Rule Maker To Buy YHOO
February 16, 1999

**When Rule Maker announces an intention to trade, that trade will be made within the next five business days, as opposed to the very next day. For more detail on how buys are determined and how this portfolio originated, please read the "11 Steps to Rule Maker Investing" section of the Rule Maker Portfolio.**

Rule Maker Portfolio Buy Report

Approximately $2,000 worth
Yahoo! Inc. (Nasdaq: YHOO)

3420 Central Expressway
Santa Clara, CA 95051
(408) 731-3300

Yep, that's right. The Rule Maker Portfolio will break new ground at some point over the next five trading days. We'll be buying a position in Internet information warehouse Yahoo! (Nasdaq: YHOO!), with the intent of holding onto this investment for five to ten years.

Of course, we know that buying into a Technology/Internet company with a five-to-ten-year time horizon will unnerve some market watchers. But, as investors, that long-term mentality of the business owner is a way of life for us.

That said, Yahoo! does represent the first example in our portfolio of a company that's neither a classic Rule Maker nor part of our Foolish Four heavies. Thus, it will bring with it additional risk for us. Yahoo! is -- in Foolish parlance -- a Tweener. It's a company that started out by Breaking the Rules. It changed the business world by setting the pace for an important, emerging industry.

Yet things have changed now, quite suddenly.

Life as a Tweener

Yahoo! has graduated into public-market purgatory, the sanctuary between fire and ice -- Betweenersville where the company neither entirely Breaks nor Makes the Rules of its game. This dodgy "Tweener" stage is the direct result of Yahoo!'s early success. Its revolutionary leadership has attracted a gang of followers, whose aim is to duplicate Yahoo!'s every move, for profit.

This leader of search engines has definitely been tweened. The company now faces competitive pressure from a number of legitimate alternatives. Were Yahoo! to disappear from the face of the planet tomorrow, Excite or Lycos or or could step in to bear the responsibility of serving the millions in need of search help online. These are clearly legitimate alternatives to Yahoo!'s service.

Tweener Examples

There's nothing terribly wrong or unusual about that, though. Being tweened goes with the territory of having once been a classic Rule-Breaking stock. Coca-Cola was once tweened by Pepsi. Cisco was tweened by 3Com. Intel was tweened by Advanced Micro Devices. American Express was tweened (and badly wounded) by Visa. The Gap has been tweened by a gang of casual apparel companies -- the latest being Abercrombie & Fitch.

And that's life in the public markets. Replication is just part of the natural process of running a successful business. As companies ascend to the dominant position in their markets, as their business model is confirmed by consumers, copycats of all sizes creep up to chew away at their profits. How well the leaders respond to this mimicry helps to guide the market's evaluation of their business in the decade ahead.

For instance, if the leader is Netscape (Nasdaq: NSCP) and its browser product is mirrored and outmarketed by Microsoft (Nasdaq: MSFT), then you have a three-year chart resembling this: Netscape's Performance Graph. The stock has yet to return to its 1995 high of $85 per share and the company has seen its chances of becoming a Rule Maker steadily decrease, week upon week (right up until its acquisition by America Online).

But if, instead, the Rule Breaking leader being mimicked is America Online (NYSE: AOL), and it successfully battles back Internet Service Providers (ISPs) and the supposed threat of Microsoft, then you have a stock chart resembling this: America Online's Performance Graph. AOL is up more than 300 times in value since its initial public offering in 1992.

Life as an Investor in Tweeners

When we buy shares of Yahoo! later this week, we'll do so with these memories fresh in our minds. One prince -- Netscape -- was shattered; another -- AOL -- was crowned king. We believe that we've found a crownable prince in Yahoo!, but there is certainly no guarantee of this.

Given that we're making an investment in a Tweener, we will be paying very close attention to our Yahoo! shares. We've drawn up a minimum expected holding period of five years rather than the normal ten, because there's no question that Yahoo! is not yet a Rule Maker. The company hasn't been public for three years, and it does not yet have $1 billion in sales.

But, enough angst! What the search engine does have is pretty extraordinary.

Yahoo! hosts visits from 48% of the total Internet audience at each month. That's in excess of 30 million regular users. With the recent acquisition of, that number will rise by at least another 25%. Then add to this that Yahoo! offers investors sterling financials and a recognizable (and well-liked) worldwide brand. Then throw in that management is young and aggressive. And top it off with the fact that this medium -- contrary to the 1990s thinking of "Bearron's" magazine -- will become the communication source for the entire world over the next fifteen years.

Add it all up and you have a company that is in excellent position to take advantage of an absolutely enormous market opportunity going forward.

But before we get too much into Yahoo!, grant us a moment to talk about why we're buying a Tweener, and the risks associated with doing so.

Why and What and How

As a real-money account, the Rule Maker portfolio does more than just illustrate the performance of several market-leading companies. This is not a mere model, Fools, swept of all life, breath, and soul. Instead, as most of you know, the Rule Maker Port is an example of applied theory, of the mind and hands working together, of real money invested in real companies resulting in real consequences.

As such, so long as we're still breathing, our investment thinking will always gently evolve. We'll abide our investment principles when it is to our maximal benefit to do just that, yet bend them if we believe doing so can lead to greater reward. This design all started back in February 1998, when we placed the Foolish Four herein, wanting to stabilize our $20,000 investment with a time-tested defensive strategy for market-beating gains (to date, the Foolish Four has actually been a pretty weak addition to the mix).

We then added Rule-Making businesses. And, believe it or not, each of these companies violated at least one of our investment principles. Microsoft came closest to the ideal, but didn't offer regular repeat purchasing from billions of people around the world. Coca-Cola had debt. The Gap's material costs were too great to push its gross margins over our high hurdle. Then Intel's profit outlook wobbled. Cisco didn't have a mass-market brandname. And Pfizer's accounts receivable were in a mildly weakened state.

There was imperfection everywhere. We could find no true Rule Makers anywhere. Yet still we went ahead, investing in the best businesses we could find, while remaining on the lookout for worldwide market leaders in industries that offered high margins, sustainable growth, and the loyalty of millions upon millions of we the people. Given our willingness to invest in a collection of near misses, it hardly now seems out of character for us to bend one variable to let Yahoo! into our stable of opportunities.

Would we really have to bend only one variable? Actually, yes.

You will see below that Yahoo! does, in fact, meet all of our criteria for excellence, except for one. With just $200 million in sales, it falls short of our billion-in-sales standard, and thus is too small to yet be garbed in the purple robe and deified. But far from scaring us out of taking a position, Yahoo!'s small sales base and high margins actually pique our interest. The profits are there, and there's still plenty of room for growth. A solid foundation, with construction ahead.

Risk and Reward

Speaking of foundations, let us now give the real reason that we feel very comfortable dropping a $2,000 investment into a tweened company. Why? Because we've already laid a firm foundation of market leaders and Dow heavies before this purchase.

We now have more than $29,000 invested in great companies. Our one-year returns of 33% are a solid eleven percentage points ahead of the S&P 500. And with 60% of our portfolio invested in Microsoft, The Gap, Cisco, Pfizer, Intel, and Schering- Plough, stirring a Tweener into the mix hardly threatens the overall concoction.

Finally, we are adding a Tweener because we have the time and appetite for the additional risk (and potential for additional reward) that the investment entails. We will be placing less than 7% of our total assets into Yahoo!, meaning that its total demise would hardly threaten our overall account.

But why talk about demise when there's so much potential ahead? Let's instead consider the business.

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