First-hand Florida Gulf report

I just got a call from Cactus Schroeder, a friend of S&A and an honest-to-goodness Texas oilman. He's vacationing at a condo in Destin on the Florida panhandle.

Cactus flew into the new Panama City airport on Southwest yesterday. The flight was full, and the airport was handling plenty of traffic. He found the new facility attractive, clean, and "easy to get into and out of."

He drove to his condo right on the Gulf and reported not a drop of oil in sight. Oil workers in boots and rubber gloves were, however, hanging out on the beaches. Also, some big fishing boats and an oil tanker were floating out in the water. But they hadn't found a drop of oil, either.

He's swimming in the surf and not at all worried  about his kids doing the same. Tomorrow, he's going out fishing about 10 miles offshore. Fishing guide boats are scarce these days because they're making more money working for BP than they ever made as fishing guides.

West of Pensacola, in Mississippi, Alabama, and Louisiana, things are reportedly much worse. But east of Pensacola in Florida, the beaches are fine.

Cactus is having a great time, getting into restaurants without waiting and generally enjoying the reduced traffic everywhere. It's not a ghost town, he says. It's just not as busy as it normally is this time of year.

Johnson & Johnson shares were down today as the company cut its 2010 profit expectations, due in part to the recall of Tylenol and 40 children's products. JNJ sales in the U.S. and Europe declined. Mr. Market is unhappy with this and punished the stock with a 2% drop.

The Egan-Jones ratings agency told investors the recalls will hurt the company's image more than its results. But Egan-Jones said, "Forget the U.S. and Europe... The Western Hemisphere excluding the U.S. was up 13.2% and Asia-Pacific was up 12.1%."

Johnson & Johnson is one of the world's most ubiquitous health care brand names. It's in stellar financial condition. It carries only $12 billion in debt versus $18 billion in cash and a market cap of $160 billion. Egan-Jones' credit rating on Johnson & Johnson is double-A-plus, a single notch below perfection.

Johnson & Johnson is a great business with a solvable one-time problem, a formula often cited by Warren Buffett as a moneymaker. A World Dominating franchise like this is certainly worth more than 12.5 times the low end of its projected 2010 profit, probably more like 18 to 20 times earnings. Johnson & Johnson is one of the all-time great dividend payers, too, having raised its dividend every year for the last 47 years. At 3.6%, the current yield could easily grow to 5% or 6% over the next 10 years, based on today's cost. World Dominator stocks are like bonds with coupons that grow.

At a cookout over the weekend, I spoke with a local dairy farmer. He confided that he went into the stock market in a big way right at the top back in 2000. He laughed it off. I had to admit, it was funny to hear a man who owns a herd of animals acknowledging his own herd-like behavior. The conversation shifted to his organic milk business, a much more pleasant topic. The business hasn't declined the last two years, but merely leveled off after several years of high growth. He's done great the last several years and well enough the last two.

I've heard the same story a hundred times. Many individual investors are good at their own businesses. They know what they're doing. They're usually able to grow in it and make more money over the long haul. Unlike their stocks, they don't get a quote on the business every day and they are intimate with the financials, the risks, the competition, and the future outlook... everything they need to know to prosper.

But with stocks, they try to dance in and out of the market like a prima ballerina, usually based on the flimsiest rationales. They forget it takes years of painful dedication and sacrifice to become a prima ballerina. If you skip the dedication and talent and insist on playing anyway, the market won't let you skip the pain.

I wonder how much better most investors would perform if they insisted on knowing every stock as if it were going to be their only business activity for the next 10 years. I bet they'd buy less often and sell almost never... and make a lot more money (much of it in dividends).

My 19-year-old son stepson was at the cookout, too. He's been volunteering at the fire department and working for his father, a homebuilder. He talked about becoming a construction worker on commercial building projects for government agencies. He says government jobs pay $42 an hour. I asked him what he'd be doing for $42 an hour. He said, "Helping out... all kinds of stuff."

In other words, $42 an hour is a boondoggle wage, paid indiscriminately out of taxpayers' pockets to everybody on the job. He knows nothing of my advice to my readers on "how to make the government pay," but he seems to have mastered the concept fresh out of high school. He likes going to work every day. I have high hopes for him. If he can't steer clear of the stock market, I hope he'll remember how to make the government pay him there, too.

I don't discourage the kids from doing anything productive that they enjoy. But I worry about my stepson becoming a builder right now. Most of those jobs are residential building, which is depressed and getting worse. Housing starts fell 5% in June, bringing them to their lowest level since October 2009. It's going to take years to work out the excess supply of homes, and this area was hit hard by the bursting of the bubble. My current home would never have gotten as cheap as it was if that weren't true. Maybe I should bring up the possibility of a career in distressed real estate investing. That's what homebuilders are doing these days...

One homebuilder sees opportunity in distressed real estate. Toll Brothers, the largest U.S. luxury homebuilder, has formed a new company to invest in just that.

The new company is called Gibraltar Capital and Asset Management. Toll Brothers said the new company would pursue:

[T]he acquisition and disposition of loan and property portfolios; the development of sites for sale to other builders; providing assistance to banks and developers in the workout of troubled real estate; and a myriad of other potential investments where our capabilities and capital access can add value.

Toll Brothers was a successful investor in distressed real estate during the last big real estate downturn in the early 1990s. Another homebuilder, Lennar, has also invested in distressed property. It bought a piece of a $3 billion loan portfolio acquired by the FDIC from a failed bank.

Toll Brothers sells McMansions. I'm pretty sure there were more of those built over the last 10 years than just about anything else. It makes more sense for Toll to get into distressed property than most homebuilders, since its homes have likely declined in value more than most over the last two years.

Both Toll Brothers and Lennar trade at slight premiums to book value. My fear is anything but a large discount to book value is still too much to pay. Hard as they've been hit, I'm still avoiding the homebuilders for now.

The machinations of Goldman Sachs often make for good theatre. The latest is the investment bank had a bad quarter because two big, bad governments ganged up on it. The U.K.'s new bonus tax cost Goldman $600 million last quarter. Its historic settlement with the SEC cost $550 million.

The Wall Street Journal website this morning ran a photograph of Goldman CEO Lloyd Blankfein with hand on head, looking very worried. Who's he trying to kid? We know its operation. That's pocket change for Goldman.

Goldman is still Goldman, and it will still magically, mysteriously come out on the right side of every trade... just like it's always done in the past. Goldman's ability to make tens or even hundreds of millions of dollars day after day is uncanny. It's so uncanny, it stinks.

If you think the new financial landscape is tough for Goldman, imagine how much worse it is for anyone who has to compete with Goldman. 

New highs: Enterprise Products Partners (EPD), Barnes & Noble (BKS; short sale).

In the mailbag, more subscribers focus on our political writing. Remember, the more the government tries to manipulate our economy, the more political finance becomes. Send your e-mails to feedback@stansberryresearch.com.

"I've heard Porter and others beating the drum about their 'world dominators' for quite a while, and I am still very confused... If I look at WMT, I see a stock that has gone sideways for 10 years, while returning a dividend of 2-3%. How is this a great bargain?

"Sure, it was a bonanza for 20+ years before 2000, but it's gone dead flat for the last decade, in spite of all their buybacks. I see that the dividend has grown steadily, from about 0.25% in 2001 to 2.5% now, but even after growing 10x that's still a fairly small reward. And I assume it's not going to grow another 10x to 25%.

"INTC has gone down for 10 years, while returning about 3%. MSFT is flat to down with dividends of 2%, and they're losing their grip in their technology market.... Why are these such great opportunities?" – Paid-up subscriber Gary Fritz

Ferris comment: Nobody made money in stocks the last 10 years because 10 years ago was the peak of the biggest equity bubble in history. Even if that weren't true, it wouldn't make any difference because stock price history is a terrible indicator of an investment's attractiveness and future performance.

I'm sorry to have to tell you your e-mail is a pristine encapsulation of why most investors don't make money in stocks. They remain focused on the rearview mirror and never learn anything about the businesses in which they buy and sell stakes as though they were playing a hand of gin rummy.

The stocks you mentioned – Wal-Mart, Intel, and Microsoft – are three of the greatest businesses ever. Today, they're stronger than ever, having maintained their enormous competitive advantages.

Intel and Microsoft earn most of the profits in the personal computer industry, roughly $23 billion pretax last year. Intel has an 80% market share of worldwide microprocessors and has consistently dictated the pace of innovation in that business. Microsoft generates more cash than any business on Earth.

Wal-Mart is the world's No. 1 retailer and has done a better job of reducing the cost of everything from toothpaste to jewelry than all the world's government welfare programs and subsidies combined.

All three of these companies earn consistent profit margins. Intel and Microsoft earn consistently thick profit margins. All three pay a rising dividend stream. Wal-Mart is a world-class dividend payer, having raised its dividend every year since it went public 34 years ago.

When the world's greatest businesses continue to grow and still trade for dirt-cheap prices, there's nothing to do but buy them. Over the weekend, I counted no less than five S&A publications that have come around to the idea of World Dominator stocks since I started recommending them a couple years ago. I can't remember a time when we've all agreed on a single investment idea.

Rather than subscribing to all our pubs separately, the best way to get all of our World Dominator stock picks is to join the Stansberry & Associates Alliance. It is by far the best deal in investment research today. If you're interested in getting every Stansberry publication (except for Phase 1) for life and receiving an exclusive invitation to our annual Alliance conference, contact Mike Cottet, our director of sales, at 888-863-9356.

"Even though I am associated with one of the 'enemies' of S&A Digest, I will lend my perspective on the referenced subject. My team runs a covered call strategy that was recently implemented. For IRA and non-IRA clients comfortable with the strategy, we have reduced 50% of the long-equity exposure in our model portfolio (developed and managed by my team since 2001).

"Our covered call model portfolio is almost identical to the long-equity portion of our model. However, some of the strategies we implement do not provide options. Therefore, we have included as many allocations available. Running a 40/40/15/5 World Balanced portfolio divides equity into 20% long only and 20% covered calls. With most contracts having short duration, we are estimating a conservative 16% ROE, annualized.

"Not only has it been successful thus far, we are saving money for clients through elimination of commissions. Imagine that, not all advisors are greedy and will stab an investor in the back. You tend to cast a large net when you spew. Yes, we work for a major wire house. Yes, we care about our clients, which I believe shows based on returns and fees. I think you make more from your subscription charges per client than we make in fees, which average 0.79%, or .0079 bps for assets under management. Try getting good advice from your online engines for that fee... Good luck." – Paid-up subscriber Trent Siskron

Ferris comment: You make a decent point (though I'm not sure about the fees). There are good apples in an otherwise bad bushel. I know a guy who works for Morgan Stanley, who likewise is trustworthy, runs a value-oriented strategy, makes money for his clients, and doesn't charge an arm and a leg.

"I have a problem understandig why everybody is beating up on the morons in Washington! What about the morons who put them there? Do they get a free pass? Or is this the age old quandry of what came first, the chicken or the egg? I thought that some scientific genius solved the chicken or egg delema!" – Paid-up subscriber A.P.

"I did not subscribe to SA to get hear political diatribes. If that is what you are about return my money!!!! I was under the naïve assumption that you gave advice about the stock market. Why are the rich afraid to play a part in the economic recovery? Too selfish? I got mine and I don't care about anybody else? When the middle class starts working again – if you ever lend them enough money to restart businesses – they wlll pay TAXES and we will rebound. Why can't the superwealthy pay their fair share of TAXES?" – Paid-up subscriber Ricki P

Ferris comment: If 90% isn't their fair share, I have to wonder how much is?

[Y]ou do not show respect for our president. What is this OBAMA! – It is President Obama. I'll be stopping my subscription to your rag now." – "Ex" paid-up-subscriber "sstipekpmp"

Ferris comment: A purely emotion-driven decision process will do wonders for your investment results. You'll wonder where all your money went.   

"At the end of each S&A you publish three sets of stocks. What do I suppose to do with that information? Are they buying suggestions? Cheers" – Paid-up subscriber Frank

Ferris comment: They're not buy recommendations. They're the top returning open and closed positions by S&A editors. We publish them so you can see the results some of our best work has produced.

"I read Mort Zuckerman's comment that Main Street is waking up to Obama's lack of job creation. But I have to wonder if there not a covert stance on the part of the banking industry to hang Obama out to dry. The banks were given hundreds of billions to bail them out and then, instead of lending to small businesses as they have done after prior recessions, they put the money in Treasuries or sat on it. Given the political leanings of every bank that I am familiar with, and I am retired from the banking industry, it is pretty solidly GOP.

"Similarly corporate America is sitting on $1.8 trillion of cash garnered from cost cutting and layoffs. The beneficiary of that horde is largely the senior management of the corporations who pay themselves huge salaries and bonuses while their companies languish. Pretty sad state of affairs." – Paid-up subscriber Bob Tanner

Regards,

Dan Ferris and Sean Goldsmith
Medford, Oregon and Vancouver, British Columbia
July 20, 2010