Motley Fool Rule Breaker Investing Fundamentals

In this podcast, Motley Fool host Ricky Mulvey caught up with Motley Fool Rule Breakers Lead Advisor Tim Beyers and Motley Fool co-founder and Chief Rule Breaker David Gardner to discuss:

• What makes a business a Rule Breaker.
• Investing lessons from Apple, Tesla, and Intuitive Surgical.
• How to invest like a venture capitalist.
• Creating your own investing rules.
• What risk actually means for an investor.

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 July 29, 2023.

David Gardner: Because it's not just the Rule Breakers stocks, or companies that we're looking at, but it's also the approach that you take as an investor to the markets, breaking the rules that others seem to abide by. A quick example, there would be most people have way too short a timeframe that they're investing for.

Mary Long: I'm Mary Long, and that's Motley Fool co-founder, and Chief Rule Breaker, David Gardner. Ricky Mulvey caught up with David, and Rule Breakers Lead Adviser, Tim Beyers, to talk about the fundamentals of Rule Breaker investing, how to find companies that solve migraine-level problems, and why risk doesn't always correlate with reward.

Ricky Mulvey: We have a lot of different flavors of investing at the Motley Fool, but one of the house specialties, house sauces, if you will, is the Rule Breaker style. Joining us to discuss the fundamentals of that is Rule Breakers Lead Adviser, Tim Beyers, and the Chief Rule Breaker himself, David Gardner. Thank you both for joining us.

David Gardner: Very excited to be here. Thank you, Ricky.

Tim Beyers: Thanks, Ricky.

Ricky Mulvey: To kick this off, I'll go to David. Let's pretend that investing is a game, and even if it's not a game, it has game-like elements. How do you play the Rule Breaker version of this game?

David Gardner: Well, I love games first of all, and I love the analogy, so that totally works for me, Ricky. I would say that the game of investing, the first thing you need to do for any game is understand the rules of the game. Fundamentally, games are rules-driven. You need to know that if you shoot the basketball from a certain length, it will be worth three points, not two. There need to be rules in place that are respected, and that properly coached you're aware of, and you're playing the game by the rules. If you want to become great, if you want to win the game or beat other people who are merely following the rules, then I think you start to say, well, when is it appropriate to break a rule? I think for the Rule Breaker investing approach, and Tim has worked alongside me and the team, now runs the team for a couple of decades now, so he's well-steeped in this. I think we look for specific rules to break a quick example. For me, I often look at stocks that don't have earnings, or earlier stage companies that look like they have crazy multiples. A lot of people were taught a rule, something like don't buy a stock with a price to earnings ratio in excess of 25. While I understand why that's a good baseline rule, and appropriate for teaching people who are getting started, most people don't even know what a P/E ratio is. That's a good rule, but really, you're going to miss many of the great stocks of any era if you're abiding by that rule. That's why we start to break the rules.

Ricky Mulvey: Tim, so what do you think David touched on the multiples and earlier stage companies? What do you think are these, maybe some more of the similarities between these companies are for investing game player, those game pieces?

Tim Beyers: There are, when you're playing a game, and in particular, if you're playing the Rule Breaker investing game, you are looking for players that are outliers. Those outliers do have some interesting characteristics. They may have some abilities that are unusual, uncharacteristic, and you're not going to find them unless you're looking for them. A good one is that this company has done something so remarkable, or another way to put it, and I've often put this on Motley Fool Live, I think of it this way, they are providing aspirin for a migraine level problem. Like if you are talking about a migraine, you or I, or really just about anybody will pay a significant premium to get relief from a migraine. If it's a mild headache, I might just want to just lay down, and maybe get some sleep and I'll wake up and I'll be a little bit better, but if it's a migraine, I want relief and I want it now. The game piece and the Rule Breakers game has that ability to solve a migraine level problem, and so they tend to grow at an incredibly accelerated pace for a much longer period of time than your average game piece. If you visualize the board, this is the game piece that jumps three spaces. This is the game piece that teleports to the other side of the board because they can do it. Because of that, they get you much closer to winning the game you want to win. In this particular case, maybe generating some generational wealth, or generating some wealth for college savings, gets you closer to goals that you want to achieve. The Rule Breaker game is one with pieces that can do things that your average game piece just can't do. The average game piece goes one space, the Rule Breakers piece goes five spaces.

Ricky Mulvey: Perhaps I should have focused on the player before the piece, but I want to follow up with you Tim on that. We think of some games, Chutes and Ladders, ages two and up, everyone can play it. Catan, [laughs] four people to six people. It's better with four people, but six can play it. Anyway, when we think of the Rule Breakers game, who are the players for this game? Who is this game suited for?

Tim Beyers: I would say this, you don't want to eliminate anybody right away. Anybody can play the Rule Breakers game. However, I think David's first point is so important. You should know the game that you're playing. When you sit down, know the rules, know what you're trying to do, and know the game. If you are going to play the Rule Breakers game, I think you want to be sure that this isn't the only game you're playing. Let's pick one of the games that you singled out there, Ricky. You're not going to play Settlers of Catan all of your life. I guess you could, but David is the only one I know who has, I think it may be over 200 board games now, or something along those lines. The endless variety of games that are available is something you should treasure. This is just one of the games, and so make this one of the games you play, but not the only game you play, and make it maybe to put some framing around this, we sometimes say, hey, you know what, if you're going to build a portfolio, maybe build a portfolio that's about 20-25% rule breakers. Then play some other games. Don't just play the Rule Breakers game. 

Ricky Mulvey: There's lots of other games, the dividend game. You could play value games, you can play the ETF game, which I guess perhaps would just be pass. David, before we move to the next questions, I wanted to give you a chance to maybe reflect or respond to anything Tim said.

David Gardner: Well, I think that Tim has done a really nice job talking about the unique positioning of the companies that we select in Motley Fool Rule Breakers. We are looking for the companies that break the game. That's why we have long-standing early recommendations on these kinds of companies. Tesla, I think 2011, somewhere in there. We have a very low cost basis. We've held it all the way through. The electric cars totally break the game of what you thought was possible from cars; how we fill them, how responsive they are. They don't need maintenance compared to so many of the ICE engine that we all grew up with. We're talking about a fundamentally rule-breaking product, that's often at the heart of the best companies. Another quick example, we've hailed it for a long time is Intuitive Surgical; surgical robotics. It's almost like you're playing the PlayStation 5, you're an incredibly master gamer on the PlayStation 5, it just so happens that as you move the controller left or right, you're making incredible incisions at minimally invasive situations, starting to do remarkable things beyond just removing prostate, which is how it started for Intuitive Surgical, starting to perform some miraculous transplants. It's Intuitive Surgical, a company that we've held for 20 years, just about at this point. These are companies that innovate, most of all, Ricky, Tim, and everybody listening.

I always look in every industry, I ask who is the innovator? Who are the guys changing the game? The Davids, not the Goliaths, that's really where we live and breathe with the Rule Breaker stock recommendations. One quick addendum. There are rule-breaking companies, the game pieces, if you will, Ricky, but then there are the rule-breaking players. I appreciate you're drawing that distinction because it's not just the Rule Breakers stocks or companies that we're looking at, but it is, it's also the approach that you take as an investor to the markets, breaking the rules that others seem to abide by. A quick example there would be most people have way too short a time-frame that they're investing for. We invest much more like venture capitalists who start a 10 year fund, make early investments. In many cases, while those VCs would love those companies go public tomorrow, instead, they patiently hold them, help grow them over the course of a decade. That's really how I think most people should be approaching their investing portfolios. Yet friends, that is a real minority in the world at large with short-term trading, all kinds of ridiculous rules people are abiding by like if it doubles, sell half and play with the house's money. Silly rules that sound like rules, but enable rule breakers like us, not just to game pieces, the companies, but the players as well to excel. Because other people are following what I think of as sub-optimal rules.

Ricky Mulvey: I think one quality and I want to stick with David with this question to start. It's the focus on early stage companies and a lot of disruptive tech. You've seen a few disruptive technology cycles when the Motley Fool started, the Internet was quite new in 1993, right now the big disruptive tech conversation is around artificial intelligence. With any of these cycles, there's pessimism. If you're a Rule Breaker investor, you have to have intentional optimism. Do you have any tips for being a long-term intentional optimist?

David Gardner: Well, I think it's always the right bet, whether we're thinking about our country. Obviously there are mixed feelings coming out of COVID in terms of the political state of our nation, other considerations there. It seems like negative headlines. Clickbait always grabs people's attention. But really, the story of our country is one of incredible resilience. I think that's one of America's five core values. From my standpoint, it's with Warren Buffett, never bet against America. I feel the same thing with Warren Buffett about the stock market by extension. That means all of the technologies from the refrigerators that replaced ice blocks, to the cars that replaced horses, to the Internet that replaced lots of things; bricks-and-mortar, newspapers, etc. Right through today, of course, to artificial intelligence, which replaces needless human activities in many cases, allowing more cheaply us to solve other people's problems and then redirect our own efforts if it's no longer valuable for me to do what I'm doing in my job, to redirect me toward something that is higher ended, I guess. It's not easy for everybody to switch their job all the time. Technology is constantly disrupting the existing establishment and opening up new opportunities. But AI is going to be an incredible job creator, I think. At the same time, it's going to be reducing the costs of lots of things that were expensive before AI showed up. Absolutely, I'm optimistic. Net-net for artificial intelligence, I would imagine my friend, Tim Beyers, is too.

Tim Beyers: I will say, Ricky, I'm optimistic about AI with a wrinkle here. I'll double down on what David said and make a statement that I think is really important. Being optimistic does not mean being blindly optimistic. I think this is really important to remember this, Ricky. You have such good reasons to be optimistic. David gave you a couple of cases of where we've seen long enduring cycles of innovation that came out of what feel like nowhere. But they endured for a long period of time. The Internet is still creating value 30 years on, that's happening right now and it's happening before our eyes. You have really good reasons to be optimistic about technology adoption cycles because historically they have lasted for longer periods of time than have been presumed at the time. They have generated way more value than we thought that they could at the time, and so they were multipliers. They were real force multipliers. Now, here's the thing though. I'm optimistic about AI, but I'm not optimistic about all AI. I think that's absolutely fine. I think there are things that need to happen for artificial intelligence to generate the compounded value we know it can create.

Some of the things I've said on Motley Fool Live, for example, is ChatGPT is not the value creators in my opinion. The thing that will happen that I'm very excited about, this is why I like a company on the Motley Fool Rule Breaker scorecard like Snowflake. Why do I like Snowflake? Because when you have data that is very specific, that you can put context around so you can teach an AI machine what it's seeing and give it context that it doesn't understand and then the data becomes the value creator in the AI machines, like, oh, OK, that sounds interesting. Let's see what we can get from that. Then I think you get huge amounts of compounded value. But this is the stuff we don't see right away. Because we don't see it right away, we underestimate its power, and we don't think it's going to last as long as it actually does. But what history teaches us to what David said before is it actually does, it lasts a lot longer, particularly when it actually does something to create habits. The Internet did change habits. We went from, hey, what is the thing that I can get access to? To the Internet saying, you can have what you want. What do you demand in terms of programming? In terms of content, I'll give you a search engine so you can go get it and you don't have to wait for it. How does that sound? Wow, that sounds pretty good. Then we get this massive unleashing of value creation.

Ricky Mulvey: I want to talk about frameworks for a bit because rule breaking and discipline are not antithetical. I want to turn this question to David. How do you use frameworks, perhaps rules that you made to stay disciplined as an investor?

David Gardner: I think it's very important to be operating within processes or systems that either you've learned from others or are employing yourself. I'm a very systematic, systemic process-driven person. But the real fun of it is, and this is a little Rule Breakery guys, the real fun of it is when you create your own systems or processes, and that's something that has distinguished our work, not just at Rule Breakers, but at The Motley Fool for many years. So I think quickly an example would be that I've designed, we may or may not use this, this is more of my thing, but a way to evaluate risk for stocks. I generally found myself dissatisfied by risk ratings when you see, I don't know, a brokerage firm put out a recommendation and it says, "Risk: medium." What is medium? What does that mean exactly? To me I think we have to very tightly define, in this case, risk, I would say risk for me as an investor is if I were to hold for a long period of time and have an extremely sub-optimal return, that is very risky. If you put your capital in a place for a long time and it loses value, that's very costly. To me that's the risk we're guarding against. It's not about near-term volatility or whether it hits earnings next quarter. That seems to me often what people mean when they say risk. So we define risk, and then guys we developed a system called the 25 point risk rating system, which I've talked to some, we've used at Rule Breakers, I've talked about it on my podcast as well. It's just a series of questions that you ask of any stock. It's largely about the company behind the stock, and each one is a yes or no answer. It's a 25-question quiz. You can google this and find that if you'd like to use it. We use it on Rule Breakers I think in different places still. This is just an example of a framework or a system or a process that we design.

Every time you say no, answering one of those 25 questions, that's bad, that gives a plus one. So the higher the number, the higher the risk. It's been a way, I think, again any investor can use this to just evaluate how risky would it be to hold that company. One of the great insights that I think Tim, that we've gotten from this approach is to realize that risk doesn't always correlate with reward. Now that is a very Rule Breakery notion, Ricky, because most people say, yeah, well, take a lot of risk, get a lot of reward, take low risk, get low reward. We've found that you can take low risk and get a lot of reward, its asymmetric. The only way you can arrive at that conclusion is if you've built a process to look into it, and then allowed enough time to elapse to see what you learned. So that's an example of us learning right out in front of our members that Tesla was actually much lower risk over the last 10 years. People still think it's a crazy risky stock and they look at the high valuation and I understand it's been noticeably at different points. But systemically, if you look at all the charging stations that they're now partnering with BMW and Mercedes with, if you look at everybody else now has their copycat electric car, the power of the brand, the visionary, that is Elon Musk, I'm generally a fan, not a fan boy, but a fan. It's lower risk than people thought, and it's been one of the best stocks you could have held over the last decade. These are examples of creating a system or process operating within it long enough to get familiar with it, and the more creative it is, gives you your own unique insights, and then you can break the rules, and win.

Ricky Mulvey: Tim, I want to pass it to you now, either following up on risk or maybe discussing a framework or rules that you've made for yourself to stay disciplined at investing.

Tim Beyers: I'll say that we still use risk ratings internally. We don't publish them at the site anymore, but we still use that same style of risk rating to understand what it is that we are buying, and so when you see it in a Rule Breakers recommendation, you can know that we have thought carefully about risk of total loss and risk of impairment of capital and whether or not we think there are things that get in the way of the growth that we want to see, because we really want to see a lot of growth inside of a Rule Breakers company. One of the most useful things of that Rule Breakers risk rating rubric that David is talking about is you got actively identifying things that get in the way of growth or can absolutely cripple a business model.

If for the most part you are finding that actually there's not a lot of things that block growth here, you can get a lot more confident about the long-term value that this company can generate. For myself, I have long been looking at, I'm a pattern seeker, like a lot of Motley Fool analysts. It's one of my natural strengths and I tend to look forwards and then come back to it. I want to see what can happen and then come back to the present. I will often look for patterns of development that have repeated over and over and over again. One of the most famous, I call it because I just think it's hilarious, I call it the bomber test. Developers. When developers commit to a software platform, when they commit to any ecosystem in which it's required to build software to compound the value of that platform. The most common one here is the iPhone. At the time that the iPhone was introduced, they put in a platform which essentially they called the App Store that was going to inherently make the iPhone more valuable over time. It was hard to see just how valuable that platform would become.

But here's what we knew, we knew that that was a very friendly development platform, and its primary competitor that it was disrupted at the time, the BlackBerry didn't have that, and so developers started shifting slowly, carefully, and then in mass to the iPhone. That was a real signal to anyone that was paying attention, that that was going to be a massive value creator, just like platforms that came before it. Like the Windows platform back in the early days of graphical PCs. Because boy, there were a lot of developers who said, I can make a lot of money there, writing software and games for Windows. What did it become? It became the most dominant platform of its time. It's not a rule, Ricky, it is a framework that allows me to look at the landscape of a market and say, who's making the money here? David has a great saying that I have adopted, it's one of the most recent Rule Breaker recs has this feature to it. It's called a win-win-win.

I'll let David speak to it in a second here. But win-win-win is if I have a platform where I can win, if you as a customer win, and a partner of that customer can also win. Everybody is winning, and as the winning compounds, we all gain. That is an economic tornado. If you see that, then I think you should get really interested. One of the businesses that I think has this win-win-win characteristic is Toast. It's a new recommendation in Motley Fool Rule Breakers. Toast is Ed. I'm oversimplifying here for the purposes of our podcast, but it's an automation platform for a restaurant. It automates the reservations list, it automates the back of the house, the front of the house. You are automating things from delivery to ordering your inventory, to managing your waitstaff, to managing the payments, so you turn over tables faster. What ends up happening is you end up getting a restaurant that is more efficient, that generates more payments, which generates more money for Toast, which generates more money for that restaurant, which generates more money for the waitstaff. You see win, win, and win, which when you get that economic tornado, you end up having people talking about, have you tried this thing called Toast? That's a very powerful tailwind. I do think there are frameworks that can be very helpful to you in identifying companies, and those or two.

Ricky Mulvey: I'm going to kick it to David, if you wanted to expand on anything with the win-win-win framework or pattern recognition.

David Gardner: I so appreciate that Tim has that in his head and in his eyes as he and the team look at the world because the companies that are going to beat the market, and I'd say over the only term that counts the long term are going to be those that are creating wins for everybody. It's just not sustainable. You're not going to be an excellent company with excellent stock returns unless you're truly creating value for others. Tim, January 21st, 2009, I want to quiz you, Tim, what happened on that day. You might know you're too humble to care too much, but that was the day that we recommended Salesforce for Motley Fool Rule Breakers. It was Tim's recommendation. That's now more than 14 years ago. The cost basis, around seven dollars a share back then. A lot of people were like what's the cloud? What is this thing, the cloud? Tim's like, the cloud has a win-win-win and so many words he said, possibility here, and it feels like Salesforce is an early leader with a visionary CEO. Marc Benioff has since become a billionaire many times over. Our cost basis of seven, looks awfully good at $224 a share today. It's a 30 plus bagger. By the way, Rule Breakers has a number of stocks that have performed better than that just to entice for anybody who's not already using the service. But at the heart of that was recognition of the tornado, as Tim just said.

In this case, it was cloud computing. Obviously, just like the Internet, cloud is still creating new value every day to day. But it's premised on something I would call conscious capitalism, and that is that everybody's winning together. There's no zero-sum game. Ricky, Tim and everyone listening, I think a lot of us think that the business world or games are all about zero-sum; if I win, you have to lose. Well, that is true of chess. It is not true of many of the infinite games being played in the world around us. One of them is capitalism. It explains why humanity rose from the swamps 100,000 years ago, unclothed and now today we take for granted miraculous technologies all around us all because we were basically trading with each other. I was buying from you, you were selling to me. We both actively said, this is helpful for me. You wanted the money from me to do whatever you wanted. I wanted the thing from you. We traded not just goods, but ideas. We've traded with each other. We've cooperated with each other for centuries, and especially in the last few centuries, we've seen the unbelievable benefits of that and so the winners are always going to be those that are creating that win-win-win.

I'm probably just underlying what Tim already said, but maybe adding in a little bit of a longer term view of things and why I remain, and I think it's rational to do so, an optimist for where we are right now and the next 30 years, which I think are going to be amazing, not just for investors, but they will, but for all of us on planet Earth. The doomers and groomers always grab the headlines. It's not just true of today jacket, it happens every generation through human history. The apocalyptic types get all the attention, meanwhile, the rest of us proceed along doing our trade, trying to reward customers who buy from us, and darn it, the stock market showed up and allowed you and me to become part owners of businesses. We like to select at Motley Fool Rule Breakers the best businesses of our time, and we hold overtime. You see the incredible benefits beating the market as we have of doing that. By the way, beating the market is one thing, but how about not acting that often, not having to spend so much time at it. If you think about Motley Fool services, we're really taking all the time out. We're doing the work for you and giving you our outcomes and we score ourselves, and you can just, I think, save a lot of time and beat the market over the long term, the only term that counts, I think, by following this approach.

Ricky Mulvey: As we wrap up, David, I want to make sure we spend some time talking about the Rule Breakers you follow now. You're no longer providing active recommendations for the service, but you follow Rule Breakers and financial education people with the Fool Foundation. Any Rule Breakers in there that you want to put the spotlight on?

David Gardner: Well, first of all, thank you for mentioning the Fool Foundation, Ricky. Yes, I remain co-chair of our company overall Fool Inc., but also Chair of the Board of the Fool Foundation, something I'm very passionate about. We're looking for Rule Breakers out there in the world of financial freedom. There are lots of people who think it's not just about teaching kids the stock market. That counts, and we'd like to see more of that in our schools. But there are lots of things that have to happen to make financial freedom happen. I think about the work, for example, of Kimberly Driggins here in Washington DC at the Washington Housing Conservancy. She basically has a vision and has enacted it across many properties in a way that we see scaling nationwide of multi-use kinds of living. You can take people who are more well-to-do, give them a beautiful place. But people who especially appreciate being around other people, they're not trying to hide behind a private community somewhere, they actually love being out there in the world at large and be there living in the same building with the nurses who might be serving them or the teachers who are teaching their kids. That approach to a Motley view of living together is really working well. You can check at Washington Housing Conservancy.

Kimberly is one of those people that we would call a Rule Breaker out there in the world of creating more financial freedom, not in this case for profit, although her model is very sustainable, not-for-profit. It doesn't need donations to drive it, it's very generative on its own. Just like Tim and others at The Fool are trying to pick winning stocks at the Fool Foundation, which is foolfoundation.org, we're looking for the winners that are creating wins across housing, across education, health, work, and money. Ricky, Tim, everyone listening, there are five drivers of financial freedom. It's not just about having money. If you don't have your health, if you're not educated properly, that financial freedom is not going to be sustainable. We're looking at an individual level and also a systemic level of who's out there creating financial freedom, and we're backing them. We'd love people to pay attention to what we're doing at foolfoundation.org. Fits very much hand in glove with what we're doing at The Motley Fool, where for profit, we're picking stocks, not-for-profit, we're trying to drive financial freedom for the people who aren't yet ready to invest in their first stock, and that's the majority of the world.

Ricky Mulvey: We will leave it at that. Tim Beyers, thank you for your time.

Tim Beyers: Thanks, Ricky.

Ricky Mulvey: David Gardner, thank you so much for your time as well.

David Gardner: Always a pleasure, and thank you, Tim, for all your good work.

Mary Long: As always, people on the 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. I'm Mary Long. Thanks for listening. We'll see you tomorrow, Fools.