RULE MAKER PORTFOLIO

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What Happened to Cash-King?

Risk in Investing
Comparing investment styles

by Al Levit (alanl@ix.netcom.com)

Glendale, CA (Dec. 15, 1998) -- This is going to be a week of comparisons. As the week goes on, I'll be comparing different companies to each other, but today I want to start out by comparing investment styles. Specifically, I want to focus on the risk in the Rule Maker portfolio and the risk that is present in some other investment styles that are popular today.

Now let me start right out by stating that we Rule Makers definitely do not consider risk to be a bad term in and of itself. On the contrary, in many cases we embrace risk in our investing. We do, however, feel that it is important that you know how much risk you are exposing yourself to when you invest. We do think it's a problem when you make an investment that you think of as risk-free, when in fact it is not.

Unfortunately, the whole world got a nasty lesson in unexpected risk this summer with the Long-Term Capital debacle. I have read that the hedge fund sold many of its deals to very sophisticated investors as investments that had very high returns and only moderate risk. The theory was that sovereign nations, like Russia, would rarely default on its debts. When this theory proved incorrect, and Russia did default (technically, they delayed payment, but that was essentially the same thing), then the loans that Long-Term Capital had made proved to be very risky after all.

The loans were very risky because the hedge fund was highly leveraged. Some accounts speculated that for every dollar investors put in, Long-Term Capital borrowed another $49 in the U.S. and lent out the entire $50 to Russia. When Russia defaulted, then the hedge fund owed the full $50! In hindsight, this was a VERY risky investment, and perhaps it was not surprising that Long-Term was able to advertise the high returns that it did.

Closer to home, lately there been have a few messages in the Cash-King Strategies board similar to the following (message 5324) left by Ryan:

"I hate these huge Internet stock moves... anyone else feel 'uncool' for not owning EBAY or YHOO or KTEL et al? Man, someone bring me back to reality... it's depressing, all that easy money being made..."

A couple of us took a crack on this message on the boards, but I think it's important for the entire Rule Maker audience to be aware of some of the issues behind this question. Specifically, these three stocks are great examples of tremendous rewards possible when purchasing relatively low capitalized companies that have great potential. These kinds of companies tend to have very high valuations in terms of price to sales, and as long as there are indications for tremendous growth, then the sky seems to be the limit in terms of the price of the stock.

However, and this is a big however, we're decade-long holders over here. When you take a look at most of the companies that have made the "huge Internet moves," there is no guarantee that those companies will even be AROUND in ten years. Does this mean you shouldn't buy them? Not at all. But it does mean that there is much more risk involved in owning those companies than in owning Rule Maker companies.

EBAY has only been public for a little while, and current investors have made a ton of money. Do you know whether EBAY will be around in 10 years? Five years? Next year? How about KTEL? Sometime a lot of money can be made in these stocks, but Dave Gardner didn't put Principle #1 in the Rule Breaker Portfolio for nothing!

How does this contrast with the Rule Makers? After all, some of our stocks are in the hole right now, and some have been quite volatile throughout this year. The big difference that I see is that with all their cash and high profit margins we are much more confident that our companies can come back from adversity than any of the Internet stocks. Our companies will not be capable of the kind of short-term rewards that you can see in an EBAY or YHOO, but if one of our companies does have a big drop, the odds are very great that it will come back over our 10-year period. The companies making the "huge Internet moves" have a considerably greater chance of merely vanishing in 10 years.

On a portfolio level, we've got nine Rule Makers in four different industry groups. If we really blow it with one (or more) we've still got the rest of the portfolio to make up for the damage. Not only that, we've got the mindless Foolish Four for about 25% of the portfolio, with it's proven record of outperformance, especially when the stock market in general is doing poorly. With all of that going for us, we look at the Rule Maker Portfolio as being one of the least risky portfolios run at the Motley Fool. Last, but certainly not least, RULE MAKER IS IN NO WAY A RISK-FREE PORTFOLIO. We are investing in stocks, after all, and there is always considerable risk in that. Most of that risk goes away with a 10-year time horizon, which is what we've got, but please don't think of this or any stock portfolio as a savings account.

Bottom line on Rule Maker vs. the Huge Internet Stock moves is this, at least in my opinion: The Internet stocks had better outperform us, and by a decent margin. After all, investors with lots of Internet Stocks have to pay for a lot of DI-GEL -- need to plug a Schering-Plough (NYSE: SGP) product -- and who knows what else. What they are looking for is a future Rule Maker or Market-King.

In addition, as investors get older they run out of time to recover if too many risky stocks go awry. As the old man of the Rule Maker group (I'm 44, but remember from Step 10, Rule Maker investors retire young), I become more and more conscious of this.

If we Rule Makers want to get risky, I think a better way to go is with the Merchant-Kings. I write about that tomorrow, as I discuss a comparison of a Rule Maker and a Merchant-King that Dale Wettlaufer (TMF Ralegh) proposed a few weeks ago. As always, post your questions to the Rule Maker Strategy Board or the Rule Maker Companies Board. Until tomorrow, Fool on!


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12/15/98 Close
Stock  Change    Bid
AXP   +3 1/4   94.75
CHV   -2 11/16 83.00
CSCO  +3 3/8   83.75
KO    +2 9/16  65.94
GPS   +1 5/16  48.81
EK    +  13/16 71.69
XON   -  9/16  74.00
GM    +1 7/16  67.19
INTC  +4 3/8   115.94
MSFT  +3 15/16 131.88
PFE   +3 1/4   115.00
SGP   +  11/16 54.25
TROW  +  3/8   35.00

                 Day     Month   Year    History
    R-Maker      +2.34%   1.67%  23.79%  23.79%
        S&P:     +1.90%  -0.07%  15.59%  15.59%
        NASDAQ:  +2.32%   3.23%  20.78%  20.78%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    131.88    68.49%
   6/23/98   34 Cisco Syst    58.41     83.75    43.38%
    5/1/98 55.5 Gap Inc.      34.06     48.81    43.31%
    2/3/98   22 Pfizer        82.30    115.00    39.73%
   2/13/98   22 Intel         84.67    115.94    36.92%
   8/21/98   44 Schering-P    47.99     54.25    13.04%
    2/6/98   56 T. Rowe Pr    33.67     35.00     3.94%
   2/27/98   27 Coca-Cola     69.11     65.94    -4.59%
   5/26/98   18 AmExpress    104.07     94.75    -8.95%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     74.00    15.02%
   3/12/98   20 Eastman Ko    63.15     71.69    13.52%
   3/12/98   15 Chevron       83.34     83.00    -0.41%
   3/12/98   17 General Mo    72.41     67.19    -7.21%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3165.00  $1286.55
   6/23/98   34 Cisco Syst  1985.95   2847.50   $861.55
    5/1/98 55.5 Gap Inc.    1890.33   2709.09   $818.76
    2/3/98   22 Pfizer      1810.58   2530.00   $719.42
   2/13/98   22 Intel       1862.83   2550.63   $687.80
   8/21/98   44 Schering-P   2111.7   2387.00   $275.30
    2/6/98   56 T. Rowe Pr  1885.70   1960.00    $74.30
   2/27/98   27 Coca-Cola   1865.89   1780.31   -$85.58
   5/26/98   18 AmExpress   1873.20   1705.50  -$167.70

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon       1286.70   1480.00   $193.30
   3/12/98   20 Eastman Ko  1262.95   1433.75   $170.80
   3/12/98   15 Chevron     1250.14   1245.00    -$5.14
   3/12/98   17 General Mo  1230.89   1142.19   -$88.70

                              CASH    $120.62
                             TOTAL  $27056.59
 
*Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.

*The year for the S&P and Nasdaq is as of 02/03/98

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