Rule Breaker Portfolio

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

Easy Come, Easy Go
Charmin as investment lesson

by David Gardner (DavidG@fool.com)

ALEXANDRIA, VA (Jan. 12, 1999) -- The Rule Breaker Portfolio gave back most of its gains from yesterday's amazing session, dropping a whopping 7.88% today.

Yesterday we rang up an historic mark: in one day, we made over $50,000. Why is that historic? Because we started with exactly $50,000 on August 4, 1994 -- which means that yesterday in one day we made more than our entire initial investment.

And you know what? Today we lost exactly $50,451.69 -- more than our entire initial investment. Easy come, easy go!

Ah, but it's all part of the Rule-Breaking investor's way of life. We don't mind volatility. Check that. We prefer volatility; in some sense, we court it. You see, the stock market has risen at an annualized rate of over 11% this century, so you have lots more up periods than down. And in those up periods, volatility is what makes you rich.

Then there are the down periods. For all I know, we're about to enter one. I look down my list today and find:

Amazon.com:     -21 1/4
America Online: -10 1/8
@Home:          -21 7/8
...these are the horses that got us here of late, helped along by:
Amgen:  -1 5/8 today
Iomega: -1/4 today
Lucent: -4 7/8 today

Any regular reader knows that we make no presumption toward predicting market movements. We are long-term investors who make our effort to locate what we think will be winning businesses, companies that Break the Rules of the existing business environment to their shareholders' wild happiness. We let the market take care of pricing from there.

We've had lots of debate recently on the Rule Breaker Portfolio message board and the Amazon.com message board about the market's pricing mechanism. One of the great conventional wisdoms of the here and now, to my way of thinking, is that the so-called "Internet stocks" are grossly overpriced, a bubble just waiting to pop. (Certainly, they got hammered today, although all they did was give back yesterday's gains.) To my way of thinking, this foregone conclusion on the part of media commentators is very very Wise, just as it has been over the past five years, as they've been saying pretty much the same thing all along.

I remember when I was on CNBC in early '98 and was about to go on the set when I saw David Faber sneer at Amazon.com as if it was a joke investment -- that would've been about 500% ago. And Lord knows Money magazine hasn't ever anywhere along the line suggested that Amazon.com would make a good investment. In fact, here's one of my favorite article titles over the past couple of years, referenced in our new book. (Our new book, by the way, is the #1 bestseller among all 2.5 million titles on Amazon.com -- woo hoo! Thank you, Fools!) The title:

"Amazon.com Stock Soars After IPO... But Can the Good Times Last?"

It was from May '97. The key quotation was this: "Clearly, though, there are many reasons to think that Amazon.com is overvalued at Thursday's closing price of [and we adjust for split, here] $3 7/8." (Bold mine.)

$3 7/8! Less than two years later, we are here at $163.

The financial media has been pretty much been dead wrong all along on these stocks, but don't take my word for it -- just go back and read their publications over the past few years. (MAN, was America Online ever flamed back when we bought it in 1994 -- today, it's everybody's no-brainer Internet play.) Which all leads to the question of why the media would suddenly be right, right now.

Listen, I'd be much more worried if news anchors led off their market summaries by explaining how attractive and fairly valued all these stocks are!

Let's dig a bit deeper in our thinking about all this and ask ourselves the question that DDelruss asked me on the message boards today. He essentially asked if there is any price I'd sell Amazon at:

"What if Amazon started selling at $7000 a share tomorrow? Wouldn't it make sense to sell at that price?"

There is simply no single dependable valuation tool that can be applied to Rule Breakers, as true of Internet stocks today as it was of Wal-Mart in the '70s, or Cisco Systems in the early '90s. Rule Breakers over market history have always possessed such power, potential, and momentum (these are special situations -- always will be -- and again, this has been a reality for decades), that we let the market price our stock as it will.

Some people can't understand this, but I regard it as rather a simple point. Is Charmin overpriced in my grocery store? I don't think so; at least, I buy it. If it were double the price it is, would I still buy it? Depends on what other values were out there. One of the beauties of free markets and capitalism (just one of the beauties) is the pricing mechanism -- the market sets the prices. I don't have to buy Charmin if I don't want to. And you don't have to pay $7000 for Amazon if you don't want to.

The Foolish approach dictates that selling occurs when you find a better place to stick your money, what I proposed more than three years ago, in a chapter entitled "Selling Strategy" in our first book. We have actually twice sold off some AOL -- the first time was to buy Amazon (among a couple of others), while the second time effectively bought @Home (or Amgen). Sometimes we make bad mistakes and sell off a good stock in order to buy something not so good -- we are quite fallible!

When you get away from price targets, technical analysis, and trading, and just buy strong companies planning to hold them (the Rule Maker Port holds its stocks for a decade -- doesn't trade at all -- and will whip the S&P 500 over that time), your sell decisions wind up coming down to YOU and your needs for the money, not any sort of arbitrary price target.

I used to invest off of price targets, and I'm very glad I've gotten beyond that. Certainly, any stock can -- in retrospect -- have appeared undervalued or overvalued at the time. Amazon now looks really undervalued when we bought it at $7 (having paid $3 more than Money Magazine suggested anyone should!). Iomega, at its top of $27, now looks as if it was really overvalued back then -- would've been nice to have sold. Retrospect makes value quite evident.

Most investors will confound themselves if they set price targets for all their different stocks and invest using them. If we had set one for any of our best stocks (America Online, Iomega, Amazon.com), we would have sold long ago -- and perhaps never have gotten in. That's because strong stocks will always appear overvalued. Note that if we had cut short our losers (a "downside price target"), we would have sold some of our losers earlier. Great, but which would have been better -- to trade out of our winners and losers quickly, using targets, or only to sell our winners and losers when we felt we had found a better place to stick our money? The answer is quite evident; it's one of the lessons of the Rule Breaker Portfolio, born out eloquently by the numbers.

In making valuation only a tertiary issue, we essentially trust the stock market's incredibly complex, elaborate, and self-interested pricing mechanism, in just the same way we trust a grocery store or a Wal-Mart and its prices.

That's all to say that if Amazon went to $7000, I believe that it would only have gotten there for some incredibly good reasons -- making the price at that point look fair (actually, probably "slightly overvalued," since that's the way all the great stocks -- Coke, Dell, Gap, America Online -- always appear).

The same would be true if Amazon dropped from $170 to $70. It would be for some incredibly good reasons.

That's about enough of that for now. Join us on the Rule Breaker Portfolio board if you'd like to weigh in with your opinion. We'll take a look at @Home's earnings tomorrow. They were so-so.

Meantime, I'm curious how the Harry Jones Portfolio did today.

Fool on!

--David Gardner, January 12, 1999

01/12/99 Close
Stock  Change    Bid 
 ---------------- 
AMZN  -21 1/4 163.38
AMGN  -1 5/8  107.00
AOL   -10 1/8 154.06
T     -1 1/16  84.13
ATHM  -21 7/8 100.00
DJT   -  3/8    4.56
DD    -1 15/16 57.81
XON   -  1/4   70.75
IP    +  9/16  46.50
IOM   -  1/4    9.00
LU    -4 7/8  108.00
SBUX  +  3/16  53.19
TDFX  -  3/16  12.69

 
                   Day   Month    Year  History  Annualized 
      R-BREAKER  -7.88%  17.53%  17.53% 1079.64%  74.38%
        S&P:     -1.92%   0.84%   0.84%  183.11%   26.43%
        NASDAQ:  -2.67%   5.84%   5.84%  222.26%   30.17%
 Note:  Yearly, historical and annualized returns for the 
S&P include dividends

    Rec'd    #  Security     In At       Now      Change
   8/5/94  1100 AmOnline       1.82    154.06    8375.68%
   9/9/97  1320 Amazon.com     6.58    163.38    2383.19%
  5/17/95  1960 Iomega Cor     1.28      9.00     602.90%
  10/1/96    84 LucentTech    23.81    108.00     353.63%
  8/12/96   130 AT&T          39.58     84.13     112.56%
  12/4/98   450@Home Corp.    56.08    100.00      78.32%
  4/30/97 -1170*Trump*         8.47      4.56      46.13%
 12/16/98   290 Amgen         85.75    107.00      24.78%
  2/20/98   200 Exxon         64.09     70.75      10.39%
  2/20/98   270 Int'l Pape    47.69     46.50      -2.50%
  2/20/98   215 DuPont        59.83     57.81      -3.38%
   7/2/98   235 Starbucks     55.91     53.19      -4.87%
   1/8/98   425 3Dfx          25.67     12.69     -50.57%

    Rec'd    #  Security     In At     Value      Change
   9/9/97  1320 Amazon.com  8684.60 215655.00  $206970.40
   8/5/94  1100 AmOnline    1999.47 169468.75  $167469.28
  12/4/98   450@Home Corp. 25236.13  45000.00   $19763.87
  5/17/95  1960 Iomega Cor  2509.60  17640.00   $15130.40
  10/1/96    84 LucentTech  1999.88   9072.00    $7072.12
 12/16/98   290 Amgen      24867.50  31030.00    $6162.50
  8/12/96   130 AT&T        5145.11  10936.25    $5791.14
  4/30/97 -1170*Trump*     -9908.50  -5338.13    $4570.38
  2/20/98   200 Exxon      12818.00  14150.00    $1332.00
  2/20/98   270 Int'l Pape 12876.75  12555.00    -$321.75
  2/20/98   215 DuPont     12864.25  12429.69    -$434.56
   7/2/98   235 Starbucks  13138.63  12499.06    -$639.56
   1/8/98   425 3Dfx       10908.63   5392.19   -$5516.44

                              CASH  $39332.55
                             TOTAL $589822.36 

</THE RULE BREAKER PORTFOLIO>

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