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No. of Recommendations: 27
Well its has over 3 years since the inception (1/6/98) of the rule maker portfolio. Considering that the rule maker portfolio has not produced worthwhile performance, the rule maker managers can now consider themselves fired.


Based on the posts on the Rule Maker boards for the past few months, yours is a common sentiment. I would also wager that a great many Fools have abandoned the Rule Maker approach as it is now constituted because of our poor performance over the past six months, which has taken our historical returns from slightly beating the S&P 500 to drastically underperforming it. At this point, I think it would be a positive development if we reexamined the results of the past three years and see what could be done to revamp the criteria. As for me, I would lobby for the following changes:

1) Valuation must be added to the criteria in some form or fashion.

I think the one thing that contributed heavily to our underperformance was the fact that we paid absurd prices for many of the stocks in the our portfolio. It is quite possible to pay too much for a good thing. For example, the BMW 3-series has repeatedly gotten high marks from the various car magazines over the years. However, I am not about ready to pay $1 million dollars for one ... they just aren't worth that much, regardless of the quality. I think we need to look at the valuation of the stock at the time of prospective purchase, and then determine what our chances are of achieving market beating returns (say 15% per year) over the next five years or longer. If the numbers don't make sense, then cross the stock off the list ... end of story. If I can't make a solid case for the stock beating the market average return over the long-term, then I don't want it in my portfolio. The 2x5y method is a step in this direction, but still seems pretty convoluted to me. It seems a lot like a discounted cash flow calculation in my mind ... you can tweak the numbers slightly here and there and wind up justify almost anything. Well, maybe not YHOO or JNPR's stock price, but you get my drift.

2) If the purpose of the Rule Maker portfolio is to validate the success of the Rule Maker criteria at selecting market beating stocks, then we need to be a lot more discriminating in which stocks get added to the portfolio.

If a stock doesn't meet several of the benchmark criteria, then it shouldn't be added to the portfolio ... period. For example, YHOO never should of been added to the portfolio because it didn't have $1 billion in annual sales. The Rule Maker managers even admitted as such when they bought it:

"...That said, Yahoo! does represent the first example in our portfolio of a company that's neither a classic Rule Maker nor part of our Foolish Four heavies..."

If it wasn't a Rule Maker then, why buy it? Wouldn't that end up invalidating the whole experiment, especially if it never evolved to the point where it could be called a legitimate "Rule Maker" ? Many would say that they are at that point right now.

3) Something needs to be done to the criteria to make it more user-friendly for financial stocks.

I know there have been a few columns on this subject, but nothing definitive has made it way into the official criteria (or the Rule Maker Ranker, for that matter) as of yet. Right now, I feel like there are many companies out there that we just ignore (GE, Citibank, etc.) for that very reason. Given that our portfolio is already heavily weighted in technology stocks, I think that adding some Rule Making finanical stocks to the fold would help us in the long-run, and potentially smooth out some of the volatility in the portfolio's performance.

I think many of the fundamentals of the portfolio make a lot of intuitive sense ... buying stocks that have pricing power, that have "light" business models, that are cash generators, and that dominate their competition both in terms of finanical strength and market share. With the few extra tweaks that I mentioned above, I think it makes even more sense as a reliable alternative to beating the market. Only time will tell which direction the portfolio decides to go. It is my belief that the last several months should have taught us some valuable lessons, which we can either heed or ignore at our own peril. As the famous quote goes: "Fool me once, shame on you. Fool me twice, shame on me."

Just my rambling two cents.

the LanceMan
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