When Do You Sell?
Our approach to 3Dfx

By David Gardner

ALEXANDRIA, VA (March 10, 1999) -- The Rule Breaker Portfolio steamed ahead another 2.67%, well surpassing the market averages blah blah blah blah.


"Hey, Fool, you're tellin' me that even with your new hot stock eBay down 11 bucks today, you guys still rose 2.67%?" Incredibly, yep. It simply speaks to the power of a little-guy investor holding onto his winners over time. Today, Amazon.com and AOL made us $15,000 in profits, with Amazon now up 20 times in value, and AOL hitting a new high-water mark, having risen more than 100 times from our purchase price less than five years ago.

So why "blah," above? What's "blah" about this? Well, the blah comes in because while we do daily accounting for our portfolio (versus the indices that day, that month, that year, and historically), we don't get terribly interested, excited, or concerned based on any shorter-term measure than TOTAL HISTORY. So while we've been beating up on the market pretty well this year, you're not seeing us get terribly excited about it. We have our game faces on, and that's the way it'll stay.

When we talk about what's not doing well for the portfolio -- which is a very Foolish thing to do, to try to understand one's mistakes -- you have to eyeball the disappointing 3Dfx (Nasdaq: TDFX). While the stock has fortunately gone like this over the past month (notice the blue line there, which is the market's average -- we at The Motley Fool always compare our numbers to the market average, as should you), it has unfortunately gone like this over the past year... all of which has led to a stock that is down 44.97% for us overall, in a nicely rising market.

Now, you'd like every stock you ever invest in to beat the market, but then again you'd also like nuclear fusion as a cheap energy source, you'd like Duke to lose in the NCAA tournament this year, and you'd like world peace. I ain't holding my breath.

Losers: How do you treat them?

When it comes to the subject of LOSERS, and what to do with your losers, I think we can begin to break down the world of investors into a few distinct groups; I can identify three. The type of investor you are is really demonstrated by how you react to the following situation:

Your new stock, purchased at $25, has nose-dived to $12 in just a few months on no big news. The market overall is slightly up over that period.

What do you do?

For some investors who primarily follow stock prices, they're out. In fact, they often exit a stock if it drops just a few bucks -- let alone a drop of 50%. I call these investors "traders," but you may call them what you like. They have a short-term mentality focused above all on the movements of a stock price. After buying that stock price, they begin thinking right away about where and when they will sell that stock price (stock price -- not business). Exiting early has a flip side: If they're investing in good companies, traders wind up a few years later asking why they sold Microsoft after a 20% gain.

For other investors, those who primarily follow businesses, not stock prices, they will not exit a halved stock -- in fact, they will often double down. They see no fundamental reason why their stock has dropped -- the business looks okay to them. In fact, they probably really love the business. So they buy more of it.

The third group of investors, of which I number myself, is obviously closer to the second than the first. I will call us "Fools." The Foolish investor has bought a BUSINESS, not a stock price. And yet he is humble enough to recognize his thinking may have been wrong -- especially as the market halves his stock. He is not strong-minded or hardheaded; he is open-minded, willing to alter his thinking. He maintains his position because he has found no rational, real-world evidence to disprove his original reasons for buying. And yet the very fact that the stock has been trashed by the market makes him cautious. He will continue to hold until either (a) he sees fundamental and empirical (which simply means real and "observable") evidence that the business's prospects are actually declining, or will decline; or (b) he finds a better place to stick the money. In almost no such situation would I add to this loser. I could have been very wrong in my original thinking -- I don't want to compound the mistake.

3Dfx: Our thoughts on this particular loser

Much of this is relevant to 3Dfx. The company has certainly not dropped on no big news. At various points, 3Dfx has reported very significant news, some bad and some good. However, many times the stock has traded a good deal lower than we believe it deserved. Consider, for instance, that 3Dfx shares are actually up more than 75% from their lows of six months ago. Still, the investment which we made more than a year ago is down 44.97% since our purchase.

I find the company's place in business right now to be among the most interesting of the 13 stocks sitting in our portfolio. 3Dfx, you'll recall, has provided the powerful chipsets to various makers of 3D graphics cards, cards which greatly improve the performance of entertainment software. At the time we purchased the stock, 3Dfx was the clear technology and brand leader within its field, a field slated to offer dynamic growth over the next several years as computers across the world become capable of running 3D graphics, rather than 2D graphics. 3Dfx had the buzz in the gaming community; it was the first choice among gamers, as well as the first choice among many entertainment software companies, who used 3Dfx's own proprietary programming language (Glide) in order to make their games run even better on these popular cards.

To draw a mainstream analogy, 3Dfx's business model was sort of like the manufacturer of sugary syrup for a carbonated drink like Coca Cola. You see, 3Dfx was providing its chipset (the "syrup") to numerous bottlers, all of whom bottled it in their own distinctive cans and bottles with their own brand names. And YET, the 3Dfx name was on every can, and gamers knew to ask for the local soda with the 3Dfx on the can when they went to the store.

Over time, other cans also showed up on the shelves, and their product tasted about as good. The stores began to get very crowded, and this hurt 3Dfx's stock.

Then 3Dfx made a radical change in its business model. A couple of months ago, it announced the purchase of one of its "bottlers," the graphics-board manufacturer STB Systems. In so doing, the company was finally showing its hand, making explicit its belief that "3Dfx" and its "Voodoo" brand of cards are so well positioned among the gaming crowd that people will now ask for the new "3Dfx" or "Voodoo" card when they go to upgrade to the next generation of 3D.

Do you realize how radical and daring this move really is?!

Imagine all the other bottlers. For years, they loved to sell someone else's excellent-tasting drink in cans that bore their own brands, with their own distinctive colors and shapes. For many, these cans were among their best-selling products. But now, the company providing the juice just yanked it away forevermore, planning on putting "3Dfx" and "Voodoo" inside only one can, one bottle -- its own. The business model has now completely changed.

The market didn't initially like this decision, penalizing the stock even more since the mid-December announcement of the acquisition of STB. Wall Street has always hated uncertainty -- at least in the short term. More recently, as the STB acquisition comes near consummation and the first product -- the new Voodoo 3 -- gets ready to hit the market, 3Dfx stock has been bid up.

We have no intention of selling the stock, as I posted to our 3Dfx message board back on December 23rd. An eternal admirer of those who Break the Rules, I am most eager to find out if the company can pull off this surprise. If so, 3Dfx will wind up looking like a bargain at today's price just over $14. If not, we may one day be selling our shares in the single digits.

So, there you have our take on our worst investment. As usual, we're focused on what's to come, not what's happened. What do you think? We have an excellent and active discussion of 3Dfx on our 3Dfx message board.

A couple of quick closing notes. Our Lunchtime News today covered Amazon.com's new deal with Dell, for those interested in reading more about collaboration between e-commerce titans partnering to co-brand Websites. Speaking of titans, hey, how about Steve Jobs duking it out with Bill Gates? Must be time for this week's installment of Dueling Fools (and okay, they're not the writers -- we're writing about them, but still....). Speaking of our writers, Louis Corrigan asks a question of interest to Rule-Breaker readers: "Is there really such a thing as a New Economy company, and if so, does it require that we use new valuation metrics?" That's in our Evening News. And finally, you'll have to wait for this weekend to find out what Marilu Henner of TV's Taxi has to teach us all about buying a car. Only on Fool Radio!

Till next time, see you on the boards. Fool on!

-- David Gardner, March 10, 1999

What's up with Harry Jones today?

03/10/99 Close

Stock  Change    Bid 
AMZN  +7 3/16 137.13
AMGN  +3 1/16  70.50
AOL   +2 3/4   92.63
ATHM  +2 1/2  125.00
DJT   -  1/16   4.25
CHV   +3 5/16  83.25
CAT   +  3/16  49.00
DD    +3 13/16 57.38
GT    -1 1/4   50.69
IOM   -  3/8    5.00
SBUX  +1 9/16  61.38
TDFX  +  3/8    14.13
EBAY  -11 3/16 155.06

                   Day   Month    Year  History  Annualized 
      R-BREAKER  +2.67%   9.28%  24.12% 1145.84%  73.16%
        S&P:     +0.55%   3.92%   5.01%  194.28%   26.48%
        NASDAQ:  +0.55%   5.16%   9.73%  234.10%   30.03%
Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91     92.63   10091.45%
   9/9/97  1320 Amazon.com     6.58    137.13    1984.21%
  5/17/95  1960 Iomega Cor     1.28      5.00     290.50%
  12/4/98   450 @Home Corp    56.08    125.00     122.89%
 12/16/98   580 Amgen         42.88     70.50      64.43%
  2/26/99   300 eBay         100.53    155.06      54.25%
  4/30/97 -1170*Trump*         8.47      4.25      49.82%
   7/2/98   235 Starbucks     55.91     61.38       9.78%
  2/23/99   180 Chevron       79.17     83.25       5.15%
  2/23/99   300 Caterpilla    46.96     49.00       4.33%
  2/23/99   290 Goodyear T    48.72     50.69       4.05%
  2/20/98   260 DuPont        58.84     57.38      -2.50%
   1/8/98   425 3Dfx          25.67     14.13     -44.97%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 203775.00  $201775.53
   9/9/97  1320 Amazon.com  8684.60 181005.00  $172320.40
  12/4/98   450 @Home Corp 25236.13  56250.00   $31013.87
  2/26/99   300 eBay       30158.00  46518.75   $16360.75
 12/16/98   580 Amgen      24867.50  40890.00   $16022.50
  5/17/95  1960 Iomega Cor  2509.60   9800.00    $7290.40
  4/30/97 -1170*Trump*     -9908.50  -4972.50    $4936.00
   7/2/98   235 Starbucks  13138.63  14423.13    $1284.50
  2/23/99   180 Chevron    14250.50  14985.00     $734.50
  2/23/99   300 Caterpilla 14089.25  14700.00     $610.75
  2/23/99   290 Goodyear T 14127.38  14699.38     $572.00
  2/20/98   260 DuPont     15299.43  14917.50    -$381.93
   1/8/98   425 3Dfx       10908.63   6003.13   -$4905.50

                              CASH   $9924.87
                             TOTAL $622919.25

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.


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