We offer a number of different investment strategies here at the Fool. The Boring Portfolio seeks stocks that provide good prospects and are trading cheaply relative to their potential. The Drip Port finds eternal businesses in which it may securely invest repeatedly over time. The Rule Maker looks for companies that are well-established top dogs in growing industries. The Rule Breaker, our baby, looks for those top-dog industries while they're still puppies.

Make no mistake, though. The goal of all these strategies is the same: to find a company that will supply future discounted cash flows well in excess of their present value. When you buy and hold for the long term, you depend on the business successfully building its income above the level of its expenses and producing ever-larger cash flows. Long-term, shares will appreciate in accordance with how well the business achieves this goal.

It's a simple and obvious observation, but it's important to remember. It means that no analyst's upgrade, no comments on CNBC, no Barron's article will affect a stock's long-term performance. It means that it won't affect our holdings one whit if we write glowingly or negatively about them. It means that even Warren Buffett's holdings must produce returns in order to grow in value.

Rule Breaker investors need to know this. They need to recognize that it's not about market momentum or the turn of fashion from B2C to biotech to B2B to, well, whatever it is today. What matters is that the business behind your stock can perform better than others and produce sufficient returns to justify the price you're paying for the shares.

That's right, I said price.

We don't talk much about price in this space, and there's a reason for that, which I'll get to in a moment. First I want to fit price into our future discounted cash flow context.

Over in the Boring Portfolio, they used to talk quite a bit about cash flow models. (You'll still find many such analyses on the Boring Discussion Board.) Their object was to find stocks that have demonstrated their ability to produce cash flow in a very predictable way. The method was summed up well in a recent Rule Maker article and its sequel. The basic point is to calculate the present value of a security after you adjust for the rate at which you expect a stock to kick off cash, minus the opportunity cost of not purchasing a very safe investment, plus some bonus for the risk you're assuming by purchasing a less-safe security.

The Rule Maker portfolio will touch on discounted cash flow, though usually less formally. Those folks generally invest in companies that have the characteristics of huge cash producers. Cash flow models for these companies aren't really helpful. As the alpha wolves in rapidly expanding industries, Rule Makers will find their way to huge piles of free cash in time, so long as they retain their Rule Making characteristics.

Here in the Rule Breaker, we are at least one step farther removed from useful cash flow models. We're looking for the alpha wolves when the pack is just forming. Our holdings often have no profits, much less free cash to share with owners, and are usually far from doing so. In time, however, we expect them to become Rule Makers. The portfolio bought them because we wanted to get dibs on that future cash at an early date. That's why we don't sell stocks like America Online (NYSE: AOL) or Amgen (Nasdaq: AMGN) that outgrow Rule Breaker status and arguably become Rule Makers. We bought them in order to get to this point; why sell them now?

Realize, though, that the farther removed from a clear cash flow model a stock is, the higher the risk that it won't perform as expected, and that you paid a much higher price than it eventually turned out to be worth.

When you look at Amgen, for example, you see about $500 million in free cash flow in 1998 and about $600 million in 1999. You've got a stream of cash that you can reasonably expect to keep flowing, as long as it retains a strong proprietary product line, ideally growing rapidly from new product infusion.

If you look at Starbucks (Nasdaq: SBUX), you find $200 million in operating cash flow in 1999, but capital expenditures outstripped that total, so that free cash flow comes out negative. Still, you can easily forecast that expenditures will trend lower in the future and that operating cash flow will outgrow it.

Amazon.com (Nasdaq: AMZN) requires greater imagination. It had negative operating cash flow in 1999 and high capital expenditures. It's possible to develop a cash flow model that justifies the current valuation (someone has, in fact, as linked here), but it depends upon, shall we say, aggressive growth projections. We here think that Amazon.com will reach those goals, but we recognize that the risk that it will not justify its price is significant.

Then there's Celera (NYSE: CRA). Not only does Celera not have positive operating cash flow, it doesn't even have revenue much worth mentioning. In fact, its eventual sources of revenue are even somewhat unclear, though one can make some reasonable assumptions and explore possibilities.

It's not possible to do much more than guess, and guess wildly, at Celera's ability to produce future cash flow. It's so unclear, so steeped in risk, that it amounts to the kind of investing that venture capitalists do. Celera could go right to zero, unable to pay out one red cent to its owners, or it could become a $300 billion company. What is the right price to pay for that potential loss or gain?

We here believe that Celera will produce future discounted cash flows to justify the price we paid for our purchase, but we realize that we could lose our entire investment. Whenever you invest in a company like Celera, or Human Genome Sciences (Nasdaq: HGSI), or Rambus (Nasdaq: RMBS), based on the hope of future revenues that will turn into profitability that will turn into cash flow, remember that you are taking a great risk.

For taking that risk, we hope to reap a proportionately rich reward.

To get started thinking like a Rule Breaker about Rule Breaking industries, stop by our newly christened Rule Breaker -- Beginners board!

Fool on!
Brian Lund
TMF Tardior whenever he can be.