RULE MAKER PORTFOLIO

<THE RULE MAKER PORTFOLIO>

A Different View on Diversification

By Phil Weiss (pweiss@homemail.com)

Towaco, NJ (Feb. 5, 1999) -- How much thought do you give to diversification in your investments? Many of the Wise constantly harp on the subject of diversifying across companies, industries, different stocks, different kinds of assets. If you get caught up in this kind of thought, you could easily end up owning a bucketful of stocks and bonds and who knows what else. If you tried to follow all the different assets that you owned, you'd have little free time for anything else.

When it comes to investing, owning few companies is usually better than owning more. There are a number of reasons for this. To help explain my point I'm going to digress for a bit. When we start our education we take things from a general perspective. When we're in college we pick a major, an area of study in which we plan to concentrate. Then we enter the real world and get a job. Every job requires some type of specialization. It doesn't matter if you're an athlete (pick a sport, then a position or event), a doctor, a lawyer, an accountant, an auto mechanic, a plumber, a salesperson, a teacher. All of these are specialties of some sort or another.

Once you've got a profession, you're most likely to specialize even more. I know that I certainly have. I'm a CPA. I work for a large corporation and specialize in International Tax Planning. There are a lot of differences between what I do and what someone who audits financial statements does.

So, we're told that when it comes to our professions we should specialize. As a matter of fact, this is probably what makes us the most successful over time. So why is it that we're told to diversify when it comes to our investments? That's a question that I just can't answer.

When we invest in Rule Maker stocks, we intend to hold our shares for at least 10 years. This gives us an opportunity to really get to know our companies and the businesses that they are in. As we get to know our companies better and better, why shouldn't we add more to our existing investments rather than buying new stocks. It seems to me that it's better to stay with what you know than to constantly take chances with what you don't.

If we look at this portfolio with a topside view, we can see that we own three technology companies, two pharmaceutical companies, two financial companies, and two consumer products companies. If we're looking to invest new money in the market, I don't see a reason for us to look at expanding into many different industries. We can look to add more money to the companies that we already own or, on occasion, another company in one of the industries that we're already invested in. As a matter of fact, I think you'll find that when it comes to Rule Maker stocks there are a lot of industries that just don't have companies that meet our investment criteria.

I think there are a lot of advantages to taking the approach that I'm outlining here. The first is that you can really get to know the industries and the companies over time. The next is that investing can be a lot more fun if you invest in what you know or what you are interested in learning more about. In January I wrote about why I thought that America Online (NYSE: AOL) was a Rule Maker. I also mentioned that I had first purchased the stock last August. I bought the stock by selling my holdings in ENSCO (NYSE: ESV) an oil service stock that I at one time had a nice gain on. Unfortunately, I sold it at a loss.

The reasons for the sale were twofold. The first was that I had decided AOL was a Rule Maker, and I wanted to purchase some for my portfolio. The second was that I had decided that the oil service industry was not one that I wished to follow. I have some other tech stocks in my portfolio, and like keeping up with the industry, so following AOL would not mean that much extra work on my part.

In the scoring system used in Rule Breakers, Rule Makers, Tom awards points to companies that are humorous and interesting. To some, these may seem like throw away points. I think that they make a lot of sense. I like owning companies that interest me. It gives me an incentive to devote time towards understanding and following them. As a matter of fact, to this Fool, that's one of the best parts of long-term, buy-and-hold investing.

I'd like to come back again to the point I made about our professional lives -- we specialize. Doesn't it make sense that we should do the same when it comes to our investments? Based on the studying I've done, that's what makes for the best investors. When I look at the investors I admire the most (e.g., Warren Buffett and Phil Fisher), I notice that they have certain things in common: They invest in a small group of companies, they take the time to get to know the companies and the businesses well, they add to existing positions in strong companies rather than constantly looking to diversify into more and more different companies. I think that this is a model that we can all learn from.

Diversification for the sake of diversification is much more foolish than it is Foolish.

A few readers have pointed out that I misrepresented a couple of the numbers when I analyzed Intel's (Nasdaq: INTC) earnings on Tuesday night. When I did my comparisons, I inadvertently picked up some of the income statement numbers from the third quarter of 1998 rather than the fourth quarter of 1997. When I corrected the numbers, I got a score for Intel of 10 of 18 using the criteria in Rule Breakers, Rule Makers. I'd like to thank all those that pointed out my mistake whether it was via e-mail or on the boards. I'm also comforted by the fact that people are taking the time to check the numbers and understand the process. That's what Fooldom is all about. Here's a message board post with what I believe are the correct margin numbers.

Have a Foolish weekend,

Phil Weiss

02/05/99 Close
Stock  Change    Bid
AXP   -2 1/8   98.13
CHV   +1 15/16 78.88
CSCO  -4       101.25
KO    -1 9/16  62.06
GPS   -2 1/16  62.00
EK    -  1/8   68.75
XON   +2       71.81
GM    -1 1/8   85.94
INTC  -2 9/16  127.56
MSFT  +  15/16 160.00
PFE   -  3/4   130.88
SGP   -  11/16 53.88
TROW  -  3/16  33.81

                   Day   Month    Year  History
        R-MAKER  -1.16%  -3.83%   4.27%  31.94%
        S&P:     -0.73%  -3.14%   1.15%  25.19%
        NASDAQ:  -1.51%  -5.28%   8.25%  43.60%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   24 Microsoft     78.27    160.00   104.42%
    5/1/98   55 Gap Inc.      34.37     62.00    80.39%
   6/23/98   34 Cisco Syst    58.41    101.25    73.34%
    2/3/98   22 Pfizer        82.30    130.88    59.02%
   2/13/98   22 Intel         84.67    127.56    50.65%
   8/21/98   44 Schering-P    47.99     53.88    12.26%
    2/6/98   56 T. Rowe Pr    33.67     33.81     0.41%
   5/26/98   18 AmExpress    104.07     98.13    -5.71%
   2/27/98   27 Coca-Cola     69.11     62.06   -10.19%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     85.94    18.69%
   3/12/98   20 Exxon         64.34     71.81    11.62%
   3/12/98   20 Eastman Ko    63.15     68.75     8.87%
   3/12/98   15 Chevron       83.34     78.88    -5.36%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   24 Microsoft   1878.45   3840.00  $1961.55
    5/1/98   55 Gap Inc.    1890.33   3410.00  $1519.67
   6/23/98   34 Cisco Syst  1985.95   3442.50  $1456.55
    2/3/98   22 Pfizer      1810.58   2879.25  $1068.67
   2/13/98   22 Intel       1862.83   2806.38   $943.55
   8/21/98   44 Schering-P   2111.7   2370.50   $258.80
    2/6/98   56 T. Rowe Pr  1885.70   1893.50     $7.80
   5/26/98   18 AmExpress   1873.20   1766.25  -$106.95
   2/27/98   27 Coca-Cola   1865.89   1675.69  -$190.20

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1460.94   $230.05
   3/12/98   20 Exxon       1286.70   1436.25   $149.55
   3/12/98   20 Eastman Ko  1262.95   1375.00   $112.05
   3/12/98   15 Chevron     1250.14   1183.13   -$67.02

                              CASH   $2205.98
                             TOTAL  $31745.36

Added $ 2,000 on August 4, 1998 to the portfolio; this will show in the numbers at a later date.

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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