Set a Fair Starting Line, as Favorites Can Falter

On Dec. 4, 2024, The Trade Desk (NASDAQ:TTD) touched $141.53. Our first Rule Breakers recommendation, made in February 2017 at a split-adjusted $3.43 a share, was up more than 40-fold.

On Aug. 18 this year, we issued a sell alert at $13.42. Same position, finishing up less than fourfold.

And Arista Networks (NYSE:ANET), a stock that spent a decade behind The Trade Desk, is now up more than 40-fold itself.

Nobody could have told you that in 2017. Nobody can tell you now. That's why we build portfolios the way we do at The Motley Fool.

Every horse gets a gate

Principle No. 3 of the six that co-founder and Chief Rule Breaker David Gardner sets out in Rule Breaker Investing is this: fair starting line. Every stock enters your portfolio at the same size, regardless of how sure you feel about it. David caps each opening position at 5%, which is what forces a field of at least 20.

Picture the Kentucky Derby: 20 horses, 20 stalls, every one the same distance from the finish. You know your favorites and your long shots. And as David writes, "some of your favorites will go lame, and some dark horses will surprise you."

The gate is the only moment you're honest about not knowing which is which.

How a favorite goes lame

The Trade Desk's pitch was clean for a decade, and it was correct. Advertisers that didn't want to hand their whole budget to Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) or Meta Platforms (NASDAQ:META) needed somewhere independent to buy from. The Trade Desk was that desk.

Then Amazon (NASDAQ:AMZN) built the same thing and priced it like a doorbuster. Amazon's platform takes 1% to 2% of what an advertiser spends. The Trade Desk takes 12% to 15%. Amazon's share of programmatic ad spending went from under a tenth to a fifth in 15 months, won on price. Three big agency holding companies pulled back within two months. Growth fell from 22% in late 2024 to 3% this summer.

The Trade Desk's advantage was its position -- the independent alternative to the walled gardens. That's a story, and stories don't hold a price.

On Sept. 4, the company disclosed it would cut about 15% of its staff, roughly 575 people. Team Rule Breakers analyst Anders Bylund, a shareholder himself, went looking for what a restructuring usually comes with and found none of it: no cost savings quantified, nobody replaced at the top, no management comment, just a bare filing. He called it "all the downsides of a sharp cost-cutting move but none of the upsides."

Then the dark horses overtook

In November 2014, Arista was months past its IPO, and its entire business was selling switches to companies that had always bought them from Cisco Systems (NASDAQ:CSCO). We recommended it in Rule Breakers. Then we added a second rec in May 2022, once the thesis was obvious to everyone -- the same late-conviction move that cost us most on The Trade Desk. The 2014 buy is up more than 40-fold, and 2022 added more than sevenfold.

Our late, comfortable, everybody-can-see-it Arista recommendation has returned roughly twice what our earliest Trade Desk rec ever did.

Advanced Micro Devices (NASDAQ:AMD) is a dark horse we never recommended at all. We picked Xilinx in March 2019, and AMD bought it outright in 2022. It's up nearly sevenfold.

Broadcom (NASDAQ:AVGO) is up roughly 30-fold, and it surprised us in a different way. Our April 2016 write-up called it a Top Dog worth running with, and we were right. But the reasons we listed were LTE networks, the Internet of Things, broadband, and storage. The artificial intelligence (AI) build-out that produced most of that return isn't in there anywhere.

Line them up. Arista past 40-fold, Broadcom near 30, AMD nearly seven, The Trade Desk retired at under four. The favorite finished last.

Losing to win

Principle No. 4 picks up where the gate leaves off. You give your stocks a fair starting line, then wake on day two to find they aren't even any longer -- and David is emphatic that they shouldn't be. Your horses separate. Now you know which is which.

Conventional wisdom says rebalance, trimming what works to top up what doesn't, which David points out is backward: It means backing your also-rans and retiring your thoroughbreds.

Adding to Arista in 2022 was backing a thoroughbred. Selling The Trade Desk was retiring an also-ran. That alert went out 17 days before the restructuring landed. Neither was available to anyone who had loaded up on a favorite.

The investment thesis for The Trade Desk changed, and it cost us a position rather than a portfolio. That's what a fair starting line buys you: the freedom to not have your faith rewarded cheaply, while the horses you couldn't pick out in 2018 run away with the race.

So, give every horse the same gate. Then act on what you see:

Back your thoroughbreds and retire your also-rans.

The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Arista Networks, Broadcom, Cisco Systems, Meta Platforms, and The Trade Desk. The Motley Fool has a disclosure policy.