in just a second.

But before we start, I want to mention what happens next week. It's my birthday next week, and your annual birthday present to me, this has happened most every year, the last several years, is that, you let me know what you've learned from me over the last year or if you're a longer-term listener, maybe what you've learned from me over the longer-term. What have you learned from David Gardner 2023 edition? Our email addresses [email protected] and you can tweet us @RBIPodcast on Twitter. Again, if you have a little extra time this week, and you want to celebrate my birthday with me, drop me a story, drop me a few lines, a few paragraphs, if you like, rbi@ fool.com, I will turn around, and share back the ones that feel most apt. The most beautifully written, most inspiring on next week's show. Thank you in advance. In our family, we do tend to make Christmas and birthday wishlists, and so I guess that's what I'm doing with you next week, except I just have one wishlist item. I'm asking you, what have you learned for me? [email protected]. Now, onto got to know the lingo, Volume 4. I mentioned at the top, we have a scoring system. Now we're trying this one out. Is it there? You'll have to let us know.

Are we all the way there? Is this going to be how it always is going forward? We'll see. Here's the scoring system this week. As we introduce each term and illustrate it for you, at the end, I'll ask you quietly to think, did I learn anything from these Fools? If you feel like you didn't learn anything, and your five minutes or so, were wasted by that time, the score would be zero, because you learn zero and we were zeros, and so zero. If on the other hand, you thought that was helpful, maybe I didn't know the term or, hey, I knew the term but they made me laugh, plus one. If as Bill Barker or Jason Moser or Tom King presented his term with his illustration, you find yourself delighted, not just by the quality of the learning, but maybe you got to smile along with it. If you really enjoyed, give it a plus two and yeah, you can definitely share your score of this week's episode on social media or just email us [email protected]. We're trying out the scoring system this week. We're not saying we have it, but maybe we do. Well gentlemen, and it is all guys this week, let's start our engines. Bill Barker, Jason Moser, and Tom King are here to teach us six terms, one simple and one more advanced. I want to turn first to you Bill. Welcome how are you doing?

Bill Barker: I'm well, thanks for having me.

David Gardner: Bill, in recent years you've been working at Motley Fool Asset Management?

Bill Barker: That is right. In the last 14 years, I guess.

David Gardner: Yeah. Recent years, like more than a decade.

Bill Barker: When I started working for Asset Management, George Bush was president.

David Gardner: You're not joking?

Bill Barker: I'm not.

David Gardner: Which one?

Bill Barker: Too long ago to remember which one.

David Gardner: The good news for me Bill, is that I still got to enjoy you on other Motley Fool podcasts and occasionally might see you outside the offices. There's a Chinese wall that's always been built between asset management and those who managed funds and our publishing business, but I think you've recently made a transition.

Bill Barker: I have. I'm back on the publishing side where I started and loved it back in the day and it's been a long time. It's changed a lot, but I think it's still a great place.

David Gardner: Thank you, Bill. It's a delight. Its makes it easier to have you on this podcast and our podcasts. Welcome back, Jason Moser, how are you doing?

Jason Moser: Yes, sir. Doing very well. Thank you for having me.

David Gardner: What are you working on these days, Jason?

Jason Moser: Well, I am splitting time between the augmented reality and beyond service and the Next-Gen Supercycle service, which is focused on the 5G wave that we're in the middle of watching play out. Then when I'm not doing that, I'm contributing my time to Motley Fool Money as I can.

David Gardner: Jason you joined me. It was just last month we reviewed a five-stock sampler together. It's good to see you again. You have been making a point to be in our office more often than not. I think part of the reason I thought to have you three on the show this week is because I see you around Fool HQ now. I'm not around all the time myself. I'm not saying you are, but it's a delight to be back together and we are here live in Motley Fool studios. Jason, thank you for leaning in every way, but especially for our members and Tom King, welcome back to the show.

Tom King: Thank you very much, David. Good to be here.

David Gardner: Tom, if you were to characterize the pandemic in a few sentences that you had no opportunity to plan or really think through. How would you describe your experience over the last few years?

Tom King: Weird. Strange behavior. I never thought that the thing that we'd run out over in the dial world scenario would be toilet paper. I didn't see that one coming.

David Gardner: Those were early days. I remember those days. Well, and I think Tom, at one point you decide to just hive off you went west young man, am I right?

Tom King: I was, yes. I spent a few weeks in Oregon.

David Gardner: I still have yet to get to Portland, but I think part of the pleasure in there, had been some pleasures, admittedly, I think obviously we can think about the hard times, but there has been more agency and autonomy on the part of a lot of people more licensed to try out things and get out there as long as we were keeping safe. Tom, I congratulate you on seeing a little bit more of America. You are originally from South Africa. Can you remind me where in South Africa?

Tom King: From the Eastern Cape, the Southeastern part of the country.

David Gardner: Excellent. It's great to see you again, Tom, thank you for joining us this week. We've got three simple terms. We're going to go around the table with these and then three more advanced terms. Don't forget our critical scoring system, 0, 1 or 2, I'll remind you, dear listener in a sec. But let me turn to you first Bill and ask you what is term number 1 for this week's edition of, got to know the lingo.

Bill Barker: The first term is share buyback.

David Gardner: Share buybacks. Bill, why did this come to mind? One of the things we try to do on this show is we try to introduce something that's relevant, maybe timely, but helpful, especially at this simpler level with this first round terms that we think investors should know.

Bill Barker: Well, I wanted to keep this very simple for the simple part of the show. The definition couldn't be more simple. A share buyback is a transaction whereby a share buys back its own shares from the marketplace. It came to mind because it's constantly in the news and it's constantly important for investors. I give you a couple of recent examples. Warren Buffett of the Berkshire Hathaway annual shareholders meeting was just last weekend and he was in the news for his shareholder letter where he took further rather direct shot at the politicians who have come out against share buybacks as being, I think financially illiterate or I can't remember the exact term, but it was basically that because it's something that Berkshire Hathaway has done and there's more to a share buyback than simply trying to make CEOs richer. Which is, I think one of the politicians attacks. A couple of other things that have been in the news, Bed Bath and Beyond now in bankruptcy. One of the reasons was because they had spent so much money buying back shares, rather than all of the other things they could have done with the money that it ended up they needed once business went the wrong way, and they didn't have that cash because they've been buying back shares for about a decade. I think they've reduced their share count by about two-thirds over the previous decade. Probably a lot of people thought that was a good thing, and that shareholders were going to be rewarded by the company buying back shares, company constantly saying, well, our shares are undervalued. The market doesn't understand. This is a bargain. We can use the money buyback shares. Well, at the end, there was no money and no company.

David Gardner: Bill, companies rack up just like individuals who make money through our salary where we rack up income we try to save it stored away, put it in the bank. Those end up on balance sheets as cash positions, short-term investments, etc. Companies out of their own cash-flow are off their balance sheet can use that money as you're pointing out, just to buy back their own shares that retires the shares that effectively widens the pie slices of every one of us who keeps holding our own position. Because if shares are retired and all of a sudden there are fewer shares and I still have my 10, then the earnings per share of the company Bill, the price per share of the company, all of these things are lifted by the reduction in share count. Did I get that directionally?

Bill Barker: That's absolutely right. It's one of the two principle ways that companies talk about returning cash to shareholders. One is to give dividends and the other is to buy back shares. People don't always think of that as giving money back to shareholders, but it is a transaction of, here's money. We're getting shares that were literally giving money back to shareholders, retiring the shares. Everybody else now has a slightly bigger piece of the pie. It's a choice that management makes also is in the news because of [Alphabet's] Google continuing to buy back a lot of its own shares at the same time. That it is reducing headcount, laying people off, getting some criticism publicly from some of the remaining and departing employees and you've got all this money, why don't you just keep us around or find something for us to do that's valuable for the company rather than kicking us out and buying back shares. So I think it's something that also attracts headlines, not just from politicians, but employees and shareholders all have an interest in these choices.

David Gardner: So I'm glad you introduced this one Bill because it both helps us understand how the world of the stock market works and specifically how we as shareholders benefit from share buybacks, assuming that management is making a good decision, buying their stock at a good point, presumably they know more than we do about the status of their operations. When companies choose to buy back shares, they feel like their stock is cheap. It looks great if they're right over the long term. But you are mentioning that some people have criticized doing this because the thought is why are you spending money just to buy back shares and enrich your shareholders when you could've helped the world, when you could have invested more expanded, or been charitable. I think it's fair to say, Bill, that we see both sides of this at The Motley Fool, but we tend to fall down on the same side of the table with Buffett because this is just decision that management can make and it benefits shareholders. I guess Bill, they could have paid dividends except that dividends are double-taxed and not very efficient, which Warren Buffett is also spoken to over the years.

Bill Barker: Berkshire Hathaway has never been one to pay dividends because of the tax consequences the differential there. Those that are taking shots at companies buying back shares point out this doesn't produce any more goods for society. You could take that money, why not just pay employees more? If you have so much money that you don't know what to do with it. Why don't you just hire more employees? Why don't you just try some things that might lead to something good for society? It's those attempts that sometimes end up getting companies in trouble. Buying back shares reduces the mistakes that you can make by allocating too much effort to too many things. But it is true that it doesn't in and of itself produce more stuff.

Tom King: I'll just add that. Berkshire Hathaway, which Warren Buffett, has spoken a lot about share buybacks and how they can add value to the remaining shareholders when they were conducted at the right price. Berkshire Hathaway has been buying back a significant amount of Berkshire stock in 2020, 2020 and 2022.

Bill Barker: One of the things that Buffett does is not to try to take credit for his own work. When he talks about how much he likes share buybacks when they're conducted at the right price, he points to Apple, major shareholding of Berkshire Hathaway, which has done a great job of buying back its shares for a long time. He uses that as an example to promote the value that shareholders experience on a good buyback rather than say, look at how good we at Berkshire [laughs] are in buying our own shares.

David Gardner: Well said Bill Wolf for each of these terms, I've asked my talented Advisor analysts to illustrate that term in a sentence of his own design Bill, what do you have for us to close out with share buyback?

Bill Barker: Well, I'm going to paraphrase Buffett because of the way that they have conducted theirs and say, companies should engage in share buybacks only when stock is available in the market at less than the intrinsic value of the stock.

David Gardner: Very classic. Bill Barker, thank you. Share buyback. Now, dear listener, to remind you of our scoring system, if you just learned a lot, you felt educated, amused, and enriched give yourself a plus too. If you're OK with that plus one and if you don't really feel like you learn anything, zero, scores you go. Let's move to term Number 2. Jason Moser, what do you have for us?

Jason Moser: Yes. Two very simple words, but when they're put together, maybe is a little bit more of a curious term, but one that I think we're all seeing these days, ad nauseum in the financial media.

David Gardner: Is it ad nauseum?

Jason Moser: No, it's not.

David Gardner: I got confused.

Jason Moser: Sorry, my bad. We've seen this phrase, it seems every day ad nauseum and the phrase is debt ceiling.

David Gardner: Debt ceiling.

Jason Moser: Tell me, if you've read, heard, or seen debt-ceiling in the past 24 hours.

David Gardner: My hand is up.

Jason Moser: Everybody's hand is up of course, because we've all seen it. It is in the middle of the financial media these days. To give you an idea of what this is all about as a country, we, unfortunately, have a little bit of a nasty habit of living beyond our means. We tend to spend more than we bring in. When you do that, you run a deficit and you need to find a way to remedy that. When you're talking about the US government, the US government deals with it by issuing new debt in the form of government securities in order to help pay the bills that we can't accommodate at that point. The debt is like alone Investors trait cash for a promise that the government will ultimately pay them back most of the time with interest. I like to think of this from a personal finance perspective. It's like a credit card. There's a limit or a ceiling on what you can borrow with your credit card. We had the same thing going here. When someone spends more than they make, how do they deal with it? Well, oftentimes they use a credit card and they run that bill up. Eventually, they hit that ceiling and they don't have any more room left on the credit card and so you either a reach out to the bank and ask them to extend your limit. Oftentimes the bank says no [laughs], because you seem to be a little bit more of a risk these days. Sometimes they'll let it go either way, it's not very good long-term behavior and not sound personal finance. We are of course, in a situation now where we're seeing that we're running up on the debt limit that we as a nation can borrow.

David Gardner: You mean the debt ceiling? Jason.

Jason Moser: The debt ceiling. Exactly. We're hitting the ceiling. There is a time limit here. They're trying to I think by somewhere in the beginning of June come to a resolution as to what exactly to do. Now, I think it's worth noting this debt ceiling dates back, I think all the way to 1972. This is not a new concept. It's something that's been around for a while. I believe that we've never voluntarily as a country we've never defaulted on our debt. Furthermore, it's obviously a political football back and forth from one party to the next. Every party blames the other party because one party is not doing it right, the other party, is the party a virtue. If you look at the US Treasury, the Department of Treasury website just going back to 1960 congresses acted 78 separate times, they permanently raised, temporarily extend or revise the definition of the debt limit, 49 times under Republican presidents and 29 times under Democratic presidents. This is something that crosses party lines. It is not something that will go away after we deal with it this time around either. There are sure to see this in the news again at some point, but it's certainly something we're seeing a lot these days. That is it in a nutshell.

David Gardner: Thank you, Jason. Very timely. You're right. We all had our hands up. We've heard that phrase used not just this week although yes, but older hands have heard that used many times the course the last few decades. Ever since Bill Barker went to Asset Management, I think I've heard at least 100 times, probably over 14 years or so. It's a very relevant term and yet it's complicated for a lot of us, it's not really clear what the ceiling number is and it's a huge number. For a lot of us, it's hard to even conceive of what that number means. It makes me wonder, Jason, what's going to be your more advanced term a little bit later because you started as it a high bar.

Bill Barker: Does anybody here remember being in New York City and seeing the national debt clock?

David Gardner: I do. I assume it's still humming.

Bill Barker: I think it's no longer there, I believe, but it is online.

David Gardner: It was a digital readout like scoreboard and it was there a New York City and Manhattan and it was just constantly showing how the national debt is running up.

Bill Barker: But you don't have to go all the way to Manhattan anymore to be terrified by the size of the debt. This is not a comment on any political choices, is just a very large number which goes up all the time. If you go to usdebtclock.org it is-.

David Gardner: Bill is facing his laptop out to the rest of us and I do see it's around $31 trillion I think and it's going up.

Bill Barker: You can't you can't even see how fast it's going up. It's one of those things like if you're pumping gas and you're trying to watch that like last digit. No.

David Gardner: Well, the good news is we've somehow managed to work with this and grow into it and through it for a century or so, we keep increasing our GDP. But it is a little bit astonishing. Bill, We're not the only country that does this by the way. It's often had governments work. I guess the good news is for so many of our Motley Fools that we've gotten to work with overtime, I hope we've taught you to save more than you spend. At a national level, that doesn't really happen in most nations these days, but at an individual level, it makes all the difference for your financial freedom.

Tom King: I think the difference between us as individuals and the United States government is that we can't create many of the debt. [laughs]

David Gardner: I think that's an important distinction, Tom and I'm glad you pointed that out.

Jason Moser: I'd be more than happy to [laughs] treasuries. But I think when you start thinking about this debt ceiling the next question really is because we hear it so much and from our perspective is how or does it even matter for the everyday investor? As an investor why should I care about this? Is this something that'll impact me? Bigger picture I would say no but I think to look at it and say that nothing would come of it if we were to default on the debt I think would be a little bit shortsighted as well. You're talking about something where the US dollar being the world's reserve currency. There would be a crisis of confidence. There is no question about that. You'd have to expect a certain level of volatility in the stock market. Credit markets would be disrupted.

David Gardner: I agree.

Jason Moser: See interest rates coming. There would be a lot of uncertainty there in the near-term and it is something worth keeping in mind.

David Gardner: Thank you for that, Jason, and that causes me to ask you, would you like to use debt ceiling in a sentence?

Jason Moser: Certainly. In my opinion voluntarily defaulting on the country's debt by failing to come to an agreement regarding the debt ceiling would leave a massive black mark on the current state of our political system.

David Gardner: Thank you very much, Jason Moser. Turn number 2 debt ceiling. We started the share buyback. We went to debt ceiling. Tom King, you are up next, simple term number 3. By the way as Tom gets ready give yourself a plus two if you learned a lot from Jason there. Give yourself a plus one if you learn a little bit. Give yourself for us is zero if you already knew all that. Tom, what do you got for us. Term number 3.

Tom King: Jason spoke about the debt ceiling. I'm going to talk about a similar term which is leverage. Leverage as a noun is a synonym for debt or borrowed money. It can also be a verb used as in the sense to leverage which is the use of borrowed money to increase the return on invested equity.

David Gardner: Tom, when I think about leverage as a verb I just think about a lever. I just think about pushing down on one side of the seesaw and the other side pops it up because you're levering it and people do that with their finances.

Tom King: Exactly. It's a word that you can visualize the meaning of it very usefully. The same way you would use a lever to lift up something heavy. In the world of finance investors use leverage or borrowed money to lift their return on equity which is the money that shareholders put into a business venture.

David Gardner: Tom, I think about this in really two different ways. One is that people do this by getting a mortgage. Let's say they're borrowing and they are in a way levering themselves up. But the reason that I think a lot of us do that is because they're lower interest rates for an asset that will gain value over time and this is a time-tested way I think of earning financial freedom eventually. There can be good leverage always, certainly, Tom can think of companies that do this with their balance sheets. But I think you're really focusing us right now on individuals, you and me as investors and what we can do with leverage.

Tom King: Yes. We all essentially use leverage when we have a mortgage to buy a house. If you can imagine how I spoke about how leverage increases the return on equity. Let's imagine that there's a house that you buy for $200,000 and you buy that house with all of your own cash. You don't borrow any money at all. Let's say that that house increases in value to $250,000 and you sell it. Your profit in this transaction is $50,000. Your return on equity in the scenario is the profit you made $50,000 divided by the amount of equity that you put into the property $200,000, 50,000/200,000 is 25%. Now let's imagine the same scenario but in this case you use some borrowed money. It's the same $200,000 house but you use $150,000 in borrowed money and $50,000 of your own money, the equity portion. The house increases in value to $250,000 again and you sell it. You repay the $150,000 loan and you're left with $100,000. Your profit in that scenario was $50,000 but your equity that you invested was only $50,000. Your profit divided by your equity is 50,000/50,000 which is 100%. You can see how the value of the house was exactly the same in both scenarios that went 200,000-250, 000. But because in scenario 2 you used leverage, you increase the return on equity that you earned.

David Gardner: Very well illustrated. I don't even think you've gotten your sentence yet Tom, although you gave us a very illustrative example. Now, Jason and Bill, in Tom's example the house went up in value over the course of time and so it felt great. You got to 100% return by using leverage. Have you guys ever seen situations where things don't go up in value and they're levered?

Bill Barker: Sure. A lot of investors have made the mistake of watching stocks go up and up in a short period of time they've used margin which is the term used for borrowing money against your stocks and then when the stock doesn't go up and goes down as can happen they're out the money that they borrowed and the amount that they've lost in-between the buy and the sell. Houses have a very good history, not a perfect history as we learned in 2008, 2009 of going up over time in this country. Stocks have a good history of going up over time but on an individual basis. A lot of them don't go up in the amount of time that you need them to do so if you're borrowing heavily.

David Gardner: Well, thank you for that example, Bill. Tom, you told me in our cafeteria before coming on the show, you were reading the Enron story. That's an example maybe of a company not really using leverage effectively. Which is the Enron book you're reading right now?

Tom King: It's The Smartest Guys in the Room.

David Gardner: I have definitely heard that. I've never felt that motivated to read it because it just feels it's going to be a bad ending. I like books with happy endings. Tom, are you enjoying the book?

Tom King: It's very good. It makes you sad about the greed that people can descend to in certain circumstances.

David Gardner: That's often what happens with margin loans as Bill was speaking to. Our personal greed gets in the way of our better judgment and we end up levering owning stocks that we shouldn't have and taking a bath. Tom King, do you have a sentence that you'd like to use leveraging as we move to halftime of this podcast?

Tom King: Yes. Before I say my sentence I'll just say that one thing to keep in mind with leverage is that shareholders always eat last but they eat what's left. Debt is great when asset prices are going up it can work out really well. But when asset prices are going down, the asset prices that the debt is linked to, when those asset prices go down, shareholders can wind up in a lot of trouble. My sentence is company Y went bankrupt because it was too leveraged and was unable to pay its debt when it came due.

David Gardner: We'll just call company Y Enron.

Tom King: Enron. It's a good example.

David Gardner: Others too. Thank you, gentlemen. That was the simple round. We're about to go back to Bill to start with our more advanced round. But before we do don't forget our scoring system. Zero if you learned nothing, two if you learned a lot, one if you're somewhere in the middle. If you've really learned a lot so far this week, we hope you have, you're at a six. If you already know all this you're at zero we hope to get you higher here as we move to our advanced term is Bill Barker. What do you got for us? Term number 4.

Bill Barker: Well. I was linking the more complicated term that I chose with the simpler one.

David Gardner: Great.

Bill Barker: It's capital allocation.

David Gardner: Capital allocation.

Bill Barker: I'll give you a sentence to define it. This is from Investopedia.

David Gardner: Shout out to our friends at Investopedia.

Bill Barker: Capital allocation is about where and how a Corporation's Chief Executive Officer, CEO, decides to spend the money that the company has earned. Capital allocation means distributing and investing a companies financial resources in ways that will increase its efficiency and maximize its profits. Capital allocation is what you do with the money that you have.

David Gardner: It's a complicated term for a fairly simple action, although it's not always simple to decide what you should do as you allocate capital, Bill.

Bill Barker: No, and this would be in the news. SVB is a company that was tasked with having a lot of deposits and it had to allocate the capital that it was in charge of and invest it in a way that made sense and the way that it chose to buy a lot of long-term treasuries to match those deposits, ended up being a terrible capital allocation the way things played out and it's gone.

David Gardner: Silicon Valley Bank.

Bill Barker: Silicon Valley Bank. There are a couple of other banks that have gotten in the news for similar actions. That's the tragic side. Most of the time, capital allocation decisions do not end up blowing up a company that quickly. Most of the time, CEOs do a better job, not necessarily maximizing the profits for a company, but that's the intent in the selection of choices that they have. Then the classic ones are mergers and acquisitions. That's a way to allocate capital, buy another company, merge with another company, put it toward research and development, buybacks, which we've talked about before, dividends, and capital expenditure, constructing a new factory, buying more laptops for your employees, hiring more people. Those are basically that the choices that a CEO is faced with, and where you make the most profit is something that is moving around all the time depending on the opportunities that are available.

There are times when a merger and an acquisition is a great profit maker for shareholders. There's times when it's a destroyer and the same with share buybacks, dividends are something, when you've got excess cash is an easy and simple way to return to shareholders. But there are times when you have to cut back on your dividend to hoard some resources that you need for a rainy day. It's the most important job that a CEO has and it's one that unfortunately, a lot of CEOs are not prepared for it because they ascend to the job, not by being great capital allocators but by being great salesman or great marketers, great coders, and it's the marriage of being great at one of these other things and then becoming a good capital allocator that creates the real wealth to shareholders. Warren Buffett's really not somebody who was a phenomenal businessman at creating products on his own but he's always pointed out that his skill is in capital allocation. That is with a lot of capital, you can make a lot of money for people by exercising that skill.

David Gardner: You did a beautiful job laying out the menu of choices that the person leading a full-profit enterprise has Bill, and I really appreciate that you pointed out that there is no one-size-fits-all obvious thing to do really contextually, how you allocate capital. You can't just read a textbook of what another company did and try to copy that because at all times different things are being asked, of a business' cash flow, there might be new competition or some new opportunity to expand. Their stock might be low, or they may have thought it was low and they allocate to share buybacks, but it was high and so that was capital destroyed. Like a lot of things in life, its going to be hard to go with a one-size-fits-all approach. But if you are aware of what the tools are in front of you and you start learning when to pick up the screwdriver and then when to pick up the hammer. That's how I think in one way of capital allocation. It's the tools in your toolbox laid out in front of you and it's knowing which one to pick up at the right moment that leads to greatness or stock market tragedy.

Bill Barker: Or you can even think of individuals who have experienced both. Somebody like Steve Jobs, who was allocating capital with Apple in Round 1 to disappointment from shareholders and his board. When he came back, he hit it out of the park several times and he was really somebody who was great at designing products, and rather than squeezing a few more dollars out of a share buyback or things like that. The research and development, he was excellent certainly at capital allocation.

David Gardner: Bill, you've had minutes since I told you about this just before the show, not hours, to plan your sentence. Do you have a sentence for us to illustrate your advanced term, capital allocation?

Bill Barker: Yeah, I'm going to reference my previous term and reference all breakfast commercials from the 1970s. That is by saying that share buybacks are an important part of a completely nutritious capital allocation breakfast.

David Gardner: [laughs] Very well done. I think back to those 1970s cereals and a lot of them and I hate them all, were not very healthy at all.

Bill Barker: No. But if you surrounded them with enough other nutritious things, [laughs] they were a part of a nutritious experience.

David Gardner: For me, Sugar Smacks were one of the healthier forms of breakfast cereal I had maybe because I hadn't surrounded by, I don't know, strawberry.

Bill Barker: Sugar Smacks had eight maybe nine central vitamins and minerals.

David Gardner: You got to figure while four or five dentists probably would recommended one out of five. Where was that other dentist?

Bill Barker: You're not going to get your thiamine by any other source?

David Gardner: Very well said. Maybe that's the term you want to bring back next time. Let's go on to term Number 5. Again, give us a two of Bill taught you something there. You are reminded of the eternal verities or inspired. Maybe you got emotional at one point as Bill is talking specifically about 1970s breakfast cereals. Jason Moser, move us on term Number 5.

Jason Moser: Dollar-based net retention. This is something you also hear referred to as net dollar retention. But ultimately this is a metric that we can measure. Oftentimes subscription businesses, these SaaS businesses, subscription or software as a subscription or as a service rather, its something at the core. It measures the amount of revenue that you're keeping from your existing customer base, and that you're also expanding within that existing customer base.

David Gardner: Jason, dollar-based net retention, again, some of our listeners totally know this phrase, but many coming across this for the first time want this broken down a little bit. Talk about the retention part of that.

Jason Moser: So to give you a couple of quick ideas here as to why it matters and, and how it works. Number 1, higher is better. It's a number that you're often going to see expressed as a percentage. As I said, higher is better. But again, when we look at subscription businesses, and in a lot of these software businesses that are subscription business. You want to know that not only are they retaining those customers, but that they are expanding the relationship with those customers. If you see where companies are not retaining and expanding, well then their financial performance will suffer over longer periods of time, and ultimately, that dollar-based net retention metric helps tell us whether companies are doing a good job of keeping their customers or not.

David Gardner: Why wouldn't we just say net retention? Why do we have to go with the dollar based and extend this whole thing? Isn't everything dollar based?

Jason Moser: It does feel like it is and that's why I think you also see it referred to as just net dollar retention. It's funny world we live in where there always seems to be another way to say some thing is fairly simply. But I think it's also a metric you often hear referred to in some cases as Dubner. When we were talking about this before coming up with other ideas of what to talk about here. One of the metrics that came to my mind, I almost pulled out here, but I wanted to ask around the table here. Does anybody here know, the metric BOPIS?

David Gardner: I feel like I know Bopkis.

Tom King: I'm immediately skeptical of that would be.

Bill Barker: I do know what it is.

Jason Moser: I thought you might B-O-P-I-S, BOPIS. It is a real metric. I have seen it referred to in earnings calls as such, and in today's omnichannel retail world, Buy Online Pick Up in Store, BOPIS, so there's a bonus for you. 

Tom King: I have found that many companies seem to introduce terms just so they don't have to talk about profits because they don't want to talk about when they will earn a profit.

Bill Barker: I'm not sure that I've ever actually bought online to pick up in store.

Jason Moser: I have not bought online to pick up in store myself, but I have run the errand to go pickup at store from something that my wife bought online.

David Gardner: But how about food? Bill, I'm buying online and then picking up at Cava.

Jason Moser: I stand corrected. I just did Chipotle the other night.

Bill Barker: That's true.

David Gardner: Now, Chipotle last I saw and they had excellent earnings a week or so ago. Hitting an all time high by the way. A lot of us just think of Chipotle as always having been there and having had some hard times five years ago or so maybe forgot about the company or the stock. Understandably, COVID. Chipotle, an all-time high this past month. But I didn't see BOPIS in their press release.

Bill Barker: I've only seen it for non-food items.

Jason Moser: For some reason, I want to say it a Lowe's.

Bill Barker: Reactor supplies

David Gardner: BOPIS doesn't sound appetizing. If you're a food company, I don't think you want to say that word.

Jason Moser: It doesn't roll off the tongue, BOPIS. It's awkward.

Bill Barker: It's just another acronym.

Jason Moser: Dollar-based net retention, Dubner. It's a lot easier.

David Gardner: Jason, putting numbers to this, a good number for dollar-based net retention is in excess of 100%.

Jason Moser: To give you a simplified way of calculating it, let's look at a company at what we'll call the base year. We're looking at a certain customer, but the customer base that it has for this base year, and maybe that recurring revenue of that customer base for that base year is $250,000. Then you look at that same customer base from a year ago. We're not talking about new customers. We're just talking about existing, and maybe you look at that existing customer base from a year ago and they were responsible for just $200,000, so $250,000 in the new year, $200,000 in the previous year. You divide the 250,000 by the 200,000 and you get 1.25. You put that out to a percentage and it's 125%.

David Gardner: Which is a very good dollar-based net retention rate.

Jason Moser: That's a tremendous retention rate because it tells you, Number 1, that you're retaining your customers, but also further that you're expanding your relationship with those customers and that really is the ultimate goal.

Tom King: Jason so the highest dollar based net retention rate I've ever seen, I think was CrowdStrike, which is in about 145% at one point. It's a bit down now. I think it's in the only, in the 120s, but at one point it was in 140s.

Jason Moser: I'd say it speaks to Number 1, the quality of offering the company has and then also I think to the market that it serves and cybersecurity. Very resilient, something that's necessary and very difficult to switch from. Once you get in that universe, it's not something you just switch around year after year.

David Gardner: It is obviously a phrase that particularly came before with software as a service you mentioned earlier, SaaS companies and the huge moves and gains peaking in spring of 2021. A lot of those companies, despite still having good dollar based net retention rates, well down as stocks, some of the Motley Fool picks, certainly. Some of them in my portfolio, maybe yours too dear listener. A lot of us got to know this. I guess the bad news is a lot of those stocks are down. The good news is, if it's over 100% for companies whose stocks may have been cut in half or so. It's probably worth looking at maybe adding to positions where you see a high dollar based net retention and the stock that's well lower. Now, you have to look at multiples and other things. There's no one-size-fits-all as we talked about earlier. Jason, do you have a sentence that you'd like to. It's going to be an unwieldy term for a sentence, but where you'd like to include dollar based net retention.

Jason Moser: Sure thing. Over longer stretches of time and dollar based net retention rate, better than 100% can be a good sign that a company is giving its customers what they want and then some.

David Gardner: Straight up right down in the middle. Thank you, Jason Moser. That's five of our six terms. Again, quick review, share buybacks, debt ceiling, leverage, and then capital allocation, dollar based net retention rate. Tom King, you have for us, the sixth and final term this week.

Tom King: Yes. My term is return on incremental invested capital.

David Gardner: Return on incremental invested capital. I would say that we are going to the 101 level at the academic level with some of our more advanced terms. This is a mouthful Tom. Return on incremental invested capital gives us more.

Tom King: Return on incremental invested capital is the profit that a business earned on the most recent dollar invested. Just to help you visualize this concept, imagine that you live in a town where there are 100 people and you're the only ice cream salesman. The first 10 ice creams you sell, you're going to be able to charge pretty much any price for, and you're going to earn a high profit on them. But as you sell more and more ice creams, the price that you're able to charge is going to decline and so is your profit.

David Gardner: When you say the price is going to decline, why is that, Tom? Why is the price can decline?

Tom King: Because we can only eat so much ice cream without getting sick.

Bill Barker: I don't know.

David Gardner: Are you sure about that? [laughs]

Bill Barker: You're not fully an American. Are you?

David Gardner: Tom, as we sell more of many goods and services, the price might decline.

Tom King: Yes, the price declines and in the scenario is making some other assumptions.

David Gardner: Stick with ice cream.

Tom King: Does the profit in your ice cream. Your return on your incremental invested capital. If you reinvest money back into your ice cream business every period and each period you're selling more and more ice cream, were you earn less and less profit per ice cream, your return on incremental invested capital is declining over time. Because we're reaching a point where people just only willing to pay so much for an ice cream. The reason this is important to understand is that some of the best businesses in the world serve markets. Where there's no competition or very little competition, where they're able to continually earn a higher return on invested capital. Each period where they go through, let's say, a year of business, and they've invested $100 and they've earned $10 in profit. At the end of that year, they can take that $10 in profit and reinvest it back into the business and continue to earn that same 10% that they earned in the first year, or possibly even better and to keep doing that for many years. No longer they can do that, the better the business is.

David Gardner: Well, I'm tempted Tom to ask you for an example, because as the stock analyst here at the Fool, this is the thing that you think about. Before we want to go stronger with more conviction toward accompany, we're back away slowly. Tom, are you ready to use return on incremental invested capital in a sentence?

Tom King: I am. Here it goes. Despite being in business for 23 years, Fortinet's return on incremental invested capital continues to be high.

David Gardner: I'm glad you mentioned Fortinet, ticker symbol FTNT, on the Nasdaq because that is well, at least for me, it's a former stock pick of mine. It remains an active, I hope, Motley Fool holding is just that. Since I'm not picking stocks directly anymore, I'm never quite sure whether we're still holding it or not. I like Fortinet. Tom, sounds like you like Fortinet, given the sentence you just threw down.

Tom King: Yes, Fortinet is a great company, also in the cybersecurity space. It's like CrowdStrike, just a wonderful company and high insider ownership, great returns on invested capital and greater profit margins as well.

David Gardner: Is this an easy figure to tease out of corporate financial statements? Do you need CEOs to call it out in press releases or conversely? Is this a regular thing that you'd apply to every stock you're looking at?

Tom King: I do my best to apply it whenever I can, but it is not an easy finger to calculate. There are a lot of accounting things that aren't quite economically relevant that you might need it back out in order to calculate this figure.

David Gardner: You're going to be using your judgment. Of course, these are the advanced term. For people who are dead serious about stock market investing and analyzing companies, you're going to often have to create your own proxies or a sense of exactly how much businesses are not just charging, but ultimately profiting from the increased sale of their products and services. There are different ways to account for these things that can obfuscate.

Tom King: Yes, that's true.

David Gardner: That about wraps up this most recent addition of first in five years for got to know the lingo here on Rule Breaker Investing, Volume 4. Here where our six terms. Again, if you loved it and learned, keep yourself a two for each of the perfect score 12. If you didn't feel that way, one or zero. I'd love to hear your scores, whether you put them out on social media or let us know directly, we're trying to be as relevant and helpful as possible. I really enjoy breaking down terms because underneath those terms are concepts and underneath those concepts, friends are dollar, dollar, dollar bill, y'all. Because understanding how financial statements work, how businesses work is right there often in the phrases that many people don't understand well enough. But as we go and grow, as investors, we increasingly construct piecing together the world. I don't know, maybe one day kit close to Warren Buffett. Not net worth but understanding. Our six terms, share buyback, debt ceiling and leverage, followed by capital allocation, dollar-based net retention rate, and return on incremental invested capital. Before I let you guys go, how about an appreciation or thought? Not about one of the terms that you brought to the table each of you brought to, but maybe the other four that you heard. I'm going to turn to you first, Tom King. The four the Bill and Jason collectively brought what jumps out to you?

Tom King: I think Bill's point about capital allocation and how anybody in the C-suite of a company needs to be a good capital allocator is so important, and he was rightly pointed out that the skills that people get their good people into the C-suite, or not necessarily capital allocation, it's something else. Yet now they have this responsibility for allocating the capital of potentially a massive company. That will have a huge impact on the future value of that company. That's the reason why here at The Motley Fool, we spent so much time. Or we like companies that have high insider ownership and high founder ownership. Because it's a rule of thumb. It's a quick way to tell whether there is good capital allocation at this business or not because they are investing their own money. Whereas some other businesses that don't have insider ownership, you need to dig a little bit deeper to figure out whether they are going to be allocated money correctly.

David Gardner: Very well said Tom King and great points, Bill. Jason, what jumps out to you about what the other guys said?

Jason Moser: Tom's discussion of leverage, that picture, you painted a seesaw. What's that in the middle of the seesaw? Is that the fulcrum? 

David Gardner: Yeah. Let's go with that. Sure. 

Jason Moser: I just want to make sure. I just I couldn't get that out on my head. I actually, in thinking of Bill's discussion on share buybacks. I really appreciated the examples. A bad one at Bed Bath and Beyond versus good ones. It's something that politicians really like they glom on and paint a picture of them being always bad. They're not always bad. Sometimes they're not good, but not all share buybacks are created equal, some are good.

David Gardner: They can be heroic, Jason. If you step in and you're willing to risk your own company's capital buying back shares, saying our stock is cheap, that's helping all of the shareholders. Ultimately, it's helping the business, assuming they're making the right call.

Jason Moser: It's absolutely right. Over longer periods of time, something we look at as analysts just make sure that share count is coming down. That's a good sign that at least they're doing what they were meant to do. Because it's not always the case that the share count is coming down.

David Gardner: Bill Barker, what jumped out to you about what the other guys brought?

Bill Barker: Well, Jason just mentioned the seesaw and that reminded me about watching the Westminster Dog show last night [laughs] and the obstacle course, and I highly recommend that you go.

David Gardner: I miss this, although I've seen the videos in past years.

Bill Barker: They're just great if you like dogs. [laughs]

David Gardner: Especially like little stubby dogs.

Bill Barker: That are having to get to the top of the seesaw. It's unclear whether they've gotten their weight so that it pushes it down and they can complete it.

David Gardner: That's leveraged.

Bill Barker: Good stuff. No, I enjoyed. Tom's mentioned the return on the incremental invested capital, that of course, is the crux of the Berkshire Hathaway thesis. Everybody, all these various companies that are operating under the Berkshire umbrella kick their profits up to Buffett and Munger and then they determine where the money goes to expand things. You don't have the pressures at the lower level of just trying to constantly grow your business. You're going to be given the capital to grow it if you have the opportunity to outperform the other choices that this master capital allocator, Munger and Buffett, the team of them choose. It's that incremental dollar that they're constantly reevaluating. The results speak for themselves there.

David Gardner: Very well said. Well, we hope your results dear listener, spoke for themselves, whether it was a zero, one or two for each of our terms, we had a lot of fun bringing that to you this week. Thank you again to Bill Barker, Jason Moser, and Tom King. A reminder, next week it's my most self-indulgent podcast of each year because it's my birthday week. What have you learned from me? It'll be the latest addition to 2023 addition of what have you learned from David Gardner, it's always fun to summarize the cardinal points or things that you've heard from me and just share them back. I take your gifts in the form of emails, [email protected] and then I share them back out as a summary of some of the most important takeaways that I can give you in investing, and business, and life. Again, [email protected], you can tweet us at RBI podcast. In the meantime, have a Fool-ish week, Fool-on.