Warren Buffett released his 2010 investors' letter over the weekend. You can read the full version here. If you own any stocks or ever plan to buy stocks, Buffett's annual letters should be mandatory reading. It's an easy way to glean insight from one of the world's best investment minds.
Every year, he discusses what's going on in his portfolio (of both equities and entire businesses), his views of the economy, and his plans for the year… And most important, he shares tips on how to value businesses and traits he desires in businesses (internalizing these lessons will make you rich).
Buffett is the ultimate long-term investor. He says his holding period is "forever." He thinks like an owner. As such, he wants businesses that treat owners well… They throw off lots of free cash flow, increase their dividends, and invest their cash efficiently.
Our friend Chris Weber likes to say there are two sure ways to get rich. You either 1) invest at the early stages of a huge bull market or 2) compound. Buffett, though he sometimes invests in emerging markets – note his PetroChina (Chinese oil) and BYD (Chinese autos) investments – focuses on compounding his returns. Take, from this year's letter, his thoughts on Berkshire Hathaway's Coca-Cola investment:
| Other companies we hold are likely to increase their dividends as well. Coca-Cola paid us $88 million in 1995, the year after we finished purchasing the stock. Every year since, Coke has increased its dividend. In 2011, we will almost certainly receive $376 million from Coke, up $24 million from last year. Within ten years, I would expect that $376 million to double. By the end of that period, I wouldn't be surprised to see our share of Coke's annual earnings exceed 100% of what we paid for the investment. Time is the friend of the wonderful business. |
Think about the above excerpt. Now reread it. Buffett finished building his Coke position in 1995. By 2021 (26 years from the buy date), he expects to make more than his initial investment every year. That's the power of compounding.
So which of our advisories do you read if you want to try Buffett-style value investing? Without question, you need Extreme Value. (For an essay from Porter on why you should read Extreme Value, click here.) Dan Ferris has internalized Buffett's investment lessons… And he's used them to make his Extreme Value subscribers a fortune over the years.
Ferris calls his "Buffett-style" investments World Dominators. As the name suggests, these companies dominate their fields… Coca-Cola, ExxonMobil, and Wal-Mart. They produce tons of free cash flow, they constantly raise their dividends, and they make their owners a fortune.
Dan currently has 10 World Dominators in his portfolio. All but his most recent recommendation is showing a profit (remember, these returns compound over time). And eight World Dominators are up double digits. While value investing is far from the sexiest investment style, it's the best for building enormous wealth. To access Dan's World Dominator portfolio, and get started on building your own dynasty portfolio, click here…
Back to Buffett… We know what he looks for in a company. And in this year's letter, he also tells us where he's looking. Buffett said he thinks this year will be "somewhat better" than 2010, but weaker than that of 2005 or 2006. Buffett also said the overwhelming part of his businesses' investments will be domestic.
While Berkshire Hathaway focused in its early years on investing in securities (largely using money from its insurance business), it's now looking to buy entire noninsurance businesses… If you look at Buffett's big recent investments, they've all been industrial companies – BNSF (railroads), Iscar (industrial equipment), and Marmon (a conglomerate). Buffett says he's looking for another major acquisition and his "trigger finger is itchy."
| There is even a supplement to this world-is-our-oyster advantage: In addition to evaluating the attractions of one business against a host of others, we also measure businesses against opportunities available in marketable securities, a comparison most managements don't make. Often, businesses are priced ridiculously high against what can likely be earned from investments in stocks or bonds. At such moments, we buy securities and bide our time. |
The above paragraph means Buffett only buys things when they're cheap. This ability to efficiently allocate capital is key for any business head. But few exercise it. It reminds me of the story of another billionaire, Henry Singleton – the former CEO of Teledyne. Between 1972 and 1984, Singleton repurchased 90% of Teledyne's outstanding stock… but only when it was cheap. Singleton made acquisitions with stock when it was expensive and bought shares back when they were cheap. Singleton never received more than $1 million a year in total compensation from Teledyne. But he became a billionaire by investing in his own company.
Again, I urge you to visit Berkshire Hathaway's website and read all Buffett's investment letters (you can find the complete list here). You can also read The Essays of Warren Buffett: Lessons for Corporate America. It's a collection of Buffett's essays. But they're grouped together by subject, not chronology.
"Put this stock on your watch list immediately… symbol, COCO."
So say the analysts behind our newest trading advisory, the S&A Grail Trader…
In the February 16 Digest, we discussed the concept of "compression," which is one of the extreme moments in time this proprietary trading system searches for in the market.
For example, last summer, the Grail signaled an extreme compression in the silver market… One Grail creator, Denny Lamson, jumped on as a signal to buy the metal. Silver skyrocketed from $18 per ounce to $30 per ounce soon after.
Today, we look at another low-risk/high-reward trading set up that the Grail identifies with regularity… We look at moments of "positive divergence."
Longtime S&A subscribers know you can make big, safe profits when an asset goes from "bad to less bad." Steve Sjuggerud has turned this type of investing and trading into an art form in True Wealth… And Editor in Chief Brian Hunt has pinpointed many huge "bad to less bad" trading opportunities in his DailyWealth Market Notes column.
"Positive divergence" is a similar concept to Steve's bad-to-less-bad model. These trades involve finding assets that have suffered major selloffs… where anyone who could possibly find a reason to sell the asset has already sold. This "blown out" feature makes these trades incredibly safe. The risk has been wrung out of the trades. Every possible seller has reached his "puke point" and given up.
At this point, the asset typically becomes incredibly cheap and hated… You'll find assets selling for 33 cents on the dollar. When assets get this cheap, just a bit of "less bad" news can send the asset screaming higher… like 100% in just a few months.
For example, things were about as "bad" as they could get for the oil company Anadarko Petroleum after the Gulf of Mexico well disaster last year. A minority owner of the now-defunct Mocondo well, Anadarko's shares fell more than 50% during the crisis.
Around that time, we noted how the stock was trading for substantially less than its intrinsic value and due to head higher. Porter recommended subscribers of his trading service sell puts (a bullish bet) to profit from the coming rebound. When things got "less bad," subscribers banked a 40% profit in just six weeks.
Denny says these sorts of trades exhibit "positive divergence." This is where the Grail signals an asset's downside momentum is exhausted and it has formed a bottom. It then "diverges" from its downtrend to register positive gains… and sets up for a big rebound.
This idea is likely the ultimate trading system… one that offers low risk (because everyone has sold), but tremendous upside (because the asset is so hated and cheap).
This leads us to one of Denny's top ideas right now… in the secondary education sector. We warned you before about this sector (also called "for-profit education"). It has suffered a stupendous fall. Allegations of fraud and questionable lending practices crushed many of these educators by 75% last year.
Now, the Grail is signaling this sector is primed for a solid rebound, especially small-cap Corinthian Colleges (COCO). Keep an eye on this potentially big winner… and make sure to learn several amazing signals this technology has generated in the past few years. To learn more about the S&A Grail Trader, click here.
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New highs: Cenovus Energy (CVE), Mirasol Resources (MRZ.V), DirecTV (DTV), Chimera (CIM), Calpine (CPN), Abraxas Petroleum (AXAS), EV Energy Partners (EVEP), SandRidge Energy (SD).
We hand today's mailbag off to Porter. We figured his Digest from Friday would generate a lot of feedback. And we were correct. Below, you'll find a long response to the many questions Porter received. If you didn't read the Digest yet, you can do so here. And if you have comments to add, send them to feedback@stansberryresearch.com.
Porter comment: As I knew it would, my Friday Digest upset a lot of readers. If you didn’t read it yet, I spent several pages explaining the overwhelming importance of asset allocation and learning to shift allocation to capture great values. I also warned you that most readers would ignore the message and shoot the messenger. I was right. Here’s a sample of some of the hate mail I got over the weekend...
"Arrogant, condescending, blather. Consists mostly of 1) self-congratulatory back pats based on what you say you did in years past, and 2) commercials to hype your 'partners' products. I want my money back. You can keep the blather." – Paid-up subscriber G.W.O.
Porter comment: Believe me, if my only goal was to sell newsletters, I would have never written Friday's Digest. As I explained, any time we write about the importance of asset allocation, we cause a big increase in demands for refunds. People get angry with us. I can't say I fully understand it, but it is surprisingly difficult for most people to confront and deal with certain realities of investing – like the importance of asset allocation and how critical it is to know how to accurately value securities. Even writing this update to Friday's Digest will trigger still more refund demands and more angry letters. So after today, I'll drop the topic.
But I know you'll never be a successful investor until you really understand the importance of asset allocation and acquire the ability to properly value securities. If you read Warren Buffett's annual letter this past weekend, you heard the best investor who has ever lived say exactly the same thing. Buffett explained how, unlike almost any other institutional money manager, he faces no restraints on where, how, and when he invests. This enables him to be driven only by a quest for great value. "Our flexibility in respect to capital allocation has accounted for much of our progress to date."
Besides fostering angry demands for refunds, Friday's Digest also caused some well-meaning subscribers confusion. Let me reiterate a few points that many people apparently overlooked or misunderstood. The most commonly voiced concern was about my End of America thesis. How should you adjust your allocation to deal with the growing risk of a major currency collapse in the coming months? Doesn't the inevitability of a big financial crisis in America mean all this asset allocation stuff is a waste of time? Shouldn't we only own gold and silver?
I'm 100% certain America is going to lose the most valuable privilege any nation has ever held – the right to print the world's reserve currency in unlimited quantities. This will have a devastating impact on our standard of living. It will cause the value of the U.S. dollar to fall by at least 50%. And that will send the price of gold and silver higher. It will also cause a sharp correction in stock prices. It will also send long-term government bonds into a decades-long bear market that threatens the stability of our banking system. None of this means you can ignore asset allocation. These problems mean you should focus carefully on the allocations you're making today.
Lots of people seemed miffed that I don't believe you should sell everything and only own gold and silver. Let me be clear: I've bought a lot of gold over the last 10 years. I have never sold an ounce – not one ounce. But I see better value today in real estate than I do in gold or most stocks. Thus, I'm buying properties – low-rent apartments out of foreclosure – in good locations (near the beach in Florida), with a gross cap rate of more than 20%. In six or seven years, I will make back all the money it cost to buy these properties. They will continue to generate cash for me the entire time.
I'm also buying very carefully selected "trophy" properties at prices more than 50% below their peak. To me, these real estate opportunities represent a terrific value, which compensates me well for the risk that real estate prices could continue to fall or the U.S. dollar will suddenly collapse. If the dollar collapses, I expect these properties will yield more, not less.
One of the hardest lessons for investors to learn is that there are always risks. The key to success is making sure you're buying a price that mitigates those risks. You should also know that I'm buying this real estate with cash. I am not at the mercy of interest rates. Instead, adding these properties to my balance sheet now will give me more financial flexibility later. If I need to, I will be able to mortgage these properties. (I have no intention of doing so, but having a real estate portfolio can be valuable that way.)
Like Buffett, I can be extremely flexible with my allocation because: 1. I'm young. At 38, I believe I have at least 30 more years of career earnings ahead of me. Thus, even if I'm totally wrong about real estate (which, as I explained, now makes up about half my portfolio), it will not change anything about my life. 2. Earlier purchases of outstanding values (gold in 2004, equities in 2008) leave me well-positioned to deal with a serious bear market or a monetary crisis. If you begin to allocate with a focus on value, you'll find the same thing happens with your portfolio over time. You'll get better and better at dealing with risks because you keep a tight focus on value.
I've received two other good questions. Here's the first one: "Why do you continue to recommend stocks in your newsletter if you're convinced that stocks are overpriced?" First of all, providing equity research is my primary job. Whether it's a great time to buy stocks or not, people want to know which stocks to buy (or sell short). We provide them with that information. We have also told our readers many, many times we don't see great value in stocks overall. As a result we've kept an active short book. Also, we've only recommended stocks whose earnings will increase significantly in the coming inflationary crisis – primarily agriculture and energy.
The second most common question is: "Why would you recommend selling everything and holding 75% cash?" I find this a funny question. Obviously, many people reading my Friday Digest totally misunderstood what I wrote.
I said if you were starting from scratch today, I would recommend a 75% cash and cash-like allocation because I don't see any obvious values (outside real estate). But that's only if you were starting completely from scratch today. I'm not suggesting anyone sell everything right now and go to 75% cash. So why would I be so cautious with new money right now? Because when you buy matters.
Take gold. For the past 40 years, central banks have been selling gold. Now, they're buying. That's why the price has doubled since the bottom of 2008. Like it or not, it is not a great time to buy gold. If you don't own any gold, I recommend biting the bullet and buying with at least 5%-10% of your portfolio, because I simply don't believe it's safe not to own any. I wouldn't expect it to be a great investment because it's not a great value anymore. With new money, I would primarily look for high-yielding cash-like investments. I would make sure to own a bit of gold and silver. And I would speculate a bit with the rest, waiting for a good opportunity to put a big chunk of my cash to work.
Learn to be patient with your capital. Learn to focus on great value. If you do this… be far, far more successful.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
February 28, 2011Buffett's latest letter... And why he loves World Dominators... Put this stock on your watch list... Bloomberg's End of America... Porter adds to last Friday's Digest...