Back in March, I wrote about how some industries are great breeding grounds for Rule Makers, while others have characteristics that make it nearly impossible for any company to satisfy our criteria and achieve the Rule Maker designation.

It's my theory that Rule Maker investors are better served by looking at industries with characteristics proven to support Rule Makers. But what about investors looking for emerging Rule Makers in new industries?

In my last article, I threw out yet another theory, suggesting that Rule Maker investors can reach for additional returns (and take on slightly more risk) by selecting the first companies to emerge from Rule Breaking industries with Rule Maker characteristics. Some examples are Amgen (Nasdaq: AMGN) and Applied Biosystems -- a business unit of PE Corp.-PE Biosystems Group (NYSE: PEB) -- in biotechnology, or Yahoo! (Nasdaq: YHOO) in the Internet portal sector.

Today, I'd like to throw out a third theory for discussion, one that relates to prospecting for Rule Makers in the Rule Breaking industries. It goes like this: The value of the first Rule Maker company to emerge from a Rule Breaking industry is further enhanced as more companies from that industry break through and take on Rule Maker characteristics.

Let's use an example from that classic Rule Breaker industry, biotechnology. Amgen was the first company to break through and establish itself with Rule Maker credentials, and remained pretty much alone for several years. In the last couple of years, however, more and more biotech companies have broken through to profitability and are climbing toward elite levels. These additional success stories validated the biotechnology industry, and the market adjusted Amgen's market value dramatically upward.

Let's turn our attention to another Rule Breaking space, the Internet, and one of this portfolio's holdings (and my own), Yahoo! Internet investors have gotten a nasty taste of the downside volatility that is a natural byproduct of Rule Breaker investing.

Because we don't pull the trigger on a purchase until a company scores high on most of the Rule Maker criteria, we have avoided most of the pain associated with the sector, though Yahoo! is down significantly from its December highs.

Throughout the dot-com meltdown, Yahoo! has maintained its status as the standard by which all other Internet companies are measured, and is currently head and shoulders above the rest of the industry. Yahoo! features all of the positive characteristics that originally fueled the manic buying of Internet companies: high profit margins, exceptional revenue growth, small asset base, scalability, and wonderful cash flow.

At the same time, Yahoo! has managed to minimize the downside of competing in the dot-com world that has eaten away at the less fortunate players in this arena: low barriers to entry, which guarantees duplication from several "me too" competitors; easy access to capital to fund those competitors; immensely high customer acquisition costs as dot-coms throw money at marketing and sales initiatives; and low customer stickiness since switching costs are generally low.

Investors looking for validation of Yahoo!'s business model need look no further than number two player Lycos (Nasdaq: LCOS), recently acquired by Terra Networks (Nasdaq: TRRA). Lycos recently reported very strong fiscal 2000 fourth-quarter and full-year results.

Heck, if you didn't know better, you'd think you were looking at the Yahoo! of five or six quarters ago. Just call it Yahoo! Lite.� Lycos has definitely reached a critical mass of users and has turned the corner to profitability. In a way it's a shame the company is being acquired by Terra Networks, because it will now be much harder to determine the progress of Lycos as an independent entity. Here's a head-to-head comparison of Yahoo! and Lycos for the most recent quarter. 

                 Yahoo! Q2      Lycos Q2
Sales ($mil)        270.12       87.91
Gross Margin        85.4%        83.8%
R&D / Sales         15.1%        8.7%
Net Income ($mil)   73.9         21.49
Net Margin          27.4%        14.7%
Cash King Margin*   48.7%        22.2%
Flow Ratio*         0.34         0.77


Daily Page Views  (July)680 mil  201 mil
Registered users  155 mil        61 mil
*Cash King Margin is based on the nine months ended March 31 for Yahoo! and April 30 for Lycos. Flow Ratios are for March 31 for Yahoo! and April 30 for Lycos.

As a Yahoo! shareholder, I like seeing Lycos succeed. Why? Because Lycos, while a fine business, is about two years behind Yahoo!, and Internet years are like dog years. The fact that Lycos can be that far behind and yet still be making great progress toward Rule Maker status is validation that the portal model is economically very attractive, even for the second-tier player.

Even more validation may be coming from Go2Net (Nasdaq: GNET), which is already cash positive, and CMGI's (Nasdaq: CMGI) Alta Vista, which is expected to become profitable in the next couple of quarters. In my opinion, the success of these companies will help reinforce that the portal business model has tremendous economics. This in turn should lead to a new appreciation of just what a great business we have in Yahoo!

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