<THE RULE BREAKER PORTFOLIO>

The Tiny Positions
Are they worth holding?

by Paul Larson (TMFParlay)

CHICAGO, IL (March 19, 1999) -- On the last trading day of winter season the Rule Breaker portfolio continued to squish the performance of the rest of the market with a 0.52% gain, bringing the year-to-date performance up to an impressive 36.75%. Since the average annual gain of the market over the past several decades is close to 11%, perhaps we should sell everything, book a 37% gain for 1999, and call it a year!

I think it's safe to say that none of the Foolish portfolios plan on going to 100% cash. Nevertheless, it's scary to see some of the foolish (small-f) out there thinking along those lines. Most true Fools will be close to fully invested in the market until they are pushing up the daisies. That is, as long as debt is not a problem.

Getting back to the performance of the portfolio, here's how the weekly returns stacked up:

Rule Breaker:  +11.03%
Nasdaq:         +1.68%
S&P 500:        +0.36%

Today I want to talk about the portfolio's three smallest positions, but first let's talk about America Online (NYSE: AOL). Today it was announced that the company will probably chop a significant number of folks from the payroll of the newly acquired Netscape as the two companies are operationally combined. This is not exactly surprising given that most acquisitions are done in order to cut costs, but it's still worth noting.

Even though the portfolio has sold portions of America Online not just once but twice, the stock still looms over the rest of the Rule Breakers with its 38% share of the portfolio's value. It still amazes me to see the shares up over 130-times the original purchase price paid less than five years ago. 130-times! America Online and its performance are obviously the exception to the rule, but isn't breaking rules what this portfolio is all about?

I thought it would be of interest to look at what AOL has done since the portfolio did its partial sales of the company last December as well as back in April of 1997. To my amazement I found that the shares are up 166% since the sale in December and up 1981% since the partial sale in 1997. Just think about that for a moment -- The Rule Breaker portfolio sold a stock less than two years ago that has since increased in value nearly 20-fold! Ouch. It's always a bit discouraging to see shares you've said "Bon Voyage!" to scream skyward, but the proceeds from the partial sales did go towards buying some real winners such as Amazon (Nasdaq: AMZN) and @Home (Nasdaq: ATHM). Obviously, we aren't feeling too bad about the performance of those Rule Breakers today.

Switching gears, one of the more common questions we get on the Rule Breaker message board has to do with the portfolio's lone short position, Trump (NYSE: DJT). The question commonly asked is:

"Trump makes up such a tiny percentage of the Rule Breaker portfolio. With an unlimited potential loss, why continue to hold the short?"

Just to illustrate what a tiny position the short position has become, the liability on the shares held short represents 0.7% of the portfolio's total assets as of today's close. This is a significant shrinkage in importance since it once represented nearly 8% of the portfolio's total value. The point that the portfolio's potential gain from this position is minimal is absolutely true, as is the unlimited loss aspect of the position. Nevertheless, just because a position is small does not mean it instantly becomes irrelevant or not worthwhile.

If Trump goes belly up, a distinct possibility down the road if the company's debt continues to spiral out of control, the portfolio still has $4826.25 to gain from the position. While small compared to the $686,268.31 total value of the portfolio, five grand is still five grand. Plus, it's always nice to have a little money on the other side of the table should the market freak out in the coming months.

The proper reply to the questions about Trump may be, "Why not continue to hold the short?" There is very little that has fundamentally changed since the short position was first initiated, and the future competition in Atlantic City in the form gambling behemoth Mirage (NYSE: MIR) is not getting any further away. The short answer to all this is that we think Trump can fall further, and there's little reason to close a position just because it has shrunk in relative importance to the portfolio. The portfolio will eventually be buying back the 1170 shares of Trump borrowed back in April of 1997, but we won't be buying anytime soon.

The second smallest position in the portfolio is 3Dfx (Nasdaq: TDFX) with a minuscule 0.8% of the total value of the portfolio as of today. Like Trump, 3Dfx once held a much more prominent position with over 7% over the total value of the portfolio tied up in the stock. Partially due to the stock being down 46.4% since its purchase as well as the other stocks growing like kudzu, 3Dfx could now go to zero and barely make a dent in the portfolio's performance.

3Dfx has become one of the portfolio's "problem stocks" that we're keeping a close eye on. With the company's purchase of STB it has essentially abandoned its strategy of licensing its chipset to as many graphics board makers as possible. Instead of counting Diamond Multimedia (Nasdaq: DIMD) as one of its customers and partners, Diamond (and others) are now competitors. While certainly a bold move by 3Dfx to vertically expand its business, the outcome of the new strategy remains to be seen. Either way, 3Dfx and the rollout of the VooDoo3 product is sure to be one of the more interesting stories to watch unfold over the next few months.

It may be hard to believe, but less than two years ago Iomega (NYSE: IOM) was the largest holding of the portfolio. Once representing over half of the portfolio's value back in 1996, it represents a mere 1.4% of the Rule Breaker's value today and stands at the third smallest in size among the thirteen positions currently held. This can partially be blamed on the anemic performance of the company and stock, but it is also due to the decision to sell part of the initial position back in April of 1997. Unlike the decision to sell AOL at the same time, this was obviously a smart move given the mostly downward action seen since.

Like 3Dfx, Iomega is one of the stocks that has the Rule Breaker crew wondering if the company really fits with the new criteria established for this portfolio. It's questionable whether or not the removable computer storage industry can really be called "emerging" today, and Iomega's business momentum is not nearly what it once was. David still likes where the company is presently positioned, yet Jeff and I are much less enthusiastic. In any case, Iomega (or any stock) won't be sold until somewhere better to place the funds has been found. Of course, the search for new companies that are breaking the rules (as well as new buzzard-bait shorts) is a continually ongoing process.

Finally, Starbucks (Nasdaq: SBUX) splits 2-for-1 after the close of trading today. Would you like your pizza served cut or uncut? Care to have two nickels instead of that dime? (In other words, we think this split is a non-event.)

And for those who have some free time tomorrow, Dave and Tom will have Yogi Berra on the radio show. They'll also be discussing the newest addition to the portfolio, eBay.

Have a great weekend!

-- Paul Larson

What's up with Harry Jones today?

03/19/99 Close

Stock  Change    Bid 
 ---------------- 
AMZN  -3 3/8  135.06
AMGN  -  7/16  77.56
AOL   +2 5/16 118.69
ATHM  +9 7/16 133.81
DJT     ---     4.13
CHV   +1       87.50
CAT     ---    46.81
DD    -  1/4   56.56
GT    +  7/8   52.44
IOM     ---     5.06
SBUX  -4 1/2   56.06
TDFX  -  1/4    13.75
EBAY  -1      159.75

 
                   Day   Month    Year  History  Annualized 
      R-BREAKER  +0.52%  20.40%  36.75% 1272.54%  76.31%
        S&P:     -1.31%   4.92%   6.02%  197.00%   26.58%
        NASDAQ:  -1.68%   5.83%  10.43%  236.23%   30.02%

Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    118.69   12959.09%
   9/9/97  1320 Amazon.com     6.58    135.06    1952.86%
  5/17/95  1960 Iomega Cor     1.28      5.06     295.38%
  12/4/98   450 @Home Corp    56.08    133.81     138.61%
 12/16/98   580 Amgen         42.88     77.56      80.90%
  2/26/99   300 eBay         100.53    159.75      58.91%
  4/30/97 -1170*Trump*         8.47      4.13      51.29%
  2/23/99   180 Chevron       79.17     87.50      10.52%
  2/23/99   290 Goodyear T    48.72     52.44       7.64%
   7/2/98   235 Starbucks     55.91     56.06       0.27%
  2/23/99   300 Caterpilla    46.96     46.81      -0.32%
  2/20/98   260 DuPont        58.84     56.56      -3.88%
   1/8/98   425 3Dfx          25.67     13.75     -46.43%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 261112.50  $259113.03
   9/9/97  1320 Amazon.com  8684.60 178282.50  $169597.90
  12/4/98   450 @Home Corp 25236.13  60215.63   $34979.50
 12/16/98   580 Amgen      24867.50  44986.25   $20118.75
  2/26/99   300 eBay       30158.00  47925.00   $17767.00
  5/17/95  1960 Iomega Cor  2509.60   9922.50    $7412.90
  4/30/97 -1170*Trump*     -9908.50  -4826.25    $5082.25
  2/23/99   180 Chevron    14250.50  15750.00    $1499.50
  2/23/99   290 Goodyear T 14127.38  15206.88    $1079.50
   7/2/98   235 Starbucks  13138.63  13174.69      $36.06
  2/23/99   300 Caterpilla 14089.25  14043.75     -$45.50
  2/20/98   260 DuPont     15299.43  14706.25    -$593.18
   1/8/98   425 3Dfx       10908.63   5843.75   -$5064.88

                              CASH   $9924.87
                             TOTAL $686268.31

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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