<THE RULE MAKER PORTFOLIO>

Adding Money on the Dips

by Matt Richey (TMF Verve)

ALEXANRDIA, VA (May 6, 1999) -- So far this week, you've seen just about every angle on how, when, and what to buy when adding money to a Rule Maker portfolio. One aspect on which you've seen a slightly different opinion each night, however, is how a stock's current price should (or should not) factor into this decision. On Monday, Tom shared that he doesn't worry at all about a company's current price; business quality is his only concern when adding to holdings. Phil admitted, on Tuesday, that he prefers to add money to Rule Makers that have pulled back from their 52-week high. And then, last night, Al stated that valuation is one of his considerations when adding money to his portfolio.

So, we have a bit of healthy disagreement among the Rule Maker managers -- nothing wrong with that. Interestingly enough, all of the Rule Maker managers are in agreement that when initially purchasing shares of a Rule Maker, the current stock price should be of no concern whatsoever. Yet, we seem to disagree when it comes to adding money to our holdings.

Here's a quick refresher from Rule Maker Step 7 on why we believe business quality is at least 100 times more important than a stock's current valuation:

"If we grant you that finding companies like Coca-Cola is a challenge, will you grant us that if you can find them, worrying about their P/E ratio today, or their projected cash flows over the next five years, or the images on their stock graph is worrying about something that will end up being totally inconsequential? Given the performance of just Coca-Cola (and there are other examples), at what point over the last eight decades would it have been smart to stress out about the stock's immediate fair price? We submit to you then, Fool, that valuation isn't half so important as quality and the durability of the business model. At least when you're building a Rule Maker Portfolio."

Like Al and Phil, I must confess that I prefer to add to my Rule Makers on the dips. Many studies have shown that you can substantially improve your returns by buying when investor sentiment is pessimistic. Every once in a while, tried-and-true, superior businesses such as Coca-Cola, Pfizer, Intel, and others suffer from worries about next quarter's earnings or some other near-term concern. When the market throws hanging curve balls like these, long-term investors should step up to the plate and take a Mark McGwire swing.

Proponents of buying the dips relish such quotes as this one from investing legend Warren Buffett:

"I'll tell you the secret of getting rich on Wall Street. You try to be greedy when others are fearful, and you try to be very fearful when others are greedy."

When prognosticators call for the end of the world, jumping in to buy shares of world-class companies is pure genius, but these opportunities are rare. Practically speaking, not only are these opportunities infrequent, but they are totally unpredictable. Should an investor only be willing to add money to stocks that have pulled back, say, 20% from their 52-week high?

Here's where an investor can run into trouble. Many of the best Rule-Maker stocks simply don't pull-back all that often. Waiting for a pull-back often carries an expensive opportunity cost. For example, let's say that Foolish Fiona is waiting for a 20% dip in her favorite Rule Maker before adding money. Well, she might have to watch the stock go up 50% or more before getting that dip -- not much of a reward for her patience. Sometimes, human stubbornness prevents us from ever buying after a missed opportunity. Here's a clip from the Fool's recent special on Berkshire Hathaway (NYSE: BRK.B) that chronicles just such a disappointment for Warren Buffett:

"I [Yi-Hsin Chang] asked Buffett about one of my favorite companies, Costco (Nasdaq: COST). I asked why Berkshire had not made a bigger investment in the discount warehouse club especially considering Charlie's [Munger] involvement on Costco's board of directors. I mean, was it a mistake of omission? Warren's response: "Yeah, you hit on a good one here. We should've owned more Costco, and probably if Charlie had been sitting in Omaha, we would've owned more Costco.... Charlie was constantly telling me about this terrific method of distribution, and after 10 years or so I started catching on to what he was saying, and we bought a little bit of Costco at Berkshire.

"We actually negotiated to buy more. I made there the most common mistake that I make.... We started buying it, and the price went up, and instead of following it up and continuing to buy more -- if Costco had stayed at $15 a share or so, where we were buying it, we would've bought a lot more. But instead it went to $15 1/8, and who could pay $15 1/8 and when they'd been paying $15 -- it wasn't quite that bad. I have made that mistake a lot of times, and it's very irritating."

Admittedly, such mistakes haven't hurt Buffett or Berkshire too badly (see chart). But, this example demonstrates that buying quality first, second, third,... fiftieth is the smartest way to invest -- whether buying shares for the first time or the tenth. Earlier I mentioned that I prefer to buy the dips, but I've concluded that when it comes to top-quality versus second-best-on-sale, top-quality wins no matter the price.

What do you think on this debate? Should a Rule Maker investor concern herself with a stock's current price? Come voice your opinion on the Rule Maker Strategy board, which is linked below.

See ya on the boards,

Matt

05/06/99 Close

Stock Change    Bid
AXP   +1 5/8    131.00
CHV   -2 1/4     97.81
CSCO  -4 1/32   106.94
EK    +  5/16    78.00
GM    -1 9/16    85.38
GPS   -5 1/8     64.25
INTC  -4 5/16    59.69
KO    -1 3/8     69.13
MSFT  -1 3/16    77.94
PFE   -2 7/16   115.88
SGP   -  3/16    50.38
TROW  +1 5/8     39.38
XON   -2 5/16    82.50
YHOO  -9 7/16   151.88

                  Day     Month  Year    History
        R-MAKER  -2.61%  -2.24%   9.58%  38.66%
        S&P:     -1.13%  -0.23%   8.68%  34.45%
        NASDAQ:  -2.45%  -2.78%  12.75%  49.57%

Rule Maker Stocks

    Rec'd    #  Security     In At       Now    Change
    2/3/98   48 Microsoft     39.13     77.94    99.15%
    5/1/98   55 Gap Inc.      34.37     64.25    86.94%
   6/23/98   34 Cisco Syst    58.41    106.94    83.08%
   2/13/98   44 Intel         42.34     59.69    40.98%
    2/3/98   22 Pfizer        82.30    115.88    40.80%
   5/26/98   18 AmExpress    104.07    131.00    25.88%
   2/17/99   16 Yahoo Inc.   126.31    151.88    20.24%
    2/6/98   56 T. Rowe Pr    33.67     39.38    16.93%
   8/21/98   44 Schering-P    47.99     50.38     4.96%
   2/27/98   27 Coca-Cola     69.11     69.13     0.03%

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon         64.34     82.50    28.24%
   3/12/98   20 Eastman Ko    63.15     78.00    23.52%
   3/12/98   17 General Mo    72.41     85.38    17.91%
   3/12/98   15 Chevron       83.34     97.81    17.36%

Rule Maker Stocks

    Rec'd    #  Security     In At     Value    Change
    2/3/98   48 Microsoft   1878.45   3741.00  $1862.55
   6/23/98   34 Cisco Syst  1985.95   3635.88  $1649.93
    5/1/98   55 Gap Inc.    1890.33   3533.75  $1643.42
   2/13/98   44 Intel       1862.83   2626.25   $763.42
    2/3/98   22 Pfizer      1810.58   2549.25   $738.67
   5/26/98   18 AmExpress   1873.20   2358.00   $484.80
   2/17/99   16 Yahoo Inc.  2020.95   2430.00   $409.05
    2/6/98   56 T. Rowe Pr  1885.70   2205.00   $319.30
   8/21/98   44 Schering-P   2111.7   2216.50   $104.80
   2/27/98   27 Coca-Cola   1865.89   1866.38     $0.48

Foolish Four Stocks

    Rec'd    #  Security     In At     Value    Change
   3/12/98   20 Exxon       1286.70   1650.00   $363.30
   3/12/98   20 Eastman Ko  1262.95   1560.00   $297.05
   3/12/98   17 General Mo  1230.89   1451.38   $220.49
   3/12/98   15 Chevron     1250.14   1467.19   $217.05

                              CASH     $70.09
                             TOTAL  $33360.65

Note: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it adds $2,000 in cash (which is soon invested in stocks) every six months.

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