Rule Breaker Portfolio

<THE RULE BREAKER PORTFOLIO>

Rule Breaker Attributes, Part 2
Plus, Starbucks, Amazon, AOL news

by David Gardner (DavidG@fool.com)

Alexandria, VA (July 22, 1999) -- Yesterday, in a revisitation of the six attributes of Rule Breaker companies, we discussed attributes one through three. Today we complete the rundown, and then we plow -- Foolishly, that is -- through some news.

Strong Management and Good Backing

The fourth attribute hearkens back to something already covered yesterday, though it is less extreme. If you'll recall, we identified visionary management as a form of sustainable advantage. Here, we make strong management (and good backing) its own attribute that must be validated.

Is this mere redundancy? Nope. There's a sizable difference between visionary management -- off-the-charts performance, companies led by unparalleled minds -- and strong management. Strong management doesn't have to be visionary -- few are because vision is a dear commodity.

How do you get to know a management as an average investor who might not have your phone call returned by the CEO? The answer is, it's easier than you might think. In our media-top-heavy world today, almost everyone's being interviewed by someone at some point. If you follow our Motley Fool message boards, you'll come across frequent links to manager interviews put up by your fellow Fools who are tracking the same thing. Heck, understanding how good management is can begin with a simple question about them, posed on our message board for the stock.

What it comes down to is that you need to have confidence that (1) your managers know where they're taking the company, and (2) they're executing successfully.

Likewise, you can get to know a company's backing in a similar way. You want to know not just who is running the company, but what sizable blocks of holdings are "long" the stock. Who provided the venture capital? Is there anyone who owns more than 5% of your company's shares? (These facts are all public knowledge, obtainable via the prospectus or -- again -- just asking about it on our message boards.) Who are these people? Do you admire them?

The fourth attribute points to the critical importance of having good people involved in your business. We in Rule Breakerdom believe very strongly that, in the end, it is the people (not the product, or service, or market share, or advertising, or what have you) that cause a business to win over the long term. So it behooves us to get to know the people to the extent that we can. Heck, attend the annual meeting. Ask a question. Go up and shake hands afterwards. (These are not deep secrets I'm divulging here.)

Brand

We believe in brands. Branding -- a company's name, its logo, its marketing tagline, the integrated appearance of its products -- counts for a ton. Most great investments are also great brands. In the end, virtually all products and services become commodities, mimicked by the relentless copycatting that is capitalism. So what causes most people to buy Coca-Cola or Pepsi when generic cola (which tastes mostly the same) goes for half their price?

BRAND, BAY-BEE. We reported on the importance of brand in the June 23rd Rule Breaker recap.

We need our Rule Breaker to have a brand. Brands count for different amounts in different industries. In retail (say, Starbucks), brand is really important. In biotechnology (Amgen), it is less so. Still, we like to be able to envision Amgen (Nasdaq: AMGN) as a brand, and we look for signs that that company -- or any of our Rule Breakers that compete in industries where a consumer brand is not critical -- is working toward making brand more critical.

That's the fifth attribute.

"Overvalued"

The sixth and final attribute involves a significant constituent of the financial media calling our company "overvalued." Even better is the phrase "grossly overvalued."

Wow! Radical idea here. You might be asking, "You sure, guys? You're telling me I want Money magazine talking DOWN my stocks, saying they're due for a huge fall?"

You better believe it. Money and Barron's are two of the biggest contrary indicators going. While neither may survive in print form over the next two decades (another radical thought, since they're at the top of the totem pole in their competitive fields), it would be a true shame from a Rule Breaking investor's standpoint if these two august voiceboxes were ever silenced.

You see, if you can find a company that is truly the top dog and first-mover in an important, emerging industry, with a sustainable advantage, excellent past price appreciation, strong management and good backing, and a distinctive (even, dynamite) brand, and then you see that SOME BLOKE AT MONEY MAGAZINE IS CALLING IT OVERVALUED?!!! This is gold.

Here's why: If everyone already liked your stock, they'd already own it. Who would come along and buy the thing, pushing the price up? Good question.

But consider what happens when major media entities run blaring headlines about how some stock is overvalued, or (in Money's case this month), that the Foolish Four doesn't work. What happens is that their readers -- and those they influence -- get scared off. They stay away. If they own the thing already, they often sell.

Now, if you're right about the company -- if it is a great company -- as it executes successfully and grows, these skeptics will eventually be converted into believers. Guess how they show that belief! They buy the stock. That's the way stock prices rise. Thus, this sixth attribute, which seems to be so radical and contrary, is as commonsensical as anything on offer here at The Motley Fool.

Truly, our best investments have been those that have been flamed, flamed MERCILESSLY, relentlessly, often thoughtlessly, by the major media. We hunger for criticism of our holdings. Talk 'em down, Barron's. Not only do we thank you for it -- we even need you to.

There you have a simple -- and, I hope, relatively concise -- restatement of the Rule Breaker attributes.

Please remember that in the end, what I think is a Rule Breaker is not necessarily right -- YOU may be defining some attributes differently, and come away with your own unique list. The nature of this work is stockpicking as an art form. What I mean by that is that Rule Breaker investors are creators. We must create a company's future in our minds to the best extent that we can, visualizing where it is going and what its profits might be. We are not scientifically analyzing past data. We are projecting forward what sorts of strides we can see our youthful upstart make in the big, wide world. Most of our work is subjective.

These things are not attractive, or even possible, for some people. Probably, many people. We're under no illusions here in RuleBreakerLand that our form of investing is for mass consumption. We are speaking to those who prize risk, who think long term, who don't flinch when their shares drop 40%, and who already have a crystal clear understanding of index funds, the Foolish Four, and Rule Making investing. Rule Breaking investing is the most aggressive form of equity investing on offer here in Fooldom. You can do wonderfully well as an investor without ever owning a single Breaker.

We do own 'em, though, and we report on some of them below.

David Gardner, July 22, 1999

Breaker News

by Jeff Fischer (TMFJeff)

Amazon.com (Nasdaq: AMZN) declined 14% following second quarter results that held few surprises. The Fool chomped on the news this afternoon in the Fool Plate Special. The Rule Breaker take: the river has not reversed course. It continues to flow as planned. CEO Jeff Bezos recommitted to heavy investment in order to make Amazon the be-all and end-all of online retailing. The company will invest heartily in distribution in order to meet both rising demand and increased product offerings. All logical. Meanwhile, the quarter's loss met expectations.

In an off-the-cuff manner, Bezos said that Amazon was pleasantly shocked with its toy and electronics sales upon launch. He went so far as to claim that after one day Amazon might be the leading online toy seller. Of course, numbers weren't available. Amazon also shared that auctions, not surprisingly, is its fastest growing business. By the fourth quarter, perhaps toys or electronics will take the torch. The company plans to offer "hundreds" of more products in the coming years.

Cash flow remains positive and inventory turns remain strong. Both items are important as Amazon builds a business. If both remain strong while building, they should be excellent when the company finally "grounds" itself.

After the market closed, Starbucks (Nasdaq: SBUX) announced third quarter results that met expectations: $0.13 per share. Same-store sales rose 6% (healthy), and revenue gained 27% to $423.8 million. The company shared that it targets year 2000 earnings per share growth of 25% (the consensus estimate stood at 26%), and it plans to open 600 new stores in fiscal 2000. Of those, 150 will adorn the Pacific Rim and the UK. Starbucks is brewing steady, market-topping earnings growth. Our buy point, however, may be teaching a good lesson.

America Online (NYSE: AOL) shared strong results after yesterday's close, topping estimates. Today's Breakfast With the Fool munched on the quarterly missive this morning.

All in all, it is difficult to view any of the business accomplishments of AOL and Amazon (as well as Starbucks) as anything but positive. These ships are maintaining their course while throwing more fuel to their noisily chugging motors, going ever faster. The stocks, meanwhile (especially in the case of AOL and Amazon), continue to priced by investors who are trying to value something dynamic and new. Throw a big pinch of active traders into the mix, and you have a recipe for volatility.

To discuss these companies, please visit their message boards or the Rule Breaker board. If I could timewarp ahead 10 years, I'd return to tell you how strong (or not) these companies are in 2009. From here, though, I just have to say: "Based on what we currently know, I believe they will be strong."

07/22/99 Close
Stock  Change    Bid 
------------------ 
AMGN  -2 1/2     72.19
AMZN  -18 1/4   107.19
AOL   -5 1/4    110.63
ATHM  -1 3/4     45.25
CAT   -  1/8     60.50
CHV   -  5/8     93.63
DD    -  7/16    71.75
DJT   -  3/8      4.81
EBAY  -6 5/8    108.69
GT    +1         55.75
IOM   -  1/16     4.31
SBUX  -1 5/16    23.94
TDFX  -  5/16    14.00


                  Day     Month  Year   History   Annualized 
      R-BREAKER  -6.41%  -7.09%  19.52%  1099.67%  65.01%
        S&P:     -1.33%  -0.86%  11.30%  211.15%   25.71%
        NASDAQ:  -2.80%  -0.06%  22.43%  272.75%   30.37%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    110.63   12071.98%
   9/9/97  1320 Amazon.com     6.58    107.19    1529.18%
  5/17/95  1960 Iomega Cor     1.28      4.31     236.81%
 12/16/98   580 Amgen         42.88     72.19      68.37%
  12/4/98   900 Excite@Hom    28.04     45.25      61.38%
  4/30/97 -1170*Trump*         8.47      4.81      43.17%
  2/23/99   300 Caterpilla    46.96     60.50      28.82%
  2/20/98   260 DuPont        58.84     71.75      21.93%
  2/23/99   180 Chevron       79.17     93.63      18.26%
  2/23/99   290 Goodyear T    48.72     55.75      14.44%
  2/26/99   300 eBay         100.53    108.69       8.12%
   7/2/98   470 Starbucks     27.95     23.94     -14.37%
   1/8/98   425 3Dfx          25.67     14.00     -45.46%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 243375.00  $241375.53
   9/9/97  1320 Amazon.com  8684.60 141487.50  $132802.90
 12/16/98   580 Amgen      24867.50  41868.75   $17001.25
  12/4/98   900 Excite@Hom 25236.13  40725.00   $15488.87
  5/17/95  1960 Iomega Cor  2509.60   8452.50    $5942.90
  4/30/97 -1170*Trump*     -9908.50  -5630.63    $4277.88
  2/23/99   300 Caterpilla 14089.25  18150.00    $4060.75
  2/20/98   260 DuPont     15299.43  18655.00    $3355.57
  2/23/99   180 Chevron    14250.50  16852.50    $2602.00
  2/26/99   300 eBay       30158.00  32606.25    $2448.25
  2/23/99   290 Goodyear T 14127.38  16167.50    $2040.13
   7/2/98   470 Starbucks  13138.63  11250.63   -$1888.00
   1/8/98   425 3Dfx       10908.63   5950.00   -$4958.63

                              CASH   $9924.87
                             TOTAL $599834.87
 
Note: The Rule Breaker Portfolio was launched on August 5, 1994, with $50,000. Additional cash is never added, all transactions are shared and explained publicly before being made, and returns are compared daily to the S&P 500 (including dividends in the yearly, historic and annualized returns). For a history of all transactions, please click here.

</THE RULE BREAKER PORTFOLIO>

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