Interview with David Gardner: Rule Breaker Investing

0:04Brian Richards:And I truly believe if there is a one-to-one between what is in your portfolio and what your hopes are for the world, not only will that feel much better, but you're going to do much better.

0:19David Gardner:That was Motley Fool co-founder David Gardner, author of the new book, Rule Breaker Investing, How to Pick the Best Stocks of the Future and Build Lasting Wealth. I'm Motley Fool producer Matt Greer. Now, my colleague Brian Richards heads up our Rule Breakers franchise here at The Motley Fool, and he recently had a chance to talk with David about the new book and about breaking the rules. David, welcome. It's great to have you here. Thank you, Brian. Great to be with you. David, I want to start by talking a little bit about the rule-breaking mindset. You've built your entire investment philosophy around, quote-unquote, breaking the rules, specifically challenging well-worn maxims like buy low and sell high.

1:02David Gardner:I'd be curious to hear a little bit about the pivotal moment or moments when you realized conventional investing wisdom was actually kind of holding investors back and how you decided to help people overcome decades of this ingrained financial thinking.

1:19Brian Richards:Well, I've always paid very close attention to language. Brian, I know you are also somebody who loves to read books. and maybe fellow English major. But I think that the language that we use is just so telling. Not only does it reveal kind of how we're thinking about things, but it often drives our actions. And so we have to be very careful with the language that we use. And buy low, sell high. It's somewhere in the 1990s, late 90s, it dawned on me, this is not actually a great phrase because the third word is sell. And so as soon as you've bought low and you hope you have, you're all of a sudden asked what your target price is.

1:54Brian Richards:And our people say, what is your sell discipline? And it becomes all about selling. And that really isn't the way to invest. The beauty of investing is that we are focused on finding great companies, buying portions of them, and then holding them for long periods of time. That's the way to rack up great returns. So I think it was the pressure of having people follow Tom and me with their own real money when we were there back on the America Online site. And then we're doing interviews and somewhere in there I was like, wait, buy low, sell high. That's actually horrible advice. Better advice is buy high and try not to sell.

2:30Brian Richards:A lot of people would go under what does he mean by buy high? The answer is feel free to overpay in the near term for great companies because they're almost always premium price. just like great products and services are usually premium price, so are great stocks. But that shouldn't dissuade you from taking early ownership in a company like Starbucks or Tesla or Netflix or Amazon. The list goes on. They're always going to look overvalued and people are always going to say, you're crazy, you rule breaker, you're crazy for buying those companies at those prices. And then we look back and say, actually, it wasn't so crazy to buy those prices.

3:05Brian Richards:So buy high and try not to sell.

3:08David Gardner:Some of the best lessons don't come from a classroom. They come from experience. On The Power of Advice, a new podcast series from Capital Group, you'll hear from CEOs, investors, and founders about how they built careers, took risks, and reinvented themselves. If you're starting your own journey, this is the kind of advice you won't want to miss. Available wherever you get your podcasts. Published by Capital Client Group, Inc. David, the book outlines your six habits of a Rule Breaker investor and your six portfolio principles for building a Rule Breaker portfolio. I want to talk about those momentarily, but first let's focus on the six traits of a Rule Breaker stock.

3:49David Gardner:This is something that you first developed back in the late 1990s. I know you've articulated it over the years in previous books and online, and it was the core of the Rule Breaker service. and your approach to investing. One of those traits, the first of those traits is being a top dog and first mover. Another one in an important emerging industry, I should add the second part of that phrase. Another one is that you look for something to have been called overvalued by the financial media, which is about as unconventional and rule-breakery as I think you might find. Can you walk us through this framework and maybe share an example of a company or maybe two that has checked these boxes either historically or in more recent times?

4:33David Gardner:Sure.

4:34Brian Richards:Well, first of all, yeah, the six traits of the Rule Breaker stock I first wrote about in our book, Rule Breakers, Rule Makers, 1999. And as I sat down to write my final stock market book, the one we're talking about, Rule Breaker Investing, one of the fun things to reflect on is I'm using the exact same six traits 27-ish years later, which is really remarkable because I think a lot of times you You might think, well, over 20 plus years, you probably have changed something. And so I love the first trait of the rule breaker stock, top dog and first mover in an important emerging industry. And when you're just focused on the companies in each industry, but not just any industry, the important emerging ones.

5:16Brian Richards:If you focus your stock market research and attention on those companies, that is a stocked pond where swim little fish that will get to be a lot bigger if you're right in the following 25 years. These will be the best stocks of any era, usually staying focused on the top dog and first mover in an important emerging industry. And Brian, you also mentioned trait number six, overvalued. And this is probably about as contrary and rule breakery as we get. And yet it works because, of course, everybody said that Amazon was so overvalued when we first recommended it in 1997 on our AOL site and the Fool.com worldwide website, which was brand new back in the day.

5:58Brian Richards:And most of the great companies, Tesla, 15 years ago, they'll never make money crazy overvalued. And that sounds bad initially until you start to realize if you're a rule breaker, that's actually a great indicator. Because if the other five traits are present, we won't go through them right now, but if the other five traits are present and the company's being called overvalued, that's kind of all you need to hear from my standpoint to start thinking, I should add some of this stock to my portfolio. You asked what are a couple examples. I would say a great example. This is a lesser known company, but Intuitive Surgical, which is basically a company in the Rule Breakers service that is converting all of the past surgery, human driven, human hands to minimally invasive robot assisted surgery.

6:45Brian Richards:And it's been doing that for 20 years. It's a company with there's no Pepsi to its Coke. It is a great example of a company that checked all six of those boxes. When I first recommended Intuitive Surgical, it was trading at 71 times earnings. And most people who get coached or taught investing are taught not to buy stocks that are trading at 71 times earnings. But it's now up more than 70. Actually, it's closer to 90 times in value from that point. And since that's happened enough times to me, Brian, I started to realize, you know, overvalued scares a lot of people away. But guess what happens?

7:19Brian Richards:They don't buy Amazon. They don't buy Nvidia. They don't buy Netflix. And then those companies do well. And slowly people start going, you know what? Actually, I am finding I'm starting to buy stuff off of Amazon. I think maybe this thing's for real. And that's the proverbial wall of worry that great stocks climb, where people who are skeptical, calling it overvalued, turn into converts, eventually buy the stock. And that's what powers generationally great stocks.

7:46David Gardner:I have no stake in the company, but I do know last month, The Economist published an article. The headline was Palantir might be the most overvalued firm of all time. And in the article, they go on to talk about how Palantir has a P-E ratio of over 600 times earnings. And I think in the dot-com era, Cisco and Oracle were something like 200 times earnings. So again, I have no stake in the company. As a follower of the Rule Breakers strategy, though, I got to be honest, it made me want to investigate Palantir because if I'm being a contrarian, it might be a good time to take a look when everyone else is not.

8:27Brian Richards:And I really love that example because it's just so near. It's so near and dear. And without bragging, I'll just say that I didn't get in really early on Palantir. And I give my wife, Margaret, a lot of credit because she started kicking the tires on this one a few years ago. But yeah, my Palantir is up 685 % in my own portfolio. So others who've been following it longer will have an even lower cost basis. But again, when we first purchased Palantir, which wasn't that long ago, I think it was the spring of 2024, it was already being called overvalued. But the thing is, we need to look at the companies more so than the stocks.

9:06Brian Richards:And we need to ask, who are the real movers and shakers? Who are the world shapers in our society today? What are the companies like Amazon, like NVIDIA, that are really going to effloresce and enable greatness and other whole industries to spawn and start because they were there doing their thing? Amazon, obviously, is a great example of that. And Netflix, the first in streaming. So these companies are, again, always going to look overvalued. And I think I want to add one more. If I'm allowed a 101 point, Brian, by that, I mean, when I took courses in college, they would be like, you know, anthropology 10.

9:46Brian Richards:And most of mine were double digits. But if we can go to triple digits briefly, I think there's an important point about overvalued and why it works. And the important point is that overvalued is only looking generally at earnings or cash flow. Most people are coached to do multiples off of those things. And they're not. And by the way, earnings are an output. Cash flow is an output. What they're not looking at are the inputs that lead to the outputs. And when you start looking at the inputs, for example, who is the CEO? Or can this company innovate? Or what about its corporate culture? Or one of my favorites, what about its brand?

10:28Brian Richards:These things are not captured on the financial statements. So most people are running numbers that only look at the outputs and early days for a company like Amazon earnings don't matter that much. And they're missing the inputs and they're not looking at what's happening in the world overall. Palantir has absolutely been a foremost practitioner of AI at scale. And it has been a phenomenal stock. And yes, it's been, Brian, it's been so overvalued all the way through.

10:56David Gardner:Perhaps the most overvalued firm of all time. That's quite a headline. I just want to stay on this thread for a quick second, David. You've told this story before about Yahoo in the 1990s. It seems like that is a kind of turning point for you in your investment journey. And Yahoo is one that you missed because you might have been more focused on the outputs and the earnings multiples and things like that. Can you talk a little bit about that Yahoo experience back in the 1990s? And also, how would you convey to an investor today who is hearing just the constant barrage of headlines, tweets, CNBC snippets, talking about how richly valued, how overvalued, how expensive everything is.

11:46David Gardner:I feel like the Schiller-CAPE ratio has been in historically overvalued territory for like 15 years, which makes it seem perhaps like it's missing the point. So anyway, just a little bit about the Yahoo story and then maybe how can somebody kind of rewire themselves to think differently?

12:05Brian Richards:Yeah, well, first of all, Yahoo was the greatest stock that I didn't pick in the early generations of the Motley Fool. I was pretty sure that Yahoo was a world beater and at that time it really was. It was the late 1990s. Before Google existed, most of us were using Yahoo to get around to surf the World Wide Web. And I just thought it was probably going to be a great company. And the stock was at 29. And I was very valuation focused more so than I am today. And so I ran the numbers because for a lot of people, investing is like a math exercise. So you sit there and you're running the numbers and you're like, this is the number that this stock should be trading at.

12:47Brian Richards:And I shall wait for it to get to that price. And I'd calculated Yahoo is worth 25 and a half. So it was at 29. And I was like, well, fine, I'm not going to recommend it because it should be at 25 and a half. I'll buy it. And for Motley Fool members, we'll recommend it at 25 and a half. And it never went to 25 and a half. It went to a thousand. And as I watched that stock go up more than 30 times in value in the succeeding five years, I decided, you know, there are a lot of people following Tom and me and our recommendations on our AOL site and our website, Stock Advisor. I need to get better.

13:21Brian Richards:I need to not do that again because the opportunity cost of missing a 30 bagger is huge versus picking a stock that loses 50 % of its value, which sounds really bad until you run the math and you realize that's almost irrelevant. And so, again, I think that for me is the iconic story of how I really started to become a rule breaker. And the question about the market today and it looks high, I just spend no time thinking about where the market is. I realize that a lot of people do. In fact, I did an interview last week with the USA Today reporter who was writing on this very topic. And he said, you know, I have to admit, he said, at the start of this year, that's what everybody was saying, too.

14:01Brian Richards:And the articles that we were writing were about how the market was high in 2025 wouldn't be a very good year for stocks. So this is just like a classic thing that happens over and over. And by the way, the market drops one year in three. Maybe 2026 will be a bad year for stocks. If it is, I'll be fully invested all the way through and investing more by dollar cost averaging into my favorite rule breakers throughout, just like you do every other year. Warren Buffett has a great line. It basically says he spends no time thinking about the macro picture or asking other people about their macro viewpoints.

14:36Brian Richards:I definitely quote that in my Rule Breaker Investing book because I love that it comes from Buffett.

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15:56David Gardner:I remember vividly you writing a pretty fun takedown of Segway, which was the sort of mobility company where mostly, I think, parking ticket folks would go around and save themselves from having to walk, I think. You called those faker breakers instead of rule breakers. They were faker breakers, companies that looked promising, but for whatever reason didn't pan out. Would be curious to hear the kind of flip side of the rule breaker six traits. What should investors look for when they're trying to distinguish genuine rule breaking companies and companies that have the facade of being a rule breaker.

16:38David Gardner:They just appear to be innovative.

16:40Brian Richards:Yeah, I really appreciate that question. I don't really spend too much time in this new book talking about faker breakers, but even in the 1999 Rule Breakers Rulemakers book, where I think I unveiled the neologism, faker breaker, I have enjoyed this over the years, because it is worth figuring out, is there a faker breaker in your portfolio? And for me, these are, as you said, Brian, companies that look like rule breakers. They might be getting a lot of publicity. They might be very innovative in some ways. But what ultimately causes them not to be great stocks? What ultimately causes us to look back and go, yeah, GoPro, I mean, amazing, but unfortunately not a great stock pick.

17:21Brian Richards:By the way, I made that stock pick. So it's not like I avoid picking faker breakers. So sometimes you can only see this in retrospect. But I think two factors are worth looking for when you're trying to suss out whether something's a rule breaker or a faker breaker. And the first is just the CEO of the company. Is this somebody that really seems like they are a five-tool athlete in baseball terms? Baseball players who can throw, run, hit for power, hit for average, and the fifth thing that I'm not thinking of by a field, those are my favorite CEOs. They're people who in business terms have a vision and then are able to actually translate that vision into a product or service and then actually scale that product or service to reach hundreds of thousands, if not millions of people.

18:11Brian Richards:And it takes a lot of emotional intelligence often. It takes a lot of daring do. There are real human traits that we're looking for in the great CEOs of the great companies. So when I don't feel like my CEO is a five tool athlete, maybe a great two tool athlete, like really can field and throw, unfortunately can't hit. That is something worth paying attention to. Obviously, you're partly just trying to judge character and you might even be trying to assess somebody who's an engineer and you're actually an English major. So do you have the skills necessary to do that? But I think it's the right question to ask.

18:44Brian Richards:So that's one thing. The other might be just often faker breakers aren't really reaching that many customers. It looks really cool and really innovative, but it's not really translating in the same way that Starbucks somehow managed to translate a chain of coffee stores globally when there was no previous American precedent for that. There was nothing that you could look at Starbucks when it came public in the early 1990s and go, yeah, well, they're just doing what blank did. So I think that, again, companies that have truly scaled become relevant. Those are rule breakers. Faker breakers may look really cool, but I'm not sure people are really using the product or ever will.

19:23Brian Richards:Google Glass is kind of another example of a faker breaker product. I realized that Meta is now trying to come out with AI intelligent glasses, and maybe one day this thing will happen, but Google Glass is a product, kind of a faker breaker product.

19:36David Gardner:David, final question for you. You've called this your final stock market book. Now, again, your attention to words means that each of those words has a meaning. It's your definitive statement on investing. I know you have been taking notes for this book for the better part of a decade. If someone could take away just one key insight from the book and all your years of experience and researching stocks and collecting companies, what would you want that to be?

20:03Brian Richards:There are two pages in the very back of the book. If anybody wants to buy the book, but just like Cliff's notes, just not even read the book and you just want a few things to remember. I've got two pages of just one liners there for you at the end. And one of them is basically the first habit of the rule breaker investor. And that's rule number one, let your winners run high. And I'm not going to try to soundbite 230 pages. By the way, a short book. That's also what I wanted to deliver is a short book. So I'm not going to try to soundbite it or say it's all about one line or one thing. But I would say if I could wave my magic wand and everybody would take that away, we would be such better investors.

20:44Brian Richards:Shout out to my brother, Tom, who has a great line we can close with. Tom said, you know, no matter how long you own any stock, whatever your average holding period is typically for you, double it and you'll probably do better. And that's another way of phrasing rule number one, let your winners run high. How many people have come and said, yeah, I had Tesla for a year or yeah, but I sold Apple back in the 80s. and you know if we had just treated it as a true investment not a trade an investment if we had not merely bought low waiting just to sell high but bought high bought great and kept holding the world would be an even happier place well thank you listeners the book is rule breaker investing

21:31David Gardner:how to pick the best stocks of the future and build lasting wealth but wait i do want to mention one more thing. David and I are supporting a team of portfolio managers who are relaunching The Motley Fool's Supernova service, a service that closed in 2021 with its portfolios averaging a 21.8 % annualized return across its nine years of existence. Supernova will be reopening in the next few days. You can go to supernovaisback.fool.com. Again, that's supernovaisback.fool.com for all the latest details and for more information on how to become a VIP for the event, including, I want to mention, how you can score a copy of Rule Breaker Investing that David has signed himself.