RULE MAKER PORTFOLIO

<THE RULE MAKER PORTFOLIO>

Counting What Matters

By Tom Gardner

ALEXANDRIA, VA (August 6, 1999) -- There are numbers, and more numbers. Simple equations that can help millions of investors make better decisions. How to tabulate a company's sales growth rate. How to assess its margins of profit. How to count inventory and to score the notes payable. How to figure the returns of the S&P 500 from one year to the next. And how to stack portfolio gains -- after the deduction of transaction costs and taxes -- against that market average return.

Numbers, and more numbers. Flashing like leaves in an autumn breeze across the landscape of the financial world. How many can you catch? The Gap posts same-store sales growth of two percent, and its stock falls eight percent. Network equipment provider Tekelec earns eight cents per share for the quarter, a penny ahead of estimates, and its stock rises more than twenty percent. Online marketer, The Cobalt Group, falls more than twenty percent after selling another four-and-a-half million shares to the public. That all happened yesterday -- and as a service to investors, we largely explain it in numerical terms.

Numbers, and more numbers -- the roots of all great investing are planted in them. But if you're not numerically inclined, don't despair. A Fool knows that investing demands little more than decidedly simple calculations -- multiplication, subtraction, addition, and division, with a splattering of decimal points and the occasional square root stamped on the mess of it all. None of it makes for an advanced form of mathematics, though yes, so much of great investing relies on an endless spate of numerical tasks.

Now, that isn't to say there aren't other qualities at play in the public markets, factors that cannot easily be sliced, measured, marked, and stored. The art of intuition, the ability to sense the direction of the commercial world, and what seem to me to be the non-quantifiable personality traits of the best investors -- like patience, constancy, humility, wit, and the ability to listen to others -- all of these expand the possibilities of our investment portfolios.

In today's article, I'd like to outline two non-numerical things that I look for when I search for a balanced portfolio of six to twelve stocks to beat the market's average return for years to come. I offer them to you in the form of two simple questions that I ask myself as I address each new investment candidate. They are:

1. How critical are the company's products or services?

I have no interest in owning the world's periphery -- in picking up what's moderately important to consumers, waiting for the right share price before buying, and then trying to hold my position for just the right amount of time. And I don't think you should, either.

As someone trained to factor in all the transaction costs and tax expenses of investing, I'm loathe to trade in and out of my stocks. And so, I've always figured that the closer I could get to the core of the human experience, to our basic necessities, the greater would be my chances of buying companies that I might smilingly hold for an entire lifetime.

To refresh ourselves, the basic human necessities are food, water, sleep, shelter, and human contact. Among the businesses serving those critical needs are food companies, beverage companies, clothing companies, housing-related companies, medical companies, communications and entertainment companies, and the financial businesses that help us provide for all of these.

These corporations, aspiring to an enduring relevance in our daily lives, have the best chances of building loyalty and name-brand familiarity. These matter a great deal to me.

That's the first question. The second?

2. How adaptive is the company to where the world is headed?

No matter how entrenched the great brands in our society are today, the world is always being remade. In a free-market system like ours, the feet of commerce don't stand still. The same principles are at play in the natural world, where everything is in a constant state of flux. The weather changes. A branch breaks, and dust scatters. A newt feasts on an injured fly. Night falls, and the light of a half moon pierces (and changes) the woodlands. We know that the natural environment is wound like a clock whose hands reach anywhere, constantly turning, reinventing, changed by the click of the next second coming.

Public corporations exist in this same world of eternal, simultaneous change. How companies adapt to a thunderstorm or a heat wave, how they handle predators, how they nourish themselves, how they interrelate with others -- these are critical concerns for any organism and critical to your assessment of them. And while no living thing can anticipate every trivial turn, still, determining how well a company is framed to adapt to the major changes in its markets is half the battle of the long-term investor. Finding that out is part of cracking the genetic code of an organization.

You might want, for example, to ask of your companies: What is their plan for the Internet? How well are they positioned to serve the rush of baby boomers rolling toward retirement? In a connected world, do they have an international game plan? What are the smallest competitors in their marketplace doing to improve the experience for customers? Can your companies integrate those changes into their models?

When I ask and try to answer these questions, I never fail to learn something new about the corporations to whom I've entrusted the capital that will support my life's future opportunities. Consider asking them, too -- even if (or particularly if) you have a Ph.D. in mathematics. Because amidst the rush of data and calculator clicks, in between the growth in accounts receivable relative to the growth in sales and the direction of gross margins, alongside the quantifiable issuance or repurchase of shares, underneath the mathematics of our public markets, sits a layer of things that cannot so much be counted as considered. In there, I look for whether my companies are engaged today in meaningful things and whether or not they are positioned for what might matter a decade hence.

Tom Gardner, Fool

[If you know of some friends who might like to learn more about reading financial statements, scroll up and click on the "E-mail this to a friend" link in the upper-right-hand corner.]

08/06/99 Close
Stock Change    Bid
AXP   -4 1/16   123.06
CHV   +  3/8     95.81
CSCO  +  3/4     62.25
DPH   -  3/16    17.88
EK    +  15/16   71.06
GM    -  3/4     60.25
GPS   -1 7/16    38.44
INTC  +  1/8     71.56
KO    -1 5/8     59.25
MSFT  -  5/8     85.13
PFE   -  13/16   32.75
SGP   -  11/16   48.38
TROW  +  3/16    33.31
XON   -1 13/16   80.38
YHOO  -1 7/16   126.94


                  Day     Month  Year    History
        R-MAKER  -0.98%  -2.97%   8.53%  36.67%
        S&P:     -1.02%  -2.14%   6.36%  31.59%
        NASDAQ:  -0.70%  -3.43%  16.20%  54.15%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
   6/23/98   68 Cisco Syst    29.21     62.25   113.15%
    2/3/98   54 Microsoft     45.13     85.13    88.60%
    5/1/98   82 Gap Inc.      23.05     38.44    66.74%
   2/13/98   52 Intel         46.93     71.56    52.49%
    2/3/98   66 Pfizer        27.43     32.75    19.38%
   5/26/98   18 AmExpress    104.07    123.06    18.25%
    6/3/99   11 *Delphi Au    17.19     17.88     3.98%
   8/21/98   44 Schering-P    47.99     48.38     0.80%
    2/6/98   56 T. Rowe Pr    33.67     33.31    -1.07%
   2/27/98   27 Coca-Cola     69.11     59.25   -14.26%
   2/17/99   16 Yahoo Inc.   126.31    126.94     0.50%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     80.38    24.93%
   3/12/98   15 Chevron       83.34     95.81    14.96%
   3/12/98   20 Eastman Ko    63.15     71.06    12.53%
   3/12/98   17 *General M    61.28     60.25    -1.68%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
   6/23/98   68 Cisco Syst  1985.95   4233.00  $2247.05
    2/3/98   54 Microsoft   2437.28   4596.75  $2159.47
   2/13/98   52 Intel       2440.28   3721.25  $1280.97
    5/1/98   82 Gap Inc.    1890.33   3151.88  $1261.55
    2/3/98   66 Pfizer      1810.58   2161.50   $350.92
   5/26/98   18 AmExpress   1873.20   2215.13   $341.93
   8/21/98   44 Schering-P   2111.7   2128.50    $16.80
    6/3/99   11 *Delphi Au   189.09    196.63     $7.54
   2/27/98   27 Coca-Cola   1865.89   1599.75  -$266.14
    2/6/98   56 T. Rowe Pr  1885.70   1865.50   -$20.20
   2/17/99   16 Yahoo Inc.  2020.95   2031.00    $10.05

Foolish Four Stocks
    Rec'd    #  Security     In At     Value    Change
   3/12/98   15 Chevron     1250.14   1437.19   $187.05
   3/12/98   20 Eastman Ko  1262.95   1421.25   $158.30
   3/12/98   20 Exxon       1286.70   1607.50   $320.80
   3/12/98   17 *General M  1041.80   1024.25   -$17.55

                              CASH    $255.59
                             TOTAL  $33646.65


Notes: 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.

*Although DPH is not a Foolish Four stock, it was spun-off from GM on June 3, 1999

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