In this mailbag episode of Rule Breaker Investing, David Gardner answers eight questions sent in from Foolish listeners.
Find out why David recommends Bank of Internet (BOFI 1.19%) and how he chooses whether to recommend controversial "battleground" stocks like it. He also discusses the best way for new investors to start building their portfolio, how to keep investing when you no longer have new money coming in, how to know when it's time to sell a loser and when to stick it through, what our "Best Buy Now" recommendation means and how he chooses when to post it, how he picks which of the companies he recommends to add to his portfolio -- and why he can't buy into all of them. All that and more in this edition.
A full transcript follows the video.
This video was recorded on June 27, 2017.
David Gardner: And welcome back to Rule Breaker Investing. I hope you've enjoyed the month of June. I certainly have. It's been fun having some summer interns here at the Fool. That always gives us a little additional vitality. I've also tried to bring some extra fun to this podcast, whether it was Zack Kanter earlier in the month or stock picks most recently last week.
I'm enjoying, already, some of the volatility that comes with the stock market. I'm taping this on Tuesday, June 27. Some of my highfliers from last week are selling off today, back to about the point they took off from last week.
So it's Mailbag. It's the last week of June. The last Wednesday of every month is my opportunity to read what's on your mind and do my best to give you back what's on my mind. Talking about adding vitality, I love your questions and thank you again for submitting them via email at [email protected], or just tweeted out to @RBIPodcast on Twitter.
And as is our wont here on this podcast, I have received from my producer, Rick Engdahl, and our helper, Gaby Lapera -- who's been great helping out with social media with Rule Breaker Investing and some of our other podcasts -- I have received from Gaby and Rick an 18-page document that I have fully read through. Now, that isn't hundreds of questions, but it is a few dozen questions, and it's not easy, necessarily, to figure out how to curate it from one month to the next, but I do my best. I have eight to cover this week. Let's get started.
Mailbag Item No. 1. Mailbag Item No. 1 comes from Eddie Fisher. He's @eddiefisher on Twitter. Eddie writes, "Hey, I'm a new investor and I listen to your podcast every day." Now I'm going to assume -- I'm going to assume -- that Eddie refers to other Motley Fool podcasts, because so far, anyway, Rule Breaker Investing has not been a daily podcast. That said, maybe, Eddie, you're catching up on over two years' worth of content and you're just listening every single day. If that's true, God bless you.
Anyway, you go on and say, "I had a question about building my portfolio. I have a handful of stocks and ETFs that I'd like to have in my portfolio, but I'm not sure what's the best way to build it up. Right now I invest 20% of every paycheck into the market."
Got to pause right there. That is awesome! Well done, Eddie. Not a lot of people can necessarily do that. We're all coming at it from different stages. Different places in our lives. What we've often said at The Motley Fool is if you can save 10% of your paycheck, that's a great goal for a lot of people. When I see 20%, that just gives me a big smile on my face. "Well done, thou good and faithful fool!"
Now, you go on to say, "Do you think it would be best to build each stock up to a certain amount one by one? Buy a few shares of each? Build up once I've established a base? Or just make the best value pick every week?" You close by saying that you've been buying ATVI -- that's Activision Blizzard -- lately, "but I realized it's almost 50% of my portfolio, so I'd like to diversify. So I guess my main question is what's the best way to build your portfolio from the ground up? Great show. You've really gotten me to love the idea and practice of investing at just 23. Thanks."
Well, when I first saw that you had 50% of your portfolio in one stock, Eddie, I thought, "He's not listening to my podcast, because we're always talking about the importance of diversification and Fools getting from zero to 15 stocks as quickly as possible."
However, as I went and read through your note, I can see you are young. You're starting out. You're in your early 20s and already saving 20% of your paycheck. That bodes so very well for you, sir. But I think the reason you have 50% in one stock is because you're just still building out the portfolio.
And, for example, if somebody had $2,000 and they decided they wanted to invest $1,000 per stock and they were going to get to $15,000 in the next couple of years, let's say, I would understand why of your $2,000, $1,000 of it might be in a single stock, because you're building toward a diversified portfolio.
And I think that's what you're doing, Eddie, so let me say this. As we build our portfolio, the No. 1 goal for us, as Fools -- and for you, as people who listen and follow what we do -- is, as I said, to get from zero to 15 stocks, or ETFs, or mutual funds, I like 15 different things as quickly as possible.
Now if you're using an app like Robinhood, or ShareBuilder, or other things that allow you to buy fractional shares, that makes it quite easy, even with small amounts of money, to get from zero to 15 stocks quickly. However, if you're not, I have a Schwab account, for example, or maybe you have an account at Bank of America or TD Ameritrade. If you have more commissions to pay, then probably you want to do it one stock at a time and build it up over time. But zero to 15.
And then really the question is what do you do when you have an extra thousand dollars after that? And from my standpoint, it comes down to one of two situations. Either you love this stuff and you have more stock ideas, and they just keep coming in. You're a kid in a candy shop and there you are. More jelly beans. A new flavor. Go ahead and add a 16th stock.
On the other hand, if you're somebody who's like, "That's enough for me! I only have so much time in my day for investing," then add to existing positions, typically adding to the ones that are winning and doing well if you're following my style of Rule Breaker Investing.
Anyway, so that's how I think about building a portfolio from the ground up. Eddie, congratulations to you that you're even doing it, that you're doing it at such a young age, and that you're putting away so much. Congratulations!
Mailbag Item No. 2. Mailbag Item No. 2 kind of follows naturally along from Eddie's note. This is from Mike Curcio in Apex, N.C. Mike writes, "Hi, David. I just joined Rule Breakers and I'm so excited to be a part of your team." Well, we're delighted to have you, Mike, and that's a great way of thinking of it, because we are a team. We're a community. In fact, each of The Motley Fool's premium services has community discussion boards where we get to know each other and ask questions much like the one you're asking here on Mailbag.
Anyway, you go on to say, "I bought Momo" -- that's ticker symbol MOMO, and it's also a company named Momo -- "after I saw your pick, and I studied the income statement and balance sheet. Stellar company. My question is this. In your personal portfolio, do you still buy mutual funds, too, or are you 100% individual stocks? Thanks, and Fool on!" Mike Curcio, Apex, N.C. I've got to include his postscript here. "P.S.: I also graduated from the University of North Carolina, Class of 1992, with a master's of accounting." So a little bit of Tar Heel love there. Virtual high-five to you, sir.
Well, Mike, you've asked some about how I invest, and generally what you're seeing me do within our services is what I do in real life. So I typically invest in the companies I'm recommending. In fact, we have another Mailbag item a little later where I'll speak more to that. But I'm keeping my money in stocks. That's what I recommend in Stock Advisor and Rule Breakers.
And indeed, that's the way I've been invested ever since I got my own account. This is a story I've told in past Rule Breaker Investing podcasts, but I know we have a lot of new listeners. The short form is that at the age of 18, each of the Gardner kids in my family got sat down by our dad and handed a portfolio that he had invested for us from birth.
So for 18 years he had been building these portfolios, and he handed it off to us at the age of 18 having taught us about the stock market as kids, and he said, "Here you go! This is all you're ever getting from me, because anything I have left when I die" -- and fortunately he hasn't yet -- "anything I have left when I die will go to your kids, so I hope I've taught you well. Don't screw up."
He's a great dad, and he gave us a real leg up. And in fact, as I've talked about in the past, that capital is ultimately why we were able to start The Motley Fool. So if you enjoy anything about The Motley Fool -- and presumably you do if you're listening to this podcast -- then we have our dad to thank for making it possible.
Now, in that portfolio I took over when I was 18 were zero mutual funds. In fact, in my head, when I turned 18 -- which was the year 1984 -- the mutual fund industry wasn't that big a thing. Certainly things like Fidelity, Magellan, and Peter Lynch's management were evident, and index funds were starting to come along, and it isn't as if it was a brand new industry, but it wasn't nearly the mega-industry that managed funds and ETFs globally are today.
I was raised without any awareness of what a mutual fund was. It didn't even occur to me to think that I would give my money over to a manager and let him or her pick stocks for me, because I was inheriting a portfolio of stocks. I had been trained to think about stocks. I did things like you did, Mike. I read the income statement and the balance sheet, whether it was for Momo or Microsoft. I felt comfortable, even as an English major, dipping into the financial statements. It's pretty simple math once you get the terms down, and I know a lot of you already know this.
So for me, I've never had mutual funds my entire life, with one exception. Here at The Motley Fool we have a 401(k) plan, and the few generic choices that we have, or at least that traditionally we've had over a long time, are funds, and I just went with the index fund. So my 401(k) is invested in just an index fund. But the portfolios that I manage for my kids and all outside that are all full of stocks, and I just have no interest in buying mutual funds.
So did I answer your question, Mike? I think I may have over-answered your question, but that's how I roll. Thanks for asking.
Mailbag Item No. 3. This one comes from James Chen, the CTO of Derivatas, LLC. Good luck, sir. All right, here it is. "Hi, David. It's been a while since I wrote in. This month marks one year since I've been investing in a Foolish way, so I thought it would be great to check in again.
"I just listened to your latest podcast on market drops, and what an appropriate message that was. I must say when I first started a year ago I was a little hesitant. At the time I had a significant amount of savings in a term deposit account earning 3% to 4% interest. I remember thinking how stupid I would feel if the market immediately crashes after I got in. After all, I felt like I've missed that great bull run. There was no shortage of Wall Street pundits predicting imminent doom. Looking back, I'm so glad that I did not give in to fear. Sure enough, right after I went all in around Brexit, the market dropped by another 2% to 3%, and my largest position at the time, SolarCity, plummeted by 20% to 30% in the weeks that followed, but I held on. Now, one year later, even with the recent sell-off, my portfolio of 15 to 20 stocks" -- there's the magic number, 15! -- "15 to 20 stocks have thoroughly crushed the market by about two and a half times, even with the market having performed so well already, including one three-bagger, two two-baggers, and a worse-performing stock that returned a 'pathetic,'" in quotes, "9% return."
Well, James, you and I know we're living charmed lives when we can look back over one year and think that. That doesn't happen very often, but it was a great year to get started. Congratulations. Anyway, you keep going.
"I think you and The Motley Fool deserve a lot of credit, since I've been heavily influenced by your podcasts, etc. Speaking of stocks that crash, I'm very curious about your thought process for recommending a stock like Bank of Internet" -- BOFI, BofI. "In full disclosure, I own BOFI myself, and I've seen it go from a high of $32 a share down to $22 a share in a matter of weeks recently. It's got to be one of the most polarizing and controversial stocks out there. People either think it's ridiculously undervalued or that it's a fraud and it's going to zero. Now it's one thing to own the stock because you see substantial upside, but I feel like it takes a lot more conviction to actually recommend a stock like this, especially given how prominent you are in the Fool community. You've done this multiple times in Rule Breakers. The first time in 2012, before the short attacks began. Then twice last year, etc." I won't read the whole note, but thank you, James.
You're basically asking about Bank of Internet, and I'm going to speak to it briefly, but I'm going to speak more broadly to what I take you to be asking about on a deeper level. So Bank of Internet is one of those Rule Breakers. Yup, we've had it for five years. It's been a winner for Motley Fool Rule Breakers.
But a couple of years ago, it got the attention of people who like to short stocks, and specifically people who, in addition to shorting stocks, will start to write articles, or dig up negative information and publish it in popular venues and create a sense that there's something deeply wrong with the company. And it's happened to Bank of Internet. It's happened to a lot of different companies. It could happen to our next pick, whatever it is, or yours next month. You're never quite sure when this might happen.
Now, Bank of Internet is a little bit more vulnerable to these kinds of things, because it is more opaque as a business. It's a lot harder to dig up negative info and cause people to ask tough questions about something like Starbucks, let's say, or Apple, because these are consumer experiences that you and I have and know.
But when you are not as in touch with something like Bank of Internet and its complicated financial statements -- it's a smaller-cap bank -- these kinds of companies are often more vulnerable to short attacks. And also, smaller companies always will be, because if you're looking to drive a price down with propaganda or good information -- if you're looking to drive a price down -- it would be a lot easier if you're trying to manipulate a stock by finding smaller companies. And that's why short attacks will usually target smaller, lesser-known companies.
Anyway, more broadly here's how I think of Bank of Internet. It's become what I think of as a battleground stock. As you said, James, some people are thinking it's a fraud. Other people are thinking it's so crazy undervalued. From our standpoint, this is a long-term holding and one that we're going to continue to maintain.
My attitude toward battleground stocks comes with two steps. The first step is I don't even want to fight a battle. I'm not going to go in there and start attacking the shorts back. In fact, once a stock takes on too much attention from other people, I'll usually start looking elsewhere for my next idea. So Step No. 1 is largely to ignore what's happening and find and talk about other stocks.
Step No. 2, though, is if this is a longer-term holding, or one that I'm confident in -- and that is true of Bank of Internet -- occasionally I'll go back and I'll re-recommend that stock, or you'll see it pop up in our Best Buys Now for Rule Breakers or Stock Advisor. It doesn't mean that I'm going into the fray or trying to make a big point of it, and I've certainly not overstated the case for Bank of Internet. I don't think I've over-re-recommended it. But I want you to know that yes, from time to time, we just go through our normal process of deciding what stocks we like for our Best Buys Now and a company like that might pop back up.
Again, I'm not intending any brave or bold stance or any big words. In the end, for me a lot of investing is like a lot of life. It's about probabilities and possibilities. Never, for me, is it about surety. So maybe the shorts are right and, if that's the case, I'm glad I have a diversified portfolio. But probably the shorts are wrong, and usually in my experience, because we've seen these over the years, there will be a lot of heat, a lot of heat, for a couple of years, and then it will all disappear as they move on to their next stock and the next act. And we keep holding and do pretty well holding all the way through.
Anyway, thanks for that question, James. I think I spoke to it maybe from three different angles, but I hope something there was useful to anybody listening. And yes, Bank of Internet is a stock that I own personally as well.
Mailbag Item No. 4. This one comes from Andy Wohlfarth writing in. Andy writes, "David, I've been a listener to all Fool podcasts for a while and also enjoy the Stock Advisor and Rule Breakers services. I just have a quick question about how the Fool picks its Best Buys Now each month, both for Stock Advisor and Rule Breakers.
"When a Best Buy Now stock is announced, is that a stock you've picked the day before, the week before, or is there simply no hard and fast timing to when it's actually picked to be a Best Buy Now? The reason I ask," he concludes, "is you most recently recommended NVIDIA (NVDA +2.59%) as a Best Buy Now, and the moment you recommended it, the stock dropped over $10 a share, making it an even better time to buy. Please tell me you're clairvoyant." Signed, Andy.
Well, first of all, Andy, it was certainly not by design that that stock dropped $10 after I called it in, and I hope if you did buy it as a Best Buy Now that you waited until just after that $10 drop. And if so, you, sir, are the clairvoyant one.
But let me tell you just briefly. I'll peel back the curtain and explain a little bit about our Best Buys Now. I know we have a lot of Stock Advisor and Rule Breakers members listening. You might not know how we do it, and you might be interested in the process.
So I have a team of talented, in-house analysts and talented remote staffers spread around the country -- sometimes the world -- all of whom have demonstrated, to my satisfaction, their ability to be right more often than not when it comes to picking stocks. And how would I know that?
Well, how about CAPS? I know a lot of you are Motley Fool CAPS fans. There's a transparent platform that we have that you and I can go on and pick stocks and show the world what we think and then be scored for how we do. And so using that platform, as I do, I simply troll the platform for great talent. People who get it right more often than not -- measured in years, not days or weeks -- and those are the people that we get to know, and they're on my Best Buy Now team. So they vote each month for what they think is a good Best Buy Now. And whenever we say Best Buy Now, what we mean is we like it now over the next three to five years.
There's sometimes confusion where sometimes people think if we say it's a Best Buy Now that means right now we think it's going to go up. But as you just proved, Andy, sometimes they go down right after we say it, by $10, and if you're long-term-minded, you're right. That was a better bargain than the day that pick came out.
Anyway, so the votes come in to me. I built this process myself, I've handpicked the teams, and then I look over the votes and then I decide whether I agree with them or not, and ultimately I handpick and curate the list of Best Buys Now on my side of Stock Advisor and for Motley Fool Rule Breakers.
And to close my answer, I'll do that process usually about three days before they're published. Now, depending on your viewpoint, you might either think, "Wow, that's pretty close to publishing, and since it's a long-term pick, that sounds pretty appropriate." Or you might have a different viewpoint. "Wow, you guys pick them three days before, and then three days later, regardless of what's happened to the market, they come out as Best Buys Now? That sounds irresponsible."
Depending on your viewpoint, I don't know what you think of three days. For me, I don't think twice about it. I often would be comfortable calling my Best Buys for next month right now. In other words, I think three-plus years for it. I think that way and I invest that way, and that's what we do with those Best Buys Now, and certainly with our new picks in our services. So that's a little bit about how Best Buys Now works, and I hope that made sense. Thanks, Andy. Good luck with NVIDIA.
Mailbag Item No. 5. And this one comes from Australia. This is from Craig Edwards, who lives in Sydney. By the way, I did get to visit your country for the first time last summer. I had a wonderful time. I think I've talked about that a little bit on this podcast.
But the talk that I got to give to about 800 members visiting from different places around Australia -- all for a Motley Fool member event, which is a great memory for me now -- I was tapping into that national phrase that you've exported to the rest of the world: "No worries. No worries, mate!" And I love the phrase, no worries, as an investor, because truly it's that attitude toward the markets and toward long-term thinking. "No worries! Buy great companies." And that was my theme of that talk that night. Craig, I think you get that.
But on to your two questions, both short. The first one is you said, "I noticed you don't own all the stocks you recommend. Does this mean you don't have as much confidence in these companies, or is it simply because you're largely fully invested, tend to hold long term, and therefore don't always have cash available to invest? For example, you don't appear to own Veeva Systems or The Trade Desk, which look like terrific businesses.
To answer Question No. 1 directly, Craig, you're right. I do not own all the stocks that I recommend. I think I oversee about 55 stocks in my family portfolios. There's several different accounts for my kids. And if you're a Supernova member, you'll know that we have about 210 stocks under active recommendation, all of which I picked over the last 15 or so years. So it seems like I'm adding about one in four of them.
Do I always get the best one-quarter? No. I love Veeva Systems and The Trade Desk. I don't own either one, you're right. Back in the day, Marvel was one of my great picks. I certainly didn't buy it right away when I picked it. Otherwise I would be a richer and happier man today. I do own some of my biggest winners -- Netflix and Priceline are good examples -- but there's no particular rhyme, or reason, or magic to which ones I select.
And you're right. More often than not, for me it comes down, I save over the course of a year and only a couple of times in the year do I actually transact. In fact, it's very hard for me to trade. Here at The Motley Fool, like a lot of our analysts, we have self-governing rules where you can't trade on either side of saying something on a podcast, let's say, or publishing something in Rule Breakers by several days.
When you actually do the math for someone like me, where I'm broadcasting on a podcast every single week, and I'm picking stocks in multiple services, and I have Best Buys Now coming out at other times of the month, there are not many times that I actually can buy stocks. It's really not particularly purposeful the times that I choose to invest nor what companies I have cash available for at the time. That's just how it's been for 15-plus years or actually 24 years or so, which is how old The Motley Fool is, and that's how I roll.
So yes, we do show our portfolio picks. Every Motley Fool employee on his or her public profile has the ticker symbols of what we own, so you could see that for me or for anybody else. But I always counsel people not to look into that too hard. For one thing, some of my kids pick the stocks for their portfolios that are there in my profile, so do you really want to follow my kids? Well, maybe you do.
And for another thing, you should know that my reputation -- and really The Motley Fool's business -- is based on succeeding for you, so the stocks that I pick for Stock Advisor and Rule Breakers matter a lot more to me than my silly family portfolios, because really the value of our business and the sum total of work that we do in this world is measured by how our members do, and whether you like The Trade Desk or Veeva Systems. And I hope you do, because they've been wonderful winners for Rule Breakers, even though I didn't happen to own those.
Question No. 2, you said, "Thanks to you I've been progressively moving my portfolio into Rule Breakers stocks and ones of interest in the Supernova universe." Craig goes on, with his Australian accent that I won't fake, "However, once this rotation is complete, it will become more difficult to buy new Rule Breakers stocks due to cash constraints if I hold the other great businesses long term. How do you approach this problem?" he asks.
Well, for me, I am still in the active earning stage of my life here at the age of 51. Perhaps you, sir, as a managing director of a business in Australia, are as well. So I just use the cash that I save over the course of a year to add to my portfolios. I typically stay fully invested at all times, so I don't keep a big cash cushion. It's just kind of what I've managed to scrape together since I last had a window where I could by some stocks.
So for those of us who still have salary money coming in -- and I know I'm speaking to a lot of Fools right there -- I just use that to throw toward new stocks that we pick. But for others of us -- and I know I'm speaking to a lot of you as well -- you are at or near retirement and you don't have as ready access to new funds to add to a portfolio, so you wonder, if I come out with a great new Rule Breaker in 2018 that sounds exciting, what do you do?
Well, that's why we created the Phoenix missions -- the portfolios in Supernova labeled Phoenix -- because we're focused with those portfolios on a fixed nest egg and those portfolios go into distribution and simulate, for the people following those missions and for many Fools, what it's like to invest when you have no new money coming in.
So I would encourage you, because it sounds like you are a Supernova member, Craig -- you mentioned the Supernova universe -- I would encourage you to take a look at those. Phoenix 1 started about four years ago, and Phoenix 2 started about one year ago. I'd encourage you to look at those and see how we manage those. In fact, we're even selling down those portfolios, simulating somebody living off those funds. So we make the tough decisions with a fixed amount of money.
Now I realize not everybody's in Supernova, and it's not a service that stays open all year long, so keep your eyes peeled for when we'll next open up Supernova if this sounds interesting to you. That will be within the next few months.
Mailbag Item No. 6. And here we start to introduce a little bit of whimsy, and that's thanks to Bill Housley who's written into this podcast from time to time. Bill, I love this one. You start with "David, are you up for a puzzle that will challenge your wits?" And I'll extend this to all of our listeners. So dear listener, are you up for a puzzle that will challenge your wits? Here's how Bill puts it.
"If a ship sets sail from Athens on a five-year journey, and along the way each and every board of the ship is replaced one at a time, upon arriving back in Athens five years later is the ship the same ship that departed, or is it a different ship? After you and your listeners have chewed on this for a while, read on for the real investing question below," which I'll now share.
"The ship known as the S&P 500," Bill says, "will occasionally replace its holdings. Is the S&P 500 of 2017 the same as the S&P 500 of 1960?" Signed, Bill, with a postscript: "Through the ages, great minds have wrestled with this paradox, including Plato and John Locke."
Well, far be it from me, or any of us listening, to attempt to answer definitively something that no doubt has puzzled Plato, John Locke, and many others. I'll take a crack at it, though, and I hope you are at home.
My answer is it's the same ship. Now, let's explore this a little bit. To take a similar analogy, when you put your foot in a river and then you put your foot in that river the next day, is it the same river or not? Because after all, the water's been fully replaced, so you're touching something that is brand new.
But think about that river, think about the ship, think about the S&P 500 and ask, what is its function or meaning? What is its purpose in relation to you? So when I look at a river, regardless of whether we dip our foot in today, next week, or 10 years from now, the river is still in the same place doing mostly the same thing. And whether a ship has had its boards replaced, it's probably still making that five-year round trip to Athens. And the S&P 500, whether it's in 1960 or 57 years later with a lot of new companies, to me it's still the S&P 500.
And here's what I mean by that. It functions as 500 of the largest companies in America, and regardless of the year, we use that as a good gauge, a proxy, for how the market does. So when you ask me "How did the stock market do last year?" I'll look at the S&P 500. I'm looking at it right now. The stock market, the S&P 500, was up 9.5% last year. Now the Dow, by the way, was up 13% last year and the Nasdaq was up 7.5%, and those can also be proxies for the market or groups of stocks. But the S&P 500, whether we're talking about 2017 or 1960, to me still fulfills the same function. It's still the same river, or the same boat.
And I'll close by saying I realize that even the mix of industries or what the companies do are fundamentally different. For example, computers. The internet. These things have showed up since 1960 in a much bigger way. So it's always a different and changing world. But Bill, I hope I've done a decent job helping us think through a question for the ages. And I'll just say back to you and any listener, if you have an alternative viewpoint, well, that's why we have July's Mailbag. So feel free to write it up and let me know how I got this one wrong.
Mailbag Items No. 7 and 8. And now Mailbag Items No. 7 and 8, and yes, I'm going to combine these and give a single answer, because they're each touching a different side of the same coin.
No. 7 is Jeremy Mittler, @Mitty81 on Twitter. Jeremy, you wrote, "I have a question for the Mailbag. I'm a longtime follower of the Fool. A subscriber for a bit more than a year. While overall I've done quite well in that time, I do have a couple of positions that are down around 50% in that time. I'm taking a Foolish approach to one of them, as the story is great and I'm happy to hold for years to come, but I'm not as confident in the other position. While I think the story is somewhat unchanged from when I purchased it, I think there's a very long road ahead and I likely made a mistake in making my initial purchase. My question is, when it is time to sell out of a position and invest in something else?"
And combining that with Mailbag Item No. 8. This one is from @ProfRooney on Twitter. Tom, you wrote, "David, question for a future podcast. I know you like to add to your winners. It's one of the lessons I've taken to heart, but what are your thoughts on adding to beaten-down stocks? I'm thinking of KMI. That was a Best Buy Now in Stock Advisor in June. The thesis remains intact, but many of those of us invested in KMI have a basis above the current price." That means it's a loser for you. "To the point, do you have any rules about when you might add to the losers in your portfolio? Best wishes, Tom."
So Jeremy and Tom, I take both of your questions to be how we handle a loser. Do we sell it? Do we add to it?
For me, there are two primary indicators you need to look at when making this decision. The first one is about the financial strength and resilience of the company. For that, I like to go to the balance sheet and look at how much cash a company has and how much debt a company has. If the company has a ton of cash and no debt, and they're down, I might well be thinking about adding to it if I still believe in the second litmus test, which I'll present in a second.
If, on the other hand, a company has not much cash and a lot of debt, or they seem stressed, I think they're probably not that resilient. I tend to think I will sell that loser. Certainly I will not add to it. Maybe I'll show it patience. So Litmus Test No. 1 -- the financial strength, the balance sheet.
Then Litmus Test No. 2 -- looking at the company. Which, by the way, I hope you've gotten to know. I hope that we study and become even fans of -- sometimes even fall in love with -- our stocks. I'm fine with that. It means you're studying it. You care about it. You're getting to know it better. Is that company -- forget about the stock -- is that company behaving in a way that you approve of?
Maybe it's doing what you expected it to when you bought it. Maybe it's selling coffee, or it's got a new semiconductor product. It's just gotten FDA approval. Maybe it's doing what you expected but the stock just happens to be not reacting well. I like those situations. It's doing what you thought it would. Stick with it.
Or maybe it's doing something entirely different, and by the way, that could be bad or good. If it's doing something entirely different -- falling all over itself or reporting bad numbers -- you can imagine I think you should sell that stock. Or sometimes companies surprise us because they do better than we expected, and that's a great reason not to fear change but to look at it and ask, "Is this company doing better or worse than I initially thought?" So Litmus Test No. 2 is looking the company in the eye, as best as you can, and saying, "Do I still want to be married to this thing for the long term?"
And for us, more often than not, tie goes to yes, and you have to be proven out of believing in your companies. So you put those two litmus tests together -- the balance-sheet test, and we'll call it the "eye" test, and you can imagine that if you pass with both of them I'm comfortable considering adding to that. Usually I'll still look to another winner to add to that, instead, but I feel comfortable with that. And if either or both of those tests fail, yeah, we try to sell those stocks.
And returning to Jeremy's note, Jeremy, you said, "I think there's a very long road ahead, and I likely made a mistake in making my initial purchase." So in situations like that, I think you need to listen to yourself. Ultimately you want to ask this of your portfolio: "Am I as well invested right now, going forward, as I can be?"
And that takes into account all of the stocks that are up for you, and all of the ones that are down. You just look at each one saying, "Is that the best idea I have? Is that how I want my money invested today?" Because all that matters is how your money is invested today going forward. So if you see a way to upgrade, by all means do it.
And that's our Mailbag for June 2017.
Now, next week I'll be introducing you to a new Rule Breaker friend of mine, a young woman who is a professional sprint-car race driver. She's also an entrepreneur and an investor in stocks. McKenna Haase will be my guest on next week's Fourth of July Rule Breaker Investing podcast. In the meantime, have a great week and Fool on!
As always, people on this 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. Learn more about Rule Breaker Investing at rbi.fool.com.
