RULE MAKER PORTFOLIO

<THE RULE MAKER PORTFOLIO>

Microsoft vs. Amazon,
Part 2

Why I'm sticking with the runner-up

By Al Levit (TMF Early)

GLENDALE, CA (April 9, 1999) -- We are barely more than a quarter of the way into 1999, and the Rule Maker Portfolio is already up 19.10%. We're ahead of the Naz, and we're crushing the S&P. Yesterday's March retail sales report sent Gap (NYSE: GPS) shares soaring as investors piled aboard the khaki soul train on optimism over the company's explosive 21% same-store sales growth and 43% total sales growth. Our 55 Gap shares have now more than doubled in value in less than one year of what will surely be many years of happy ownership.

Of course, we know that our portfolio's present rate of growth will inevitably slow. Over the next 10 years, we will undoubtedly suffer through quarters, and perhaps even years, of negative performance. That's the nature of the stock market. But, we don't mind Mr. Market's manic-depressive ways. It's this very volatility, or "risk" according to the Wise, that makes the stock market so rewarding for long-term investors.

See, the short-term volatility of stocks causes investors to demand a higher rate of return on equities than on more stable investments, like bonds. For investors with a time horizon of a decade or longer, the everyday ups and downs of the stock market are a very small price to pay for the much higher returns that stocks ultimately provide. Over five-year periods from 1871 to 1992, stocks outperformed bonds more than 71% of the time. And, for periods of 30 years or more, stocks always outperformed bonds. (For these and more numbers in support of long-term investing, check out the Fool's Buy-and-Hold Apocalypse.)

As Peter Lynch states in his immortal work, Beating the Street, "Gentlemen who prefer bonds don't know what they're missing." Here in Rule Maker Land, we couldn't agree more. Further, we believe that by buying and holding a basket of the very best companies, we can outperform the S&P 500 over the long-haul. That's our goal. So far, we're off to a great start, but we have a loooong way to go.

Two companies that we'll be watching closely in the coming years are Microsoft (Nasdaq: MSFT) and Amazon.com (Nasdaq: AMZN). As I noted yesterday, in a five-year race between Microsoft and Amazon, the Rule-Breaking e-tailer is far ahead in terms of share price appreciation. For all I know, Amazon will continue to outperform Softy, even as Microsoft hopefully outperforms the rest of the market. Even so, I'm perfectly happy owning Microsoft, and I know I wouldn't be happy owning Amazon. In today's column, I'll try to explain why.

Each of us has companies that we would not feel comfortable owning. Sometimes, we may not want to own certain companies for ethical reasons. (I've covered that topic before.) Other times, we shy away from investing in companies for far less altruistic reasons. For example, I have no interest in owning a company whose future is highly uncertain. And I'm not alone in this category. Investing legend Warren Buffett also favors businesses whose future prospects are relatively predictable. Unlike Mr. Buffett, I'm not at all afraid to invest in great tech companies, but I like to see a profitable business model in place.

This is the problem that I have with Amazon. The e-tailer is not making money now, and it seems to constantly push the profitability point farther and farther into the future. On January 26 of this year, during the quarterly conference call, Amazon CFO Joy Covey mentioned that "all of Amazon's expansion plans and aggressive spending to build the core business should translate into even greater losses going forward." CEO Jeff Bezos added, "Amazon and other Internet pure plays are very volatile. Because of that, Amazon.com should be a very small fraction of a long-term investor's portfolio. It shouldn't be any portion of a short-term investor's portfolio."

All of this did nothing to scare off investors. Amazon closed at 115 on the day of the conference call. The words of caution from the CEO and the prediction of losses from the CFO resulted in the stock price increasing to 125 the next day. Since then, the company has expanded its product line and membership, and it is certainly the top dog in e-tailing. Amazon is growing like a weed, and a lot of people must be betting that a bucketful of profits will be coming down the road.

Personally, I prefer to wait and see how great a profit can really be produced out of Amazon's model. At this point, I understand how Amazon can expand its revenue, but I'm not nearly as sure how the company can create and expand its profits. Fooldom teaches us to invest in what we understand, and therefore I refrain from investing in Amazon.com.

By now I'm beginning to realize that this discipline may continue to have a high "opportunity cost," meaning that I might make a lot of money if I "took a flier" and invested just because other Fools I trust think that Amazon can and will make money. After all, a strong consensus seems to believe that Amazon will eventually be the Wal-Mart of the Internet.

Investing that way doesn't work for me, and I don't think it's Foolish. Even if I could do it, I would not be happy spending half my life worrying about whether Amazon would ever be profitable. Moreover, I probably couldn't hold this volatile stock for any length of time if I didn't believe in its business model. I'd probably wind up selling at the wrong time and losing money.

Thus, I'm afraid I'll just have to settle for the 85% return that Microsoft has delivered over the last six months. I just hope Microsoft can deliver similar "underperformance" in the future. I realize that's a mere pittance compared to what Amazon.com shareholders have been receiving, but you take what you can get. Whether Microsoft's returns are stunning or stale over the next six months, I'm looking forward to the rewards of holding this fantastic (and fantastically profitable) company for years to come.

Oak's up next week, and I'll be back in three.

Fool on,

Al

04/09/99 Close
Stock  Change    Bid
AXP   +  5/8   128.38
CHV   +  1/4   94.00
CSCO  +  1/2   118.13
KO    -  1/8   60.75
GPS   +1 15/16 74.69
EK    +1       62.94
XON   +  7/16  74.69
GM    -2 1/4   85.63
INTC  -  1/4   130.81
MSFT  -  5/16  94.25
PFE   +3 9/16  146.00
SGP   +  5/8   59.81
TROW  -1 1/16  32.56
YHOO  +  5/16  207.00

                    Day   Month    Year  History
        R-MAKER  +0.43%   6.93%  19.10%  50.70%
        S&P:     +0.33%   4.82%  10.01%  36.08%
        NASDAQ:  +0.76%   5.33%  18.26%  56.88%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     94.25   140.84%
    5/1/98   55 Gap Inc.      34.37     74.69   117.31%
   6/23/98   34 Cisco Syst    58.41    118.13   102.23%
    2/3/98   22 Pfizer        82.30    146.00    77.40%
   2/17/99   16 Yahoo Inc.   126.31    207.00    63.88%
   2/13/98   22 Intel         84.67    130.81    54.49%
   8/21/98   44 Schering-P    47.99     59.81    24.63%
   5/26/98   18 AmExpress    104.07    128.38    23.36%
    2/6/98   56 T. Rowe Pr    33.67     32.56    -3.30%
   2/27/98   27 Coca-Cola     69.11     60.75   -12.09%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo    72.41     85.63    18.26%
   3/12/98   20 Exxon         64.34     74.69    16.09%
   3/12/98   15 Chevron       83.34     94.00    12.79%
   3/12/98   20 Eastman Ko    63.15     62.94    -0.33%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   48 Microsoft   1878.45   4524.00  $2645.55
    5/1/98   55 Gap Inc.    1890.33   4107.81  $2217.48
   6/23/98   34 Cisco Syst  1985.95   4016.25  $2030.30
    2/3/98   22 Pfizer      1810.58   3212.00  $1401.42
   2/17/99   16 Yahoo Inc.  2020.95   3312.00  $1291.05
   2/13/98   22 Intel       1862.83   2877.88  $1015.05
   8/21/98   44 Schering-P   2111.7   2631.75   $520.05
   5/26/98   18 AmExpress   1873.20   2310.75   $437.55
    2/6/98   56 T. Rowe Pr  1885.70   1823.50   -$62.20
   2/27/98   27 Coca-Cola   1865.89   1640.25  -$225.64

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   17 General Mo  1230.89   1455.63   $224.74
   3/12/98   20 Exxon       1286.70   1493.75   $207.05
   3/12/98   15 Chevron     1250.14   1410.00   $159.86
   3/12/98   20 Eastman Ko  1262.95   1258.75    -$4.20

                              CASH    $185.03
                             TOTAL  $36259.34

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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