RULE MAKER PORTFOLIO

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What Happened to Cash-King?

Balance-Sheet Disaster

By Tom Gardner (TomGardner@aol.com)

Alexandria, VA (Dec. 30, 1998) -- Three investor-centric, instructive New Year's Resolutions came in after the bell last night. I thought I should post them here. Together, they offer valuable insights into the research of public companies. And that's of critical importance to Rule Maker investors as we look for the world's greatest businesses from which to generate repeating and expanding profits, year after year.

What we're looking for is nothing more than the classic style of compounding interest -- the principle that Albert Einstein labeled the most miraculous and enlightening bit of knowledge that he ever came across (yep, ahead of e=mc2).

Without further adieu, three ways to improve long-term compounding in your portfolio:

Resolution #1: Reading Financial Statements

TMF Yorick (Michael), Fool Writer -- My personal resolution for 1999 comes by way of a short story...

As a commercial real estate analyst, I have to admit that I was good at understanding the upscale hotel market again this year (not a humble statement, yet true). It was clear to me that upscale hotels were facing more demand than supply in 1998, and generally they were. So I picked a stock for the Fool's Valentine's Day Feature called Patriot American Hospitality that had properties and brands perfectly positioned to take off like a (slow, but high altitude) rocket.

But, in my research, I missed something.

I overlooked the enormous implied dilution (if all did not go well) of some derivatives that were buried on the balance sheet, called "equity forwards." I also didn't pay sufficient attention to the amount of their financing ($1.8 billion or thereabouts) that had to be rolled over in the next 18 months. Uh-oh.

In 1998, Patriot American lost it's glamour, the Commercial Mortgage Backed Securities market dried up when the Russian worries surfaced, and my stock selection tanked. Storm clouds are still forming today. The company can't roll over the debt; management is facing a Chapter 11 filing, even though the hotels are doing extremely well; and Leon Black's Apollo together with Boston's Thomas Lee are going to put up $1 billion and eat the shareholders' lunch (read: my lunch).

And so, my resolution for 1999 is to read the small print on the balance sheet and, if I can't understand it, I won't buy.

Now, should I still be learning this lesson at my age (I'm slightly older than the average employed Fool here)?

No.

And have I learned any other lessons from this? Only one. A tried and true lesson. Beware when you've been doing well as an investor. Do not mistake a bull market for Rhodes Scholar brains and assume you can understand (and thus invest in) everything out there.

Any other lessons?

Okay, one more. Whenever there's a foolproof deal, Wall Street invents a better fool (small "f" fool.) I know, this time I was it.

Resolutions #2 and #3: Going With What You Know

#2: TMF Seymor (Louis), Fool Writer: In 1999, I vow to be honest with myself about how much I really know about a potential investment. If I can't explain at least three things that could go wrong with my investment thesis, then I need to do more homework.

#3: TMF Runkle (George), Fool Community: I resolve in 1999 not to buy any stock that I can't explain in less than five minutes. My explanation must pass the "11-year test." That is, it must be understood by and make sense to my 11-year-old son.

Conclusion

The lessons from these three resolutions are evident. I won't bore you trying to dig more out than you can. But I hope we all resolve in 1999 to understand what we're buying, what we own, and -- as is so important with great companies -- whether we shouldn't just buy more of a good thing. Michael, Louis, and George have taught me a lot over the past few years, and they've closed my year with some great reminders.

Tomorrow, I'll be back with my own take on the financial year that was and I'll cast an eye on the future. I promise it'll be a doozy. This portfolio can't ring out 1998 without visiting with the Wise, can we?

Tom Gardner, Fool


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12/30/98 Close
Stock  Change    Bid
AXP   -  3/16  104.81
CHV   -  15/16 84.19
CSCO  -  13/16 92.69
KO    -1 9/16  67.81
GPS   -3 9/16  57.13
EK    -  1/4   72.00
XON   -1 1/16  74.63
GM    -  7/8   72.94
INTC  -1 7/8   119.19
MSFT  -1 1/2   139.00
PFE   +1 3/4   126.13
SGP   -  3/4   55.50
TROW  -2 5/16  31.25

                 Day     Month   Year    History
        R-MAKER  -1.82%   7.17%  30.61%  30.61%
        S&P:     -0.79%   5.87%  22.46%  22.46%
        NASDAQ:  -0.68%  11.15%  30.04%  30.04%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    139.00    77.59%
    5/1/98 55.5 Gap Inc.      34.06     57.13    67.72%
   6/23/98   34 Cisco Syst    58.41     92.69    58.68%
    2/3/98   22 Pfizer        82.30    126.13    53.25%
   2/13/98   22 Intel         84.67    119.19    40.76%
   8/21/98   44 Schering-P    47.99     55.50    15.64%
   5/26/98   18 AmExpress    104.07    104.81     0.72%
   2/27/98   27 Coca-Cola     69.11     67.81    -1.87%
    2/6/98   56 T. Rowe Pr    33.67     31.25    -7.20%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     74.63    15.99%
   3/12/98   20 Eastman Ko    63.15     72.00    14.02%
   3/12/98   15 Chevron       83.34     84.19     1.01%
   3/12/98   17 General Mo    72.41     72.94     0.74%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3336.00  $1457.55
    5/1/98 55.5 Gap Inc.    1890.33   3170.44  $1280.11
   6/23/98   34 Cisco Syst  1985.95   3151.38  $1165.43
    2/3/98   22 Pfizer      1810.58   2774.75   $964.17
   2/13/98   22 Intel       1862.83   2622.13   $759.30
   8/21/98   44 Schering-P   2111.7   2442.00   $330.30
   5/26/98   18 AmExpress   1873.20   1886.63    $13.43
   2/27/98   27 Coca-Cola   1865.89   1830.94   -$34.95
    2/6/98   56 T. Rowe Pr  1885.70   1750.00  -$135.70

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon       1286.70   1492.50   $205.80
   3/12/98   20 Eastman Ko  1262.95   1440.00   $177.05
   3/12/98   15 Chevron     1250.14   1262.81    $12.67
   3/12/98   17 General Mo  1230.89   1239.94     $9.05

                              CASH    $120.62
                             TOTAL  $28520.12
  
*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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