RULE MAKER PORTFOLIO

<THE RULE MAKER PORTFOLIO>

Back to Basics, Part 1
Plus, buying more Microsoft

By Matt Richey (TMF Verve)

ALEXANDRIA, VA (July 6, 1999) -- First things first: As Tom Gardner announced last Tuesday, beginning this month and in each month hereafter, we will add a fresh $500 to our account, which we will normally invest shortly thereafter. In addition, since the portfolio regularly earns cash dividends and cash in lieu of partial shares from stock splits, we will attempt to regularly reinvest any extra cash (less what is necessary for taxes) as soon as possible.

Recently, Rob, Phil, and I wrote about our opinions of where the fresh money should go. After drawing straws, I won, so I'll be making the call this time. Within the next five trading days, the Rule Maker Portfolio will purchase about $600 of Microsoft (Nasdaq: MSFT) for the reasons explained in June 24's column Microsoft: Just Getting Started.

Now, on to our main feature...

10 Rule Maker Criteria

This week, let's slow down for a moment and turn our eyes to the core principles behind Rule Maker investing. Whether you're a beginner or a veteran to investing and finance, I encourage you to consider the benefits of the Rule Maker portfolio's simple, tried-and-true approach to beating the market.

This strategy is one of company ownership, rather than stock trading. The difference is in the time horizon for investment. The Rule Maker's decade-long outlook is unique in the world of actively managed mutual funds and financial advisors, both of whom are driven by quarterly investment results. Their short-term mentality compels them to feverishly trade stocks in search of Wall Street's flavor of the week. In contrast, I propose that an individual investor will suffer less worry and achieve superior returns by taking long-term ownership in a handful of carefully selected stocks of her own choosing. The first step is finding world-class companies.

Luckily, this is quite easy, because each of us encounters a number of great companies as we go about our daily lives. Check out some of the companies I've already encountered only half-way through today: I shaved with a Gillette razor, checked my e-mail on AOL, clicked into My Yahoo! for personalized news, shopped at Gap Online, worked on a Dell computer using Microsoft applications and an Intel processor, re-energized myself with a shot of caffeine from a mid-morning Diet Coke, and ate a cinnamon scone for lunch at Starbucks.

Of course, not every single one of those nine companies is necessarily a good investment, but that list would make a great starting point if I were searching for investment ideas. You, of course, will have your own list of companies based on your own consumer experiences. Once you have a list of companies that are potential investments, you need a means for determining whether a company is worthy of your hard-earned savings.

That's our topic for tonight and the rest of this week. Below are the ten "Rule Maker Essentials," as we're calling them. These guidelines aim to help you synthesize the essential elements of a company's business model. In addition, the criteria serve as prerequisites for a company's earning the esteemed title, Rule Maker. Indeed, these criteria set a very high bar. Only the best of the best are able to o'erleap it. Rarely will a company ace all of the criteria, but the best Rule Makers fulfill most of the ten.

Rule Maker Essentials:
  1. Dominant brand
  2. Repeat-purchase business
  3. Convenience
  4. Expanding possibilities
  5. Your familiarity and interest
  6. Sales growth of at least 10%
  7. Gross margins of at least 50%
  8. Net-profit margins of 7% or greater
  9. Cash no less than 1.5x long-term debt
  10. Efficient use of cash (Flow Ratio below 1.25)

Regular readers of this column will recognize that most of these criteria are unchanged from the original nine principles upon which this portfolio was founded in January 1998. But as our thinking has solidified, and especially with the introduction of Tom Gardner's more comprehensive framework for identifying Rule Makers in his half of Rule Breakers, Rule Makers, we found the need to update our basic principles for identifying the best companies for long-term investment.

Nothing has changed about our strategy, except that we are even more focused on finding the most durable, high-quality business models. As you can see, Rule Maker analysis is both qualitative and quantitative in nature. The first five criteria focus on qualitative aspects of a company's business. The second five are numerical metrics based on the company's financials. Together, the 10 guidelines serve as the basic measures of excellence for evaluating Rule Makers. While these 10 are not comprehensive, they do serve as the core requirements for Rule Makerhood.

Tomorrow, I'll continue our Back to Basics Week with a closer look at #1 - #5, the qualitative side of business analysis. On Thursday, we'll look at metrics #6 - #8 regarding the income statement. And on Friday, we'll round out the week with a look at the #9 and #10, covering the all-important balance sheet.

Want to talk more about these new Essentials? Join us on the Rule Maker Beginners message board (linked below). Otherwise, enjoy your evening, and Fool on!

  • Rule Maker Strategy Board
  • Rule Maker Companies Board
  • Rule Maker Beginners Board
  • Rule Maker Ranker Spreadsheet (Excel 97, 68k)
  • Rule Maker Ranker Spreadsheet (Excel 95, 41k)

    07/06/99 Close
    Stock Change    Bid
    AXP   +  3/8    138.00
    CHV   +2 1/16    98.31
    CSCO  -  3/8     66.69
    EK    -  3/16    70.38
    GM    +3 1/16    71.69
    GPS   -  1/8     49.75
    INTC  +  3/8     63.88
    KO    -1 3/16    63.63
    MSFT  -2 7/16    89.56
    PFE   -  5/8     38.00
    SGP   -  3/16    54.31
    TROW  -  1/8     39.81
    XON   +  11/16   80.19
    YHOO  -3        175.13
    

    
                      Day     Month  Year    History
            R-MAKER  -0.48%   2.96%  17.11%  48.19%
            S&P:     -0.22%   1.12%  13.50%  40.37%
            NASDAQ:  -0.15%   1.91%  24.82%  65.58%
    
    Rule Maker Stocks
    
        Rec'd    #  Security     In At       Now    Change
        2/3/98   48 Microsoft     39.13     89.56   128.86%
       6/23/98   68 Cisco Syst    29.21     66.69   128.34%
        5/1/98 82.5 Gap Inc.      22.91     49.75   117.12%
       2/13/98   44 Intel         42.34     63.88    50.87%
       2/17/99   16 Yahoo Inc.   126.31    175.13    38.65%
        2/3/98   66 Pfizer        27.43     38.00    38.52%
       5/26/98   18 AmExpress    104.07    138.00    32.61%
        2/6/98   56 T. Rowe Pr    33.67     39.81    18.23%
       8/21/98   44 Schering-P    47.99     54.31    13.17%
       2/27/98   27 Coca-Cola     69.11     63.63    -7.93%
    
    Foolish Four Stocks
    
        Rec'd    #  Security     In At     Value    Change
       3/12/98   20 Exxon         64.34     80.19    24.64%
       3/12/98   15 Chevron       83.34     98.31    17.96%
       3/12/98   20 Eastman Ko    63.15     70.38    11.45%
       3/12/98   17 General Mo    72.41     71.69    -0.99%
    
    Rule Maker Stocks
    
        Rec'd    #  Security     In At     Value    Change
       6/23/98   68 Cisco Syst  1985.95   4534.75  $2548.80
        2/3/98   48 Microsoft   1878.45   4299.00  $2420.55
        5/1/98 82.5 Gap Inc.    1890.33   4104.38  $2214.05
       2/13/98   44 Intel       1862.83   2810.50   $947.67
       2/17/99   16 Yahoo Inc.  2020.95   2802.00   $781.05
        2/3/98   66 Pfizer      1810.58   2508.00   $697.42
       5/26/98   18 AmExpress   1873.20   2484.00   $610.80
        2/6/98   56 T. Rowe Pr  1885.70   2229.50   $343.80
       8/21/98   44 Schering-P   2111.7   2389.75   $278.05
       2/27/98   27 Coca-Cola   1865.89   1717.88  -$148.02
    
    Foolish Four Stocks
    
        Rec'd    #  Security     In At     Value    Change
       3/12/98   20 Exxon       1286.70   1603.75   $317.05
       3/12/98   15 Chevron     1250.14   1474.69   $224.55
       3/12/98   20 Eastman Ko  1262.95   1407.50   $144.55
       3/12/98   17 General Mo  1230.89   1218.69   -$12.20
    
                                  CASH     $70.09
                                 TOTAL  $35654.47
    
    

    Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.

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