<THE RULE BREAKER PORTFOLIO>

Amazon.BOMB? Not Likely.
Plus, Merrill's threatening your financial health

By David Gardner (MotleyFool)

ALEXANDRIA, VA (June 1, 1999) -- The Rule Breaker portfolio suffered one of its poorer days of 1999, dropping a solid nickel in value (down 5.56%). That was about double the Nasdaq's two cents (off 2.37%). The S&P 500 fared better than both, off 0.58%.

The general malaise all May surrounding those of our Rule Breakers that primarily exploit Internet technology continued. On this, the first day of June, our portfolio remains up 26.39% for the year, well ahead of the S&P 500 (up 5.61%), largely due to the performance of these companies.

I guess I feel OK about that, as our goal is to beat the market year in and year out, even if we don't always finish at our highs. In fact, it won't be every year that we maintain such a lead over the market despite watching a large holding like Amazon.com lose more than 50% of its value. That's exactly what has happened in the past several weeks.

Such volatility will always characterize the revolutionary companies of which we become part owners through our long-term investment purchases. Volatility, thy name is BreakerPort. Comes with the territory. It's always been this way, and it always will be, for richer and poorer. That's why our approach is not for everyone -- in fact, it's not for most people. It's only for those who can stare at a company they own as it loses half of its value and say, "No biggie. Because I continue to believe in this one for the long term."

Does that mean, by the way, that Fools always react this way? Of course not. The Foolish approach involves keeping your eyes peeled as you watch your company and its competitors, and the way its industry is involving. It's about being a student of businesses (not stock prices), picking the best ones with the most staying power, and then staying. Staying, until (if ever) your business loses its staying power and violates the reasons you bought it in the first place. It's at that point that you re-evaluate.

Back to Amazon, it lost 10% of its value today, ostensibly in reaction to the predictable routine jab from Barron's. Predictable? Certainly. Every 3-4 months, that august retro-thinking publication singles out Amazon for strongly-worded, misplaced mockery. That mockery was a bit more strongly-worded than usual this time around -- putting "AMAZON.BOMB" on the cover, with a scary cartoonish depiction of founder Jeff Bezos's face sitting inside a bomb.

The sheer lack of wit of the title reminds me of sports fans who (for instance) say things like "the Boston Red Sux," instead of "the Boston Red Sox." It's the easy tweaking of a name to express easy criticism. It would be as if I titled today's writeup mentioning Barron's this way:

Bear-On's Wrong Again

It is my hope, discriminating reader, that you would think less of me for using such a title, just as I think less of any publication that hopes to stay relevant when it goes 36-point with "AMAZON.BOMB." Perhaps my point is too subtle, or hazily conveyed. I hope not.

Have I read the Barron's article? No, I have not. And I doubt I will. Without being bullheaded about this, I expect that they make the same points they always do, about low barriers to entry ("anyone can do this"), insurmountable competition, incalculable P/E ratio, and "Net frenzy." In other words... the very same points that Barron's consistently makes in criticism, starting with America Online back in 1994. (You know the result, since.)

Of course, if you find something compelling about the article that is outside of these (or the few other criticisms consistently leveled at the company since it came public in 1997), please contribute those to our Rule Breaker Portfolio message board. I enjoy thinking about this stuff, and I particularly like challenges to my thinking as I Foolishly maintain an open mind, as always. The regular arguments, though, will not suffice. They were made just as repetitively and passionately two years ago when we bought Amazon at $6 1/2, and are therefore quite obviously irrelevant to the market's thinking.

Though the stock has been halved in the past month, it remains up some 15 times our purchase less than two years ago.

Remember that cover stories like the one this weekend have, in the past, been fantastic contrary indicators. If this tradition continues, Amazon.com would be a sweet buy today at $106.

Switching gears, I'll be filing the third installment of our "Psychology of Investing" series tomorrow, barring any more immediately compelling material. For those who are unfamiliar with the first two installments, they are here and here.

Onto other things, Merrill Lynch will soon be offering $30-online trades to its customers, less than one year after stating publicly and emphatically that online trading represented "the greatest threat to Americans' financial health"!

What we are watching here is the inevitable and continued playing-out of events that all of Fooldom has been predicting and expecting for several years now. You could look for instance at our depiction of the industry in The Motley Fool Investment Guide (written way back -- in Internet terms -- in 1995), or any one of hundreds of message-board postings at fool.com from people who knew this would happen.

Lo and behold, it is. The financial services industry is being whacked, hard, and it's a long time in coming. The winners are its formerly disconnected and beleaguered customers -- y'know, you and me.

I don't expect price cuts to end anytime soon. I think we may find, in time, that the profit margins (the pennies of profits on each dollar of sales) enjoyed by financial services companies will move toward 0% -- razor-thin, KMartlike margins. In fact, this is the way I often state the mission of The Motley Fool (though it's not our actual one):

"To reduce the profit margins of the transactional financial services industry to ZERO."

Essentially, what I'm saying here is that we exist to help you cut out the middleman and make better, more informed, more rewarding choices on your own. Viva the Internet.

This whole Merrill thing is so, so ripe. I'm just not sure which lesson to draw out of this. Here are some possibilities.

  • Just the latest sign that expensive, value-subtracted "full-service" brokering is headed the way of the Macarena.
  • Makes you wonder just how clueless management really is at old-world financial services companies. What exactly does "management" mean, here -- are we redefining what the term means?
  • What inevitably happens to a business that puts its sales force at direct odds with its customer base?

We continue to predict that you will hear a great big sucking sound (Perot's phrase) made by money that is being Hoovered out of the financial services industry, back into the pockets of those who were being hosed by it. "Full-service" brokers today, managed funds tomorrow.

And Amazon.Bomb? Gimme a break. No time soon.

Fool on.

David Gardner, June 1, 1999

06/01/99 Close

Stock  Change    Bid 
------------------ 
AMGN  -1 5/16    61.94
AMZN  -12 15/16 105.81
AOL   -6        113.25
ATHM  -9 3/16   117.56
CAT   +3 7/8     58.75
CHV   -2 1/16    90.44
DD    +2 3/4     68.19
DJT   +  1/8      5.44
EBAY  -10 11/16 166.50
GT    +1 3/16    60.88
IOM   +  1/16     4.63
SBUX  -1 3/4     35.13
TDFX  +  1/8     19.50

                  Day     Month  Year   History   Annualized 
      R-BREAKER  -5.56%  -5.56%  26.39% 1168.62%   69.37%
        S&P:     -0.58%  -0.58%   5.61%  195.90%   25.23%
        NASDAQ:  -2.37%  -2.37%  10.00%  234.92%   28.49%


    Rec'd    #  Security     In At       Now      Change
   8/5/94  2200 AmOnline       0.91    113.25   12360.80%
   9/9/97  1320 Amazon.com     6.58    105.81    1508.28%
  5/17/95  1960 Iomega Cor     1.28      4.63     261.21%
  12/4/98   450 @Home Corp    56.08    117.56     109.63%
  2/26/99   300 eBay         100.53    166.50      65.63%
 12/16/98   580 Amgen         42.88     61.94      44.46%
  4/30/97 -1170*Trump*         8.47      5.44      35.79%
   7/2/98   470 Starbucks     27.95     35.13      25.65%
  2/23/99   300 Caterpilla    46.96     58.75      25.10%
  2/23/99   290 Goodyear T    48.72     60.88      24.96%
  2/20/98   260 DuPont        58.84     68.19      15.88%
  2/23/99   180 Chevron       79.17     90.44      14.23%
   1/8/98   425 3Dfx          25.67     19.50     -24.03%

    Rec'd    #  Security     In At     Value      Change
   8/5/94  2200 AmOnline    1999.47 249150.00  $247150.53
   9/9/97  1320 Amazon.com  8684.60 139672.50  $130987.90
  12/4/98   450 @Home Corp 25236.13  52903.13   $27667.00
  2/26/99   300 eBay       30158.00  49950.00   $19792.00
 12/16/98   580 Amgen      24867.50  35923.75   $11056.25
  5/17/95  1960 Iomega Cor  2509.60   9065.00    $6555.40
  4/30/97 -1170*Trump*     -9908.50  -6361.88    $3546.63
  2/23/99   300 Caterpilla 14089.25  17625.00    $3535.75
  2/23/99   290 Goodyear T 14127.38  17653.75    $3526.38
   7/2/98   470 Starbucks  13138.63  16508.75    $3370.13
  2/20/98   260 DuPont     15299.43  17728.75    $2429.32
  2/23/99   180 Chevron    14250.50  16278.75    $2028.25
   1/8/98   425 3Dfx       10908.63   8287.50   -$2621.13

                              CASH   $9924.87
                             TOTAL $634309.87
 
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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