Rule Breaker Portfolio

Fool Portfolio Report
Friday, December 12, 1997
by Jeff Fischer (TMFJeff@aol.com)


ALEXANDRIA, VA (Dec. 12, 1997) -- Almost any stock related to Asia fell this week, and especially any stock having to do with technology. The S&P was down an insignificant amount on Friday, but the Nasdaq lost nearly 1.5% to end the week down a hefty 6%. The Fool didn't fare much better, down 4% over the last five days, while the S&P lost 3%.

As long as the American economy is strong and inflation is in check, it would logically take external factors to harm it and to harm the American stock market. For now, Asia may be impetus enough. With over 60% of the world's people living in Asia, economic instability in the area is bound to impact most all international companies -- and their stocks. Companies most affected, initially, are those selling products that are discretionary purchases. Not every company or consumer needs the latest, fastest computer, or networking product, or software -- especially if the near-term economic picture is uncertain.

When the world of free trade is running at full steam and American companies have earnings estimates that assume a strong world economy, any letdown presents lower earnings numbers and a correction in near-term stock valuations. Right now, we're still very much in the initial stage of any coming disappointment, even though some companies have already blamed Asia for slow sales (3Com and Oracle being recent examples). The currency situation, meanwhile, impacts many companies even if international sales increase. Coca-Cola, Johnson & Johnson, and Pfizer are just three of the many high-class companies that have experienced lower net income even as sales volume grew overseas. "High class" are the operative words in that last sentence. Great companies are not immune to the world economy and, therefore, the resolve of many investors will certainly be tested many, many times over the coming years.

Even the stocks of great companies will stumble, fall, or splat in some economies. Long-term investors realize that they can't know when this will happen for certain or when stocks will rebound, and they also realize the tax implications of selling and trying to buy back lower. My favorite way of investing in what is becoming an increasingly interesting or difficult stock market is to dollar-cost-average, as we're doing in the Drip Portfolio. In that case, you buy the same leading companies at different prices over time, and you buy more when the stock is lower. Other than that, the stock market -- in all of its bull, bear, or other forms -- is, for most of us, just something in which to buy what we know -- buy the very best -- and hold on. Let time take its course. Anything else -- leaping in and out, trying to guess global economies, hedging excessively -- is unnatural and defeats the natural course of progress that is known as "compounding returns off of a growing base," which is what long-term investing is all about.

More important than the stock market as a whole, of course, are the individual stocks that we each own. Buy only what you understand, and understand it in the context of the industry and global economy in which it operates. Coca-Cola is much less likely to get clocked by an economic slowdown than is Intel, while Pfizer will continue to sell needed drugs in any economy. All portfolios that move beyond the Foolish Four or S&P 500 should hold "defensive" positions in companies that produce strong sales in any economy, or that create their own niche in which to sell. Holding those types of companies alongside more economically sensitive stocks makes a lot of sense and helps a portfolio weather any storm that might circle around the world.

The Fool Portfolio was helped this week by America Online (NYSE: AOL), which is largely creating its own industry. The stock rose $2 for the week. Little else helped us except for our short of Trump Hotels and Casino Resorts (NYSE: DJT), which consistently hit new lows on news of the company acquiring another $100 million in debt financing last week.

After rising sharply the past few months, Iomega (NYSE: IOM) is finally bleeding back some of the gain and closed the week down nearly $5. A few Fools have written us asking why we haven't written about the stock as it has fallen a dollar here, two dollars there. We haven't mentioned it because there isn't anything new to mention. The business hasn't changed, the earnings estimates are no different, and no news has recently crossed our screens. The stock has simply fallen with the market, and in many cases, less than the market. That said, it isn't exactly cheap. The stock now trades at 30 times the 1997 earnings estimate of $0.88 per share. I'd call that reasonable, based on the known information. Iomega splits 2-for-1 around December 22.

Innovex (Nasdaq: INVX) is one of the few stocks in the world trading at 7 times earnings estimates while having 24% net profit margins. Geesh! At some point the market will see the value of this company as slightly higher than the value of your typical low-margin disk drive maker, the stocks of which are selling at these low multiples and perhaps for good reason.

Innovex was chosen for the Fool Port in part because it has such incredible margins and because it sells product to nearly all of the drive makers -- owning 70% of its market -- and it isn't a drive maker itself. It suffers a slowdown when they do, but not with as much consequence. The company hasn't had to cut prices and hurt margins as the drive makers are often forced to do, and it has still shown strong growth year-over-year. The stock lost $3 on Friday on confirmation that drive makers are lowering orders from other companies and perhaps on the Quantum news from the day before (Quantum is one of the three largest drive makers in the world and expects lower earnings in part due to drive prices, and is a major customer of Innovex); and perhaps it fell because about two-thirds of Innovex's sales are made in Asia.

We don't think that companies are going to stop buying lead-wires that cost a few quarters apiece, though, especially when they're needed in order for a disk drive to work. It's difficult for Innovex to grow at a pace slower than the drive industry, which -- when the disk drive competitors aren't stuffing the drive channel to the hilt at their own peril -- grows with the computer industry, for the most part. Earnings estimates have been lowered consecutively as the expected growth in the drive industry has continued to slow since we bought the stock, however, and now analysts expect Innovex to grow earnings about 10% in fiscal 1998, rather than 20%. Innovex has stated that it still expects to grow 20%, though.

As for the stock market as a whole, after three record years we may be due for a few slow or down years -- who knows. Mexico has experienced tough times and the U.S. market was able to overcome it, but the businesses of leading U.S. companies are much more tied to Asia than they are to Mexico. Whatever happens, it will be interesting to see it unfold and to see how it is resolved, and we'll be here every market day to share thoughts and to gather thoughts from readers to share as well.

Make your own decisions, be comfortable with them, and don't think that any "expert" out there can tell you when to start buying or selling stock. Nobody knows, and the fact that some people out there think they do know should make you leery of them and their hubris -- or ignorance. In the long run, the simple passing of time presents the best opportunity if you invest in great companies. Is that boring? Warren Buffett calls long-term investing a very ordinary thing, and who would argue with him? We wouldn't, except we call investing long-term Foolish, rather than ordinary.

Much more important right now, though, is that the holidays are around the corner. Have a Foolish weekend!

--Jeff Fischer

Do your Foolish gift shopping now, in time for the Holidays. And consider the Industry Focus '98 book, to learn not only about industry-leading stocks, but about the industries in which they operate as a whole. Simply visit FoolMart for details. Fool on!

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TODAY'S NUMBERS
Stock Change Bid ---------------- AMZN -1 1/4 54.50 AOL - 1/16 86.13 T + 9/16 57.69 CHV -2 1/16 75.50 DJT - 1/16 7.13 GM - 3/4 62.50 INVX -3 19.00 IOM - 9/16 26.44 KLAC -2 1/16 34.13 LU - 7/8 75.13 MMM - 1/2 92.38 COMS -1 1/16 34.25

Day Month Year History FOOL -1.72% -1.36% 22.39% 226.64% S&P: -0.16% -0.21% 28.71% 107.98% NASDAQ: -1.41% -4.00% 19.02% 113.36% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 86.13 1084.19% 5/17/95 980 Iomega Cor 2.52 26.44 949.11% 10/1/96 42 LucentTech 47.62 75.13 57.77% 8/11/95 125 Chevron 50.28 75.50 50.14% 8/12/96 130 AT&T 39.58 57.69 45.76% 9/9/97 290 Amazon.com 38.22 54.50 42.59% 8/12/96 110 Minn M&M 65.68 92.38 40.65% 8/12/96 280 Gen'l Moto 51.97 62.50 20.25% 4/30/97 -1170 *Trump* 8.47 7.13 15.87% 8/24/95 130 KLA-Tencor 44.71 34.13 -23.68% 8/13/96 250 3Com Corp. 46.86 34.25 -26.91% 6/26/97 325 Innovex 27.71 19.00 -31.43% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 30574.38 $27992.51 5/17/95 980 Iomega Cor 2509.60 25908.75 $23399.15 9/9/97 290 Amazon.com 11084.24 15805.00 $4720.76 8/11/95 125 Chevron 6285.61 9437.50 $3151.89 8/12/96 280 Gen'l Moto 14552.49 17500.00 $2947.51 8/12/96 110 Minn M&M 7224.44 10161.25 $2936.81 8/12/96 130 AT&T 5145.11 7499.38 $2354.27 4/30/97 -1170*Trump* -9908.50 -8336.25 $1572.25 10/1/96 42 LucentTech 1999.88 3155.25 $1155.37 8/24/95 130 KLA-Tencor 5812.49 4436.25 -$1376.24 6/26/97 325 Innovex 9005.62 6175.00 -$2830.62 8/13/96 250 3Com Corp. 11714.99 8562.50 -$3152.49 CASH $32438.81 TOTAL $163317.81








Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.