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The secret to finding the best ASX shares – breaking all the rules

Some of the best ASX shares to own over the last five years have broken all the rules.

The Motley Fool (U.S) ‘Rule Breaker’ investing service, run by Motley Fool co-founder David Gardner, looks for six simple, but crucial, characteristics when hunting for long-term winning companies. Many of the best performing ASX shares would meet his criteria. 

Let’s look at David Gardner’s six traits and see how they apply to some of the best performing ASX growth shares like Xero Limited (ASX: XRO), CSL Limited (ASX: CSL) and Afterpay Ltd (ASX: APT).

1. A ‘top dog’, ‘first mover’ company in an important, emerging industry

Being the first mover in an emerging industry usually requires significant investment and risk. However, companies that successfully navigate this stage can build a deep understanding of the industry which is difficult for competitors to replicate. Accounting platform Xero was early to seize on the potential of cloud storage – an important, emerging industry – to enable small businesses to cost-effectively manage their accounting.

2. Holding a sustainable advantage

A sustainable advantage, says Gardner, can be gained through “business momentum, patent protection, visionary leadership, or inept competitors”. CSL is an example of a company that has built a formidable advantage through continuous research and development and patent protection.

3. Strong past share price appreciation

Here is where traditional investing rules start to go out the window. David Gardner’s ‘rule breaker‘ criteria looks for companies that have a history of strong upward share prices. This goes against the common ‘buy low, sell high’ philosophy of many investors, but in Gardner’s own words, “We think the winners generally keep on winning.”

4. Good management and smart backing

This element can be hard to assess from outside the company, but if the company has had a consistent management team with a history of making good investment decisions, it’s likely well on its way.

5. Strong consumer appeal

Strong consumer appeal is about giving customers a positive experience to generate repeat business. Users are certainly smitten with the simplicity of the by now, pay later service offered by Afterpay. This is an incredibly powerful position for a young company to drive future growth.

6. Documented proof that the stock is considered overvalued according to the financial media

Gardner’s final point, similar to number three, goes against conventional investing wisdom. Being labelled overpriced, he argues, is less relevant if the other five ‘rule breaker’ characteristics ring true. This is because growing companies regularly command high valuations. Gardner cites Amazon as an example, which was labelled ‘overvalued’ back in 2000. Since then, Amazon shares are up by many, many multiples.

I must admit I remain cautious here. There is often more risk to owning fast-growing, cash-burning companies with high valuations. If the growth story changes unexpectedly, the share price can plummet. Recent examples of this are Gentrack Group Ltd (ASX: GTK) and Nearmap Ltd (ASX: NEA).

Still, if you’re looking for tomorrow’s winning ASX companies, perhaps consider companies that feel like they break all the rules.

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Regan Pearson owns shares of Xero and Gentrack.

You can follow him on Twitter @Regan_Invests.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of AFTERPAY T FPO and CSL Ltd. The Motley Fool Australia owns shares of and has recommended Nearmap Ltd. The Motley Fool Australia owns shares of Xero. 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. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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