What David Gardner Learned by Trolling for Smaller Fish in Big Ponds

By Markets Fool.com

In this segment of theRule Breaker Investingpodcast, Motley Fool co-founder David Gardner goes back to the very beginning of his investing days, when he was just a young man.One he bought into was a machine vision company that was off the Street's radar, but the style of investing that got him into it was this: Looking for the third or fourth ranked player in a closed, niche industry, that was less widely known to analysts. Question is, how clever is that technique?

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A transcript follows the video.

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This podcast was recorded on Sept. 21, 2016.

David Gardner:

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OK. Early investment number five was Cognex. Now, the reason I'm highlighting this one is because Cognex is a going concern today. It has been a fine public company for a couple of decades, and I'm happy to say it's a winning Motley Fool Stock Advisor pick. I recommended it multiple times and I think it's served our membership really well. So I'm excited about the company going forward from 2016, but right now we're dipping back into the early 1990s.

At the time, there was a stock market service, a stock-picking newsletter much like we run today at The Motley Fool, and it was a special situations letter. It was run by a guy named Walter Ramsley, who was very influential for aspects of my investment development back in my mid-twenties.

So Walter today, I believe, works at Walrus [Partners], if I'm Googling him properly in Minneapolis, Minnesota. But back then he ran his own special situations service. Walter had been an analyst, I believe, at Value Line, the aforementioned Value Line, and he was focused primarily on companies that were off Wall Street's radar. And this was highly attractive to me at the time, and Cognex was a good, winning example.

Now part of the reason I eventually shifted from this strategy is because I didn't find that I won quite enough with this approach, but I'm highlighting Cognex because the machine-vision company, which today is using its machine vision in very high-speed manufacturing lines to identify defects in microscopic semiconductors at high speeds -- that company, if you take the tech and roll it back about 25 years ago, that's what Cognex was doing back then.

But I'm not really speaking so much about Cognex right now, but rather the style of investing that Ramsley, and then I, by association, practiced. And that was specifically looking for companies that, the way I would describe it today, would be the third or fourth player in a niche industry. So it's a company you wouldn't have heard of -- like Cognex in 1990 -- and it's a company that would be in kind of a closed industry. Not something that was open to a huge amount of innovation or change. It wasn't a Facebook or an Amazon-like approach back then.

It was finding small caps, and the dream was that we would be buying them in advance of Wall Street finding out about them, and inevitably, if the company performed well, Wall Street would begin to cover it, and at the time, the stock would begin to rise because [of] new money managers. Wall Street attention would be coming in, and you would get an extra plus up from the attention from the institution.

So that was systematically the process that we were practicing back with that approach. And indeed, when it came time to write The Motley Fool Investment Guide, once we'd started The Motley Fool in 1993 as a newsletter for our parent's friends, just a couple of years after I had started with Walter's service, right through to 1994 when we debuted in August 4 of 1994 on America Online, we started to write our first book in 1995, and still this style and these thoughts were going through my head. It's how I invested.

So if you ever saw an early copy of The Motley Fool print newsletter -- and if you did, it means you're a friend or family member of mine, because that's the only people who saw the first year of The Motley Fool newsletter -- you would have seen a number of picks of these kinds of companies. And I'm disappointed to tell you, 20 years or so later, that very few of them are even still in business.

Now, that doesn't mean they're bad investments, but it does mean that if you're playing the long-term game, you probably don't want to be finding niche players that aren't even the leader. They're the third or fourth dog back on the Iditarod dog sled in their industry, and these are companies that generally are not going to stand the test of time, and often Wall Street wouldn't pay that much attention to them.

And in the end, I kind of abandoned the approach as I began to shift to what is my final investment story I'm going to share with you this week. But I still appreciate Ramsley's work. It was very influential for me. I learned a lot more about fundamental analysis of companies by studying the technologies and businesses of each of the companies that he would feature month in and month out through his investing newsletter.

And in a lot of ways, today, Motley Fool Stock Advisor, one of the services that I run at The Motley Fool, still does this same kind of thing -- not looking for those kinds of companies, but picking a stock month in and month out according to a style and just letting the results show themselves over the course of time, hopefully beating the market.

So I appreciate Walter and his work, but we shifted away from that. Although I will mention that today, The Motley Fool's Hidden Gems service is a service that continues to look for those kinds of companies, although in a much more intelligent way than I was as a 20-something back then.

David Gardner owns shares of Amazon.com and Facebook. The Motley Fool owns shares of and recommends Amazon.com, Cognex, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.