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The Motley Fool's Rule Breakers, Rule Makers: The Foolish Guide to Picking Stocks

The Motley Fool's Rule Breakers, Rule Makers: The Foolish Guide to Picking Stocks

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by David Gardner, Tom Gardner

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From the bestselling authors of The Motley Fool Investment Guide and its successful, savvy prequel, The Motley Fool's You Have More Than You Think, here's an engaging, humorous, and practical stock-picking guide, packed with Foolish insights, that caps off this invaluable personal finance trilogy from


From the bestselling authors of The Motley Fool Investment Guide and its successful, savvy prequel, The Motley Fool's You Have More Than You Think, here's an engaging, humorous, and practical stock-picking guide, packed with Foolish insights, that caps off this invaluable personal finance trilogy from David and Tom Gardner.
The Motley Fool's Rule Breakers, Rule Makers presents the sophisticated, yet easy-to-understand stock-picking methods that have kept the Motley Fool portfolio beating the Standard & Poor's averages by more than 30 percent. The key is investing in small start-up companies that have historically offered the greatest investment returns (the "rule breakers") as well as huge companies that maintain legal monopolies in their fields (the "rule makers"). The Gardner brothers explain
* How to identify the best investments in today's public markets: the rule breakers and the rule makers

• The definition of a "tweener" — a maturing rule breaker — and how to detect the Tweener Death Rattle

• When to buy and when to sell, and how to manage your portfolio on a regular basis
In their first two books, the Fools got you started in investing and freed you from the fees and worries that Wall Street's Wise Men have been imposing on investors for decades. Now, by sharing their methods for picking rule breakers and rule makers, they guide you through a stock market that has seen company valuations soar to unprecedented heights and that promises to continue providing roller-coaster thrills. The Motley Fools are the ultimate companions to bring along for a safe, fun, and profitable ride.

Editorial Reviews

Publishers Weekly - Publisher's Weekly
The sassy creators of the popular personal finance Web site and authors of the bestselling The Motley Fool Investment Guide (1997) now offer advice on how to evaluate the investment potential of specific companies. Here, the Gardners proffer five key principles by which to judge innovative "Rule Breaking" companies. Among them: "top dog-and-first-mover in an important emerging industry" (Whole Foods Market); "sustainable advantage due to business momentum, patent protection, visionary leadership, or inept competitors" (Wal-Mart, Amgen); and "smart management and good backing" (Intuit). Yet, while the Gardners tell readers not to pay attention to analysts' expectations and earnings statements, they proceed to break their own rules, explaining that, as companies get more profitable and grow into "Rule Makers," investors should look to more traditional measurements such as sales-to-debt ratios, growth, etc. The book is certainly more fun than most stock-picking manuals, and the insights into company management are amusing. In discussing the poor performance of Boston Chicken, the authors write, "Rather than being inept, Boston Market wound up playing chicken with companies whose managers were smarter and more experienced hands at this game." However, novice investors may find the advice more difficult to follow than previous Motley Fool books.

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Chapter 1

Rule Breakers Introduction: Evolution

I say the earth did shake when I was born.

— William Shakespeare, Henry IV, Part 1 (III, i)

As Charles Darwin did before him, the celebrated Harvard paleontologist Stephen Jay Gould has made much ado — has filled whole books, actually — about one of our society's common misconceptions regarding evolutionary theory. Namely, that many of us fallaciously view evolution as a process of continual improvement, as if our species — all species, in fact — were following a constant upward progression from less complex to more complex, from less intelligent to more intelligent, from weaker to stronger.

We tend to think this way because we all tend to place our own species (not without some cause, mind you) at the height of the "evolutionary pyramid." It is we, after all, who have developed selfconsciousness, who are capable of creating tools to build everything from fast cars to junk cereals, who have thought things through enough to touch the moon. And we're the latest thing, as species go, the most recent arrival to the party. (Humanity has only been on the planet for the last 45,000 years, meaning that our character's first appearance comes in the latest chapter, 100,000, of our planet's long-running drama.) Given all this, one can easily see how some might conclude that evolution must involve constant improvement: the most creative species of all has been the most recent development on planet Earth. Everything must have been a prelude to the Coming of Man.

Gould counters this fallacy by explaining that evolution doesn't necessarily entail something getting better and better, only that it is continuing to adapt successfully to changing environments. He would argue, for instance, that ff global environmental conditions suddenly made it advantageous to be stupid, only the stupid among us would survive and eventually propagate — that's just natural selection, the principle at the heart of the theory of evolution, at work. Of course, that's a silly example, but it's useful in distinguishing what is "true evolution" from what isn't. Natural selection simply causes species to evolve in a way that best suits their given environment; it does not by definition result in species that are inherently and progressively "smarter," faster, stronger.

If you're wondering just what the heck this has to do with a business-and-investing book, wonder no more. Consider this: Natural selection, the crucial driving force of organic evolution, is the cleanest metaphor I can think of for what drives success in business — and success is of utmost interest to business managers and long-term investors alike.

In the context of this book, the things being naturally selected are not advantageous genetic traits, but, rather, the advantageous characteristics of a business model or strategic plan, as well as those of a particular workforce capable of dreaming up such plans and executing them. The agents of natural selection in business are not, of course, environmental conditions, but customers and their needs. It is customers who naturally select businesses, and thereby cause industries and economies to evolve over time. Some companies will win and some will lose, and what separates the one group from the other will be its ability to adapt to the needs of customers in changing consumer and marketplace environments. If you understand this, you're already well on the way toward understanding what a Rule Breaker is.

Before progressing, let's make this really clear:

organic evolution = business evolution

competing species = competing businesses

natural environment = marketplace environment

natural selection = customer selection

OK, with that said, know that the evolution of the business world has fixed a number of rules that have become so ingrained as part of the status quo that many of us take them for granted. Do these examples feel like rules to you? They do to me:

* Typewriters will never come back to displace computers.

* By virtue of their sheer global dominance, Coca-Cola and PepsiCo cannot be dislodged as the number-one and number-two market leaders in soft drinks.

* What worked yesterday in fashion will be flouted today but could emerge tomorrow as the Next Big Thing.

* Home-cooked meals are yielding to eating out, takeout, and delivery.

* With its superior technology and near monopoly, Intel cannot be dislodged as the market leader in microprocessors.

These truisms and many others form the "rules" of our time; they define the way our world works, the way things are — the way that business has evolved. Most businesses did not have a part in creating this status quo, but they probably still benefit from it, as in some cases they work to supply the beneficiaries (the Rule Makers), or, in most cases, at least buy from them.

But the only constant, as we've heard again and again, is change. And thus the changing needs of customers change the business environment and create opportunity. Indeed, it is when established industries fail to evolve that opportunities arise for the Rule Breakers.

So let's make like Scrooge and spend some time gazing back at the rules of Business World Past. Do these sound familiar?

* Ma Bell telephony provides consumers with the cheapest, most efficient way to exchange information when not face-to-face.

* World markets are best understood by matching them with their political alignments; economies are NATO-aligned, Soviet-aligned, or other.

* Superstores are the natural, most profitable, and emphatic endpoint to retail, the final stop in a progression that ran from mom-and-pop to boutique and on through mall.

* The bubonic plague is incurable.

At one or another point in history, each of these was a rule every bit as unwavering as our previous set of examples. Yet now, they are all in tatters. This list could go on and on, too: the horse-and-buggy — hello, Ford the candle — hello, Edison the iceman came, then — hello, refrigerators! — the iceman went!

How does this happen? Remember the fallacy that Stephen Jay Gould points out in our ideas about evolution: most of these companies or industries are guilty of it. Once-successful companies that ultimately became unsuccessful believed in and focused on constantly improving, rather than adapting. Their research and development money went to upgrade their existing products and their marketing money was spent on promoting these products; they were always looking to cut costs, and their competitive research was confined to the study of industry players who were playing the same game by the same set of rules. Companies like this are doing all the right things, but it may be the beginning of the end.

For in such circumstances, the original business solution that brought a company into being in the first place may suddenly be lost. But whether due to myopia, arrogance, fear, or sheer inertia — or a combination of these — the company's in too deep and can't turn back. Time for some competitor, some naughty entrepreneur, to come in and kick down the doors, and the one thing you can say for sure about capitalism is that this is exactly what will happen: someone's going to start breaking all the rules.

As an investor, you want your money riding on that entrepreneur. As a businessman, you should aspire to be that entrepreneur. (And as citizens and customers, we will all benefit hugely due to that entrepreneur.)

This part of the book attempts to define, locate, and illustrate what sets these Rule Breakers apart. Each of the following half-dozen chapters will introduce and examine one of the Rule Breaker's attributes, all six of which must be present in any true Rule Breaker.

Why Rule Breakers? Why bother reading on? Two reasons:

First, Rule Breakers provide investors with the most dynamically high returns achievable on the public markets — period. Inspiration enough? OK, if not, consider this (we're thinkin' T-shirt here): Rule breaking investors have more fun. (It's true!)

Second, Rule Breakers provide inspiration and guidance to all business people, be they managers, planners, or executors. Rule-breaking is capitalism's special sauce, its tastiest and most necessary condiment. So, let's spend some time together eating like gourmands and studying like chefs.

Then, be the sauce.

Copyright © 1999 by The Motley Fool, Inc.

Meet the Author

David Gardner graduated as a Morehead Scholar from the University of North Carolina at Chapel Hill. He was a writer for Louis Rukeyser’s Wall Street newsletter before he and his brother, Tom, stared the Motley Fool in 1993. They both live in Alexandria, Virginia.

Thomas Gardner graduated from Brown University with honors in English and Creative Writing.

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The Motley Fool's Rule Breakers, Rule Makers: The Foolish Guide to Picking Stocks 3.7 out of 5 based on 0 ratings. 3 reviews.
Guest More than 1 year ago
Having been disappointed in the earlier investing books by the Gardners (You Have More Than You Think and The Motley Fool Investment Guide), I found Rule Breakers, Rule Makers to be a solid and satisfying investment book. That was a pleasant surprise. If you decide to read any of the books by the Gardners, I suggest this one. The book is a combination of a conceptual search for outstanding growth companies to buy stock in, along with a quantitative discipline to test your thinking. This is also unusual in investment books, 99 percent of which are qualitative only. The first half of the book focuses on Rule Breakers, newer companies that have successfully established a new business model that will emerge as the new standard in their space. The examples are pertinent and interesting to consider. The cases are turned into specific guidelines for you to consider in selecting stocks. In a time when new business models are created much more frequently than ever before, this is a superb focus for an investment book. I strongly suggest you read and focus on what is said here to select the companies. Generally, you will not be able to pick stocks that will outperform the market. See John Bogle's excellent book, Common Sense About Mutual Funds, to learn more about why. The only approach that I think has a chance is to locate business model innovators. My research into top performing stocks has shown this factor to be determinative for many of the best companies. The Rule Maker section looks at more mature companies that have such market power that they can create a successful future for themselves. The main benefit is that it may be easier to sleep with a portfolio full of these stocks because they are typically not as volatile and as high priced as Rule Breakers. I particularly liked the appendix where 12 companies (AOL, Cisco, Coca-Cola, Dell, Disney, Gap, Intel, Kmart, Microsoft, Nike, Pfizer, and Schering-Plough) are evaluated using the Gardners' methods. This makes it much easier to understand their concepts. People who love the usually flippant style of the Gardners may not love this book as much as I did. The book is more conservatively written and framed than the usual Motley Fool style. But where money is concerned, clarity should be selected over humor. I think the Gardners made the right decision. If you are interested in stocks that may well grow faster than the market, I suggest this book as a solid way to evaluate the potential candidates. The book compares well to other books that look at this same question, being more specific and helpful. I also suggest that you consider the thinking in ChangeWave Investing as a test on your ideas drawn from this book. Well done! Good luck in applying these concepts to an appropriately-sized part of your portfolio when you can buy outstanding companies cheaply!! We may be nearing such a moment later in 2001. Donald Mitchell, co-author of The Irresistible Growth Enterprise and The 2,000 Percent Solution
Anonymous More than 1 year ago
In a world where we need as much insight as possible...ideas of samll companies with big dreams and big companies with a steamroller product always catches my attention. This book takes a lot to get to a few points!...
Anonymous More than 1 year ago