Rule Breaker Portfolio

Fool Port Rocks On
Tonight, the First
Portfolio Principle

by David Gardner (DavidG@fool.com)

ALEXANDRIA, VA (Nov. 9, 1998) -- The Fool Portfolio fared well today, rising 0.58% vs. a rise of 0.24% for the Nasdaq and a drop -- a bad day -- for the S&P 500 of 0.95%.

Now up 71.88% for the year, The Fool Portfolio is the best-kept secret in the financial world today. Its aim is pure education, but it's market-beating, it's free, and you get all of our thinking -- right or wrong -- laid out for you day after day, with the managers there on the message boards at http://boards.fool.com participating in an interactive conversation on each stock's thread.

With humorous irony, we ask our readers not to hold their collective breath waiting for any financial mag to do a writeup on this portfolio's 1998 success anytime soon -- or, more importantly, its historical return. It just doesn't serve any of their own interests -- much better to point to the gooroos of Wall Street for opinion and comment. I thought about this the other night when I saw Mario Gabelli on the Lou Dobbs show on CNN. When was the last time this guy beat the market averages? And why does Dobbs throw softball interviews to the CEO of Merrill Lynch -- er, Larry Finch -- instead of actually serving his viewers by asking some tougher questions about commission-based incentive systems and "long-term" capital "management" hedge funds? But don't get me started again.

Ironically, when the Fool Port suffered a mild drop in the summer of 1997, the vultures of the financial media suddenly came out of their eyries and descended on our nook of cyberspace in droves, reporting on its "demise." Peering over our 477% historic return (vs. 147% for the S&P 500 and way below that for the average mutual fund), I'd say reports of our death have been greatly exaggerated!

And geez, we're publishing this stuff for free... no expense ratios or front-end loads, here... (Giggle.)

OK, in fine Foolish fashion, let's take a quick look at our big LOSER today. Starbucks (Nasdaq: SBUX) declined after a lone Lehman analyst lowered his earning estimate for the company to better reflect management's third quarter guidance that called for about $1.20 per share in fiscal 1999 earnings. The analyst lowered his estimate from $1.20 to $1.25 per share, to $1.17 to $1.22 per share. Yep. Not much to this one. In street lingo, a guy knocked his 1999 earning estimate down a few pennies in order to be closer with the average estimate.

Starbucks announces earnings on Thursday and $0.28 per share is expected. The analyst did expect a strong fourth quarter, but is hinting that management could trim its 1999 estimate below the $1.20 mark. We'll see in the conference call.

Turning to our biggest winner, America Online (NYSE: AOL) announced plans to increase ease of access internationally, adding many more points of presence overseas in the near future. As I just spent last week in the UK for The Motley Fool UK Investment Guide (into its second printing -- buy a few to brighten up the holidays for your favorite Brit!), I really did appreciate the ease of just signing onto my AOL account from London. Most of your local JoeBobNet Internet service providers (ISPs) still have a way to catch up, there.

And one earnings note today: Late after the market closed, Innovex (Nasdaq: INVX) reported fourth quarter earnings of $0.13 per share, which compares to an estimate of $0.14 per share. For the year, the company earned $1.05 per share despite a languid disk drive industry and increased competition in Innovex's niche. Gross margins, however, suffered -- they fell from 43% to 33% year-over-year. The company has new products in the works that will determine its 1999 performance and, especially, the years beyond. The conference call is tomorrow and the Fool will of course have the replay information for you. To discuss Innovex, please visit the company's message board on the Fool.

The Fool Portfolio will shortly undergo a mild transformation into its new name -- the Rule Breaker portfolio -- to mark its new, slightly modified approach. (If this is news to you, just click on this relevant past column for explanation.)

Tonight we unveil the first of what will probably be six official principles of this portfolio, principles which will occupy a permanent place in this space once we unveil the whole enchilada. Each of these principles serves as an overt statement of our methods and approach as we invest our own real money right here before you. In many ways, of course, we lay out our methods and approach every day in this space and in all of our buy and sell reports. But heretofore, we had never laid out an explicit description of the Rule Breaker portfolio's mission and its "truths," the truths we may hold to be self-evident but nevertheless need to make explicit! Beginning tonight -- and as we release each new principle in the coming weeks -- we offer you, the Foolish reader, a series of short documents that provide the foundation for what you find here each day. So without further ado, here is one of the six:

#####

We consciously take on lots of risk, believing that for experienced and Foolish investors, high risk will lead to high reward.

The Rule Breaker portfolio does not shy from risk -- quite the opposite, in fact. We consciously take on risk in the belief that smart high risk will lead to smart-looking high returns.

For this reason, mimic this portfolio at your own risk. Of all the portfolios at The Motley Fool, this is the most aggressive, the most suitable for those who can afford to lose lots of money in pursuit of lots of money. Mimic any aspect of this portfolio at your own risk, because we're taking lots of risk with it.

How do we measure risk? We don't really; it's only intuitive. We have little interest in the traditional measures of risk used mostly by the Wise -- things like "beta" that purport to measure risk based on the volatility of a stock or a portfolio. A better measure of risk might just be market cap -- the higher the cap, the lower the risk. We often buy small-to-mid-cap stocks in this portfolio, so that's one evident example of conscious risk. That's OK -- the smaller the acorn, the larger the oak. (We hope!)

We also take risk in our portfolio allocations. At various points in this portfolio's history, one or two stocks have represented huge slices (30%+) of the overall pie. This has been used by the Wise as a criticism of the portfolio, the idea being that (1) we got lucky with one good stock in the first place, explaining our outperformance, and (2) we're being irresponsibly risky in allowing such stocks to occupy as much of our holdings as they do.

Answering these, we have never put more than 10% of our portfolio into any single holding. The only way a given stock begins to look overweighted is because it appreciates at three times the rate (or more) of the rest of the portfolio. Why did that happen in the first place? Ask yourself. Our own answer is that we found a good investment, and we are loath to start selling off portions of it in order to fund what will most likely be lousier investments. That's poor pinochle. Warren Buffett, the self-made multibillionaire who is the richest investor in the world, has had upwards of 30% of his money at various points in Coca Cola. Crazy, eh? To some, we suppose. Another word we might choose instead is "Foolish."

Finally, if you want to beat the market as a private little-guy investor, the way to do it IS through your best one or two stocks. Those who buy and hold a single great company for a decade or more will almost always outperform the market in their investing. This remains one of the great secrets -- a secret that will remain hidden by the institutions who simply cannot and will not do this. Note again, if you will, the example of the greatest market outperformer of all: Warren Buffett.

From time to time we have balanced the portfolio by selling off a portion of a big winner, but we generally do that much later than most people expect and only when we believe that the money will be equally or better invested in some new selection.

#####

There you have one of our six principles: an explicit statement that we are taking on risk consciously in the belief (demonstrated effectively so far) that greater risk will lead to greater reward. This approach is not for everybody -- indeed, it is not for most. That's why we offer numerous other portfolios here at The Motley Fool. For many investors, it may be enough to choose to investigate just one or two stocks out of this portfolio as they look to round out their own portfolios.

For those who are familiar with our upcoming book, Rule Breakers, Rule Makers (now available for online purchase, though it won't be out for another 8 weeks), please note that the attributes of a Rule Breaker that I lay out there are not to be confused with our portfolio principles. Those attributes describe a Rule Breaker; these principles are simply our guides to managing our Rule Breaker portfolio. Hope I've made that clear!

Finally, each of our six portfolio principles is not an immutable piece of sculpture. We are purposefully laying them out here first in order to gauge and garner your reaction. We would love to receive e-mail about the principle above (and each one), particularly from those who enjoy engaging in the thinking that underlies what we're doing here. If you have appreciated the explicit statement, let us know. If you see some way to improve on it, please let us know. If it's not clear, let us know about that, too! We're here for ya! In fact, without you, we wouldn't be here. That's at the core of Foolishness.

-- David Gardner, November 9, 1998

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Today's FoolWatch: all the latest in Fooldom.


Bookmark Live Fool Port Quotes

11/09/98 Close
Stock Change Bid ---------------- AMZN +2 5/16 126.88 AOL +4 7/16 144.44 T + 13/16 64.25 DJT - 1/16 5.69 DD - 5/8 61.88 XON -1 1/2 72.00 INVX -1 16.13 IP - 3/8 45.75 IOM - 11/16 8.00 KLAC - 3/4 35.38 LU -1 1/2 88.38 SBUX -2 9/16 46.38 COMS - 15/16 34.69 TDFX + 5/8 14.13

Day Month Year History Annualized FOOL +0.58% 7.44% 71.88% 476.83% 50.84% S&P: -0.95% 2.87% 16.46% 146.55% 23.58% NASDAQ: +0.24% 5.06% 18.51% 158.41% 24.95% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 144.44 3871.95% 9/9/97 580 Amazon.com 19.11 126.88 563.89% 5/17/95 1960 Iomega Cor 1.28 8.00 524.80% 10/1/96 84 LucentTech 23.81 88.38 271.20% 8/12/96 130 AT&T 39.58 64.25 62.34% 4/30/97 -1170*Trump* 8.47 5.69 32.84% 2/20/98 200 Exxon 64.09 72.00 12.34% 2/20/98 215 DuPont 59.83 61.88 3.41% 2/20/98 270 Int'l Pape 47.69 45.75 -4.07% 7/2/98 235 Starbucks 55.91 46.38 -17.05% 8/24/95 130 KLA-Tencor 44.71 35.38 -20.88% 8/13/96 250 3Com Corp. 46.86 34.69 -25.98% 6/26/97 325 Innovex 27.71 16.13 -41.81% 1/8/98 425 3Dfx 25.67 14.13 -44.97% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 102550.63 $99968.76 9/9/97 580 Amazon.com 11084.24 73587.50 $62503.26 5/17/95 1960 Iomega Cor 2509.60 15680.00 $13170.40 10/1/96 84 LucentTech 1999.88 7423.50 $5423.62 4/30/97 -1170*Trump* -9908.50 -6654.38 $3254.13 8/12/96 130 AT&T 5145.11 8352.50 $3207.39 2/20/98 200 Exxon 12818.00 14400.00 $1582.00 2/20/98 215 DuPont 12864.25 13303.13 $438.88 2/20/98 270 Int'l Pape 12876.75 12352.50 -$524.25 8/24/95 130 KLA-Tencor 5812.49 4598.75 -$1213.74 7/2/98 235 Starbucks 13138.63 10898.13 -$2240.50 8/13/96 250 3Com Corp. 11715.99 8671.88 -$3044.12 6/26/97 325 Innovex 9005.62 5240.63 -$3765.00 1/8/98 425 3Dfx 10908.63 6003.13 -$4905.50 CASH $12005.75 TOTAL $288413.63

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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.