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No. of Recommendations: 68
I would dissemble with my nature where 
My fortunes and my friends at stake requir'd
I should do so in honour.

-- Coriolanus, Act III, Scene ii


In today's column, you noted that "One of the resounding investing lessons that many investors (including us Rule Maker managers) painfully re-learned during 2000 is that valuation matters in investing."


I'm sorry, but how could the RM managers have "re-learned" this lesson, when it was so expressly rejected in the portfolio's founding. Heck, the recent unpleasantness confirms the predictions that were made on the very day the portfolio was founded, almost three years ago!

To quote from Tom Gardner's introduction to the new Rule Maker (then "Cash King" porfolio):

II. We are buying overvalued stocks

Of the eight growth businesses whose shares we'll purchase in the next few weeks, all of them look overpriced by traditional valuation methodology. At 30-40-50x earnings, these large-cap stalwarts are, in my estimation, discounted 2-3 years forward. And that means we could see zero growth from our investments over a 24-36 month period. Furthermore, we could witness an interim decline in the value of the overall Cash-King portfolio of 30%.

Who knows? We're prepared for it, though. We expect to be substantially rewarded in the decades ahead.

III. We aren't going to sweat short-term volatility

This potential 2-3 year "silent" period of no returns coupled with a potential 6-12 month "storm" doesn't faze us and won't shake us from our mission -- to accumulate wealth and build financial security over a 20-30 year period. It's our belief that, for long-term investors, buying business quality is 50-100 times more significant than buying temporarily undervalued stocks. For that reason, we're not going to try to time our entry into these investments.

We don't like the thought of potentially watching these stocks double again before falling back 10%; that's a painful way to save 10%!

I'm not sure that I understand why this year would have led the RM Managers to "re-learn" any lessons at all. When you bought these companies three years ago, you made your best assessment of their prospects relative to their price - and you determined that they were discounted 2-3 years forward. You knew when they were bought that you could go 2-3 years with minimal gains.

You expected this. You predicted this!

The RM philosophy, like its sibling RB, is founded on the notion that "quality" trumps "valuation." Your own "Step 7" proclaims it:

So even though (in your best business judgment) you believed that these companies were all overvalued, you bought them anyway - because you believe that their inherent quality will allow them to outperform the market notwithstanding the 2-3 year "correction" you anticipated.

I think you're doing a wonderful thing in recognizing the importance of valuation, but I think you are losing a wonderful educational opportunity. The RM Strategy was based on the notion that you can outperform the market by looking at business quality, with little regard to valuation. In essence, you were saying that Great Businesses were systematically undervalued by the market, even as they appeared to be overvalued, and that those who were scared off by the apparent overvaluation were losing the opportunity to benefit from that outperformance. If you are now rejecting that notion, it will be more educational to do it explicitly, rather than suggesting that this is a lesson that you once knew but are now "re-learning."

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