Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>
What Happened to Fool Port?

< Pinch Pinch >
And lessons learned

by Paul Larson (TMFParlay@aol.com)

CHICAGO, IL (Dec. 28, 1998) -- As we enter the last week of the year, those of us associated with the Rule Breaker Portfolio are again forced to pinch ourselves to insure that we aren't dreaming. <pinch pinch> The performance on the day was, yet again, something to smile about with the Rule Breaker Portfolio up 7.46% versus a mixed market.

Just how good of a day was it? Amazon (Nasdaq: AMZN) was up another $27 1/8. It doesn't really look all that impressive when converted to a 8.35% move, but I love the fact that today's profit alone covered the $19.74 split-adjusted cost basis this portfolio has on the shares still held. Even more amazing is that America Online (NYSE: AOL), up $21 1/16, covered the Rule Breaker's $1.82 original cost basis over ELEVEN TIMES. Just today. Behold the sweet power of compounding!

Any news causing today's moves in our "A" stocks? AOL's recent inclusion in the S&P 500 certainly doesn't hurt, nor does the hit movie You've Got Mail staring Meg Ryan, Tom Hanks, and AOL. On the other hand, Amazon, I surmise, is hopping from this holiday's sales figures. I know I personally spent nearly $200 on the site on gifts for friends and family, and I'm sure I wasn't the only one avoiding the mall and clicking in. It was my first real purchase at the site, and I found it fast and easy. Plus, gifts to remote family members were conveniently sent directly to them. I know I'll be revisiting the site repeatedly in the coming year, and, of course, looking at the sales figures in the coming quarterly reports with interest.

In any case, this has simply been an amazing year, nay, decade for the Rule Breaker portfolio. Let's take a look back over the years and see just how well this portfolio has fared:

Yearly performance figures:

1998 (As of today's close)
Rule Breaker  209.83% <pinch>
Nasdaq         38.84%
S&P 500        26.28%                    

1997
S&P 500        31.01%
Fool Port      25.75%
Nasdaq         21.64%

1996
Fool Port      42.93%
Nasdaq         22.71%
S&P 500        20.26%

1995
Fool Port      68.17%
Nasdaq         39.92%
S&P 500        34.11%

1994 (8/4/94 -12/31/94)
Fool Port      11.03%
Nasdaq          4.41%
S&P 500         0.19%

Started on August 4th of 1994, this portfolio has only been in existence for roughly four and a half years, and in only one of those years, 1997, did this portfolio lose to the market as a whole. Although, that year was still a split-decision since the then Fool Portfolio still managed to best the Nasdaq. Losing to the S&P by 5% in one year can certainly be forgiven when you spank it by 170% the next. We're proud of the performance, and the above numbers tell it all.

When pulling the yearly numbers from the archives, I found a timely quote David Gardner wrote in late 1996. He said, "We know that years in which our portfolio will rise in excess of 40% are special.... So I'll remind any of our few readers at this point that need such reminding that these times are well above-average, and we shouldn't allow our expectations to ratchet up to any new level. Eleven percent is the historic market return... plan for that, and be grateful when you do better."

Color us *extremely* grateful this year. 1999 may very well be a down year for the Rule Breaker portfolio, and we are very much aware that years like this in which the portfolio triples are certainly the exception to the rule. (We like breaking rules!) As individual investors we are confident we can beat the market over the long term, sometimes even beating it by an extremely wide margin. Nevertheless, don't expect a repeat performance. 1998 has truly been a special year. None of us are this good.

Let's switch gears. When Jeff was handing out scribing assignments he wanted the four columns this week (no trading on Friday thanks to the holiday) to be about what each of the writers has learned in the past year. Without further delay, here are some of the points that really got hammered home for me personally over the past twelve months.

9 months is not "long term"

I used to think that by holding a stock for 9 months and looking at where a company was going to be a few quarters down the road that I was thinking "long-term." If there's one thing I've learned this year it is that the true long-term investor thinks in terms of years, not quarters. Looking at the earnings estimates for the next couple of quarters ahead certainly gives some knowledge about the near-term, but my primary concern in 1999 is where a company is going to be five to ten years down the road.

Valuation is myopic

I'm not quite ready to throw away my tool of comparing a company's earnings and cash flow multiples to that of the market, but you can bet in the coming year I'll be looking more at the quality of the business and less at the current price tag. Some of the biggest mistakes I've made (and opportunities I've missed) came when I got freaked by a relatively high valuation. A stock's intrinsic price is the discounted value of all its future cash flows. This means yesterday's cash flow is irrelevant, and those in the coming twelve months are far from the only cash flows to be looking at.

Don't short open-ended situations

I stared at the incredible valuations some of the Internet stocks carried throughout the year and was tempted to take short positions in some of them. Lucky for me, I decided to pass on by. (Phew!) This near-disaster experience reminded me of this very old tenet that we Fools hold. Don't short open-ended situations! I can't believe I started the year Dueling against owning Yahoo. There's a 10-bagger I missed.... (Darn, I wasn't dreaming!)

Dilution kills

One of the largest criticisms of this portfolio over the past two years or so has been that such large chunks of the gains have come from two stocks. The Rule Breaker portfolio only has 13 positions for a reason, and many will say that is far too few for a portfolio of this size. Nonsense. If the Rule Breaker would have diluted its holdings in AOL and Amazon for a dozen other mediocre investments we would not have to be pinching ourselves. This is not to say we recommend putting all your eggs in one or two stocks, it's just that beating the market when holding and tracking 30 or more different positions is extremely difficult. Trust me, I've tried. For an insightful column on this topic, click here.

Know why you're in the market

Even though this year looks like it is going to end up in the "W" column, I think it's important not to forget the volatility we saw through much of the late summer and early fall. Times like that make for good reminders to look at your personal situation and make sure that you don't need any of the funds in the market for the next 5-10 years. (Or longer!) While the market came back and most are sitting pretty, don't forget those frightening times. They will happen again, and you don't want your expected cash withdrawals to coincide with a depressed market.

Well, those are just some of the more salient lessons I've learned over the past year, and I hope that you've learned a thing or two from both our successes and our mistakes. That's what we are here for -- to Educate, Amuse, and Enrich. I know I've had a great time scribing this column, and I look forward to writing about an exciting 1999.

Fool on!

-- Paul Larson


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Bookmark Live Rule Breaker Port Quotes

12/28/98 Close
Stock  Change    Bid 
 ---------------- 
AMZN  +27 1/8 351.94
AMGN  +3 9/16 104.56
AOL  +21 1/16 157.06
T     +  7/16  75.00
ATHM  +  5/8   81.50
DJT   -  1/4    3.75
DD    +  11/16 56.63
XON   -  1/8   74.50
IP    +  3/8   43.69
IOM   -  1/4    7.81
LU    +3 3/4  111.25
SBUX  -1 1/16  51.31
TDFX  -  7/16  11.75
 
                   Day   Month    Year  History  Annualized 
      R-BREAKER  +7.46%  49.65% 209.83%  939.79%   70.33%
        S&P:     -0.06%   5.32%  26.28%  167.34%   25.06%
        NASDAQ:  +0.80%  11.84%  38.84%  202.74%   28.65%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  1100 AmOnline       1.82    157.06    8540.73%
   9/9/97   440 Amazon.com    19.74    351.94    1683.07%
  5/17/95  1960 Iomega Cor     1.28      7.81     510.16%
  10/1/96    84 LucentTech    23.81    111.25     367.28%
  8/12/96   130 AT&T          39.58     75.00      89.50%
  4/30/97 -1170*Trump*         8.47      3.75      55.72%
  12/4/98   450@Home Corp.    56.08     81.50      45.33%
 12/16/98   290 Amgen         85.75    104.56      21.94%
  2/20/98   200 Exxon         64.09     74.50      16.24%
  2/20/98   215 DuPont        59.83     56.63      -5.36%
   7/2/98   235 Starbucks     55.91     51.31      -8.22%
  2/20/98   270 Int'l Pape    47.69     43.69      -8.40%
   1/8/98   425 3Dfx          25.67     11.75     -54.22%

    Rec'd    #  Security     In At     Value      Change
   9/9/97   440 Amazon.com  8684.60 154852.50  $146167.90
   8/5/94  1100 AmOnline    1999.47 172768.75  $170769.28
  5/17/95  1960 Iomega Cor  2509.60  15312.50   $12802.90
  12/4/98   450@Home Corp. 25236.13  36675.00   $11438.87
  10/1/96    84 LucentTech  1999.88   9345.00    $7345.12
  4/30/97 -1170*Trump*     -9908.50  -4387.50    $5521.00
 12/16/98   290 Amgen      24867.50  30323.13    $5455.63
  8/12/96   130 AT&T        5145.11   9750.00    $4604.89
  2/20/98   200 Exxon      12818.00  14900.00    $2082.00
  2/20/98   215 DuPont     12864.25  12174.38    -$689.88
   7/2/98   235 Starbucks  13138.63  12058.44   -$1080.19
  2/20/98   270 Int'l Pape 12876.75  11795.63   -$1081.13
   1/8/98   425 3Dfx       10908.63   4993.75   -$5914.88

                              CASH  $39332.55
                             TOTAL $519894.11

</THE RULE BREAKER PORTFOLIO>

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