Rule Breaker Portfolio

The Lesson of the
NFL Coach
Plus, get ready to Break some Rules!

by David Gardner (DavidG@fool.com)

ALEXANDRIA, VA (Oct. 20, 1998) -- The Fool Portfolio got thrown for a loss Tuesday, much like the Washington Redskins did last Sunday. Actually, our hometown Washington Redskins have been thrown for a loss repeatedly throughout the season -- every Sunday -- not yet having won a single game. The low point had to be The Battle of the Beaten a couple weeks back, when the 0-5 Skins took on the 0-5 Eagles. Not much pride in winning that game, but one can only imagine the low spirit of the team that lost the game. One can only imagine, that is, the team spirit of the Redskins. Pardon my Portuguese, but the Redskins suck.

There's an investment lesson in all this, so bear with me for a couple of paragraphs.

The Redskins have demonstrated one of the truisms of NFL football, namely that the coaching staff matters. Lots. The coaching staff matters far more in the NFL than, say, major league baseball or the National Basketball Association. A baseball manager picks his lineups and flashes occasional signals throughout the game. He also decides when to yank a pitcher; outside of those things... not much more. (It's funny to think that baseball coaches are the only ones in all of sports who wear their team's uniforms, given that they don't do that much.) And the NBA is very similar. If I were running an NBA team I'd shock the league by making one of my players the player-coach, skipping the additional salary for a head coach. My player-coach would make sure guys passed the ball around, and that the stars took themselves out when they were tired. Outside of that, an NBA coach doesn't need to do much.

Contrast these with football. The NFL head coach is ultimately responsible (with the rest of his staff) for designing his team's offense and his team's defense. In addition, he (or another on the coaching staff) calls every play used by those offenses and defenses. (Yes, some quarterbacks call their plays too.) If you've ever played a dice football game of any sort, you know that play selection is by far the most important factor that leads to success on the gridiron. If you blitz left and I run right I'm fine; if I run left, I'm smoked. By contrast, playcalling is ephemeral and comparatively irrelevant in the NBA, NHL, or Major League Baseball.

Which now leads us back to our investment lesson. Given the importance of the coach in the NFL, please notice that the same teams with the same coaches go back to the playoffs year in and year out, in the NFL. The reverse is also true, which is perfectly logical: The same coaches fail to make the playoffs, year in and year out, in the NFL. The Redskins provide a very clear example, but they're just one of a myriad of such examples. The Redskins made it to the playoffs virtually every year of Joe Gibbs's coaching reign in the '80s, winning a few Super Bowls. (And if Joe Gibbs came back to coach them again, they'd quickly return to the playoffs, and stay there.)

That's the same coach all the way through, designing the offenses and the defenses and calling the plays. But when the highly talented Gibbs retired for a life of family and NASCAR, the team replaced him with a former assistant coach who didn't work out. They then replaced that guy with the present coach, Norv Turner, who also hasn't worked out, demonstrating our point in reverse: A poor coach will consistently design poor plays and make poor play calls. The Redskins have thus been Jekyll and Hyde -- making the playoffs throughout Gibbs's career, and not having made them once since.

Beginning to see the point? Take a look at the Fool Portfolio. There you largely see a few stars, guided by smart coaches, who consistently beat the markets quarter in and quarter out, making the playoffs, making shareholders lotsa money. And then you see the also-rans, the companies like 3Com and KLA-Tencor that for several years now have failed to come anywhere near the market averages. Yes, in retrospect it would've been much better to own an index fund or Spider instead of those darned things. Investors don't always have the benefit of hindsight, though -- at least, not until it's truly hindsight. Anyway, the point is that your winners typically keep winning while your dogs typically keep barking up a storm; the challenge is then to hold your winners. If you can manage to do so, your portfolio should wind up somewhat like ours -- tripling the market averages over more than four years.

One stock that contradicts the Lesson of the NFL Coach is Iomega (NYSE: IOM). Here was a company that won, really won, like few stocks ever have. We had a 25-bagger within a year, though Iomega should never have gone that high or done that well had a massive short squeeze not propelled it up there in the first place. Anyway, since May of 1996 the stock is down dramatically, providing an exception to the rule of the NFL Coach. With the management now gone that once created and suffered the incredible parabola of IOM stock over the past few years, we now have a new manager, James Sierk, in charge of the H.M.S. Zip Drive. Since Mr. Sierk took over the helm in late March, the stock has dropped from $7 to its present perch above $4. But I believe it's too early to "blame" that result on Mr. Sierk; the market for small-cap stocks has cut many of them in half since March, regardless of business performance.

With cost-cutting in place, including the shelving of an expensive ad campaign that didn't work very well, Zip sales are now picking up and Iomega drives closer to selling its 20 millionth Zip drive. No meaningful competition exists to its #1 removable-storage industry poll position. The company is currently slated to return to profitability in the fourth quarter, and the stock is up 30% from recent lows. With all this as a backdrop, The Motley Fool will be interviewing Mr. Sierk tomorrow, an interview that will be published here at fool.com on Thursday. If you'd like to suggest questions for us to ask, drop by the Iomega message board and help us ferret out whether the new head coach is Joe Gibbs, Norv Turner, or someone in between.

Finally today, Jeff and I want to begin preparing you for some changes you'll be seeing in the coming months here in the Portfolio section. First off, I want to make sure anyone reading this column tonight knows that in addition to this Fool Portfolio we have numerous other portfolios that we use as real-money teaching tools. They are the Boring Portfolio, the Cash-King Portfolio, the Drip Portfolio, and the eternally beloved and outperforming Foolish Four. You can find their performance listed in our scorebox every night on the main Portfolios page (a definite bookmark at http://www.fool.com/portfolios.htm).

But in conjunction with our upcoming Motley Fool book, Rule Breakers, Rule Makers, we will be calling this portfolio the Rule Breaker Portfolio and making some changes in order to conform it to the Rule Breaker approach laid out in the book. As I am the author of the Rule Breaker section (Tom writes Rule Makers), those changes will be fairly easily and consistently implemented. Basically, "Rule Breakers" are stocks like America Online, Amazon.com, Iomega, and others that come along and break the rules of business in their respective industries. They appear on the scene as top dogs in new industries, defy traditional valuation metrics, sport a brand, etc. -- all characteristics of the Rule Breaker as taught in our book. Thus, in the coming months, we'll probably be jettisoning various stocks in our portfolio that do not share Rule Breaker characteristics, aligning this portfolio with its true aim of teaching about investing in dynamic growth stocks.

The book came about -- my half of it, anyway -- in answer to the frequently asked question: "Hey guys, I've read your previous books, and based on those I would NEVER have bought a stock like Amazon.com in my portfolio. But you have in yours. Why?!" That book, which debuts in January, contains the answers. And this portfolio will sit in line with that.

Thus, in the coming months look for us to lay out some additional and new principles right here in this space, a slightly new attitude, and some new investments.

Get ready to watch us Break our own Rules.

Fool on!

-- David Gardner, October 20, 1998

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Bookmark Live Fool Port Quotes

10/20/98 Close
Stock Change Bid ---------------- AMZN +1 106.75 AOL -2 5/16 103.06 T + 3/8 61.88 DJT --- 3.50 DD -1 7/16 64.19 XON +1 11/16 76.56 INVX --- 11.13 IP + 3/16 48.56 IOM - 1/8 4.19 KLAC + 7/16 28.06 LU -1 3/8 74.75 SBUX + 3/16 37.38 COMS -1 3/4 30.25 TDFX - 7/8 10.13

Day Month Year History Annualized FOOL -0.84% -1.53% 40.45% 371.34% 44.55% S&P: +0.14% 4.61% 9.63% 132.10% 22.15% NASDAQ: -0.58% -3.23% 4.38% 127.61% 21.59% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 103.06 2734.16% 9/9/97 580 Amazon.com 19.11 106.75 458.59% 5/17/95 1960 Iomega Cor 1.28 4.19 227.04% 10/1/96 84 LucentTech 23.81 74.75 213.97% 4/30/97 -1170*Trump* 8.47 3.50 58.67% 8/12/96 130 AT&T 39.58 61.88 56.34% 2/20/98 200 Exxon 64.09 76.56 19.46% 2/20/98 215 DuPont 59.83 64.19 7.28% 2/20/98 270 Int'l Pape 47.69 48.56 1.83% 7/2/98 235 Starbucks 55.91 37.38 -33.15% 8/13/96 250 3Com Corp. 46.86 30.25 -35.45% 8/24/95 130 KLA-Tencor 44.71 28.06 -37.24% 6/26/97 325 Innovex 27.71 11.13 -59.85% 1/8/98 425 3Dfx 25.67 10.13 -60.55% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 73174.38 $70592.51 9/9/97 580 Amazon.com 11084.24 61915.00 $50830.76 4/30/97 -1170*Trump* -9908.50 -4095.00 $5813.50 5/17/95 1960 Iomega Cor 2509.60 8207.50 $5697.90 10/1/96 84 LucentTech 1999.88 6279.00 $4279.12 8/12/96 130 AT&T 5145.11 8043.75 $2898.64 2/20/98 200 Exxon 12818.00 15312.50 $2494.50 2/20/98 215 DuPont 12864.25 13800.31 $936.06 2/20/98 270 Int'l Pape 12876.75 13111.88 $235.13 8/24/95 130 KLA-Tencor 5812.49 3648.13 -$2164.37 8/13/96 250 3Com Corp. 11715.99 7562.50 -$4153.49 7/2/98 235 Starbucks 13138.63 8783.13 -$4355.50 6/26/97 325 Innovex 9005.62 3615.63 -$5390.00 1/8/98 425 3Dfx 10908.63 4303.13 -$6605.50 CASH $12005.75 TOTAL $235667.56

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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.