I was thinking about Microsoft today, after doing a podcast interview with S&A's Frank Curzio this morning. Both Frank and I are bullish at current prices.
Microsoft reported free cash flow of $22 billion for its 2010 fiscal year, which ended on June 30, 2010. Once you strip out its net cash position, Microsoft's earnings power trades at less than nine times free cash flow.
Microsoft shouldn't even exist. It's been around for decades and it's a huge company. Yet it still earns super-thick profit margins. Back in Economics 101, we learned thick profit margins attract price competition, causing margins to narrow. But not Microsoft's.
Microsoft earns the lion's share of the profits in the PC industry... Microsoft's net income is four times that of Intel, and Intel dominates its market with an 80% global share of the microprocessor industry.
I'm not here to philosophize about how Microsoft got so dominant or how it maintains thick margins. All we need to know is that it rules the roost. I can understand Mr. Market asking, "How can this be?" But Mr. Market is missing the point.
You want safe? Microsoft has one of the few triple-A balance sheets left in the world, with over $36 billion in cash and just $5.9 billion in debt. There's virtually zero financial risk. You want a great business? Our friend Glenn Tongue of hedge fund T2 Partners calls Microsoft "the most cash generative business in the world," and I agree. You want cheap? Microsoft at less than nine times free cash flow is so obvious, so in your face, such a no-brainer right now... it's like a bond yielding 9.7%, with interest that grows.
And of course, every time I write about Microsoft, I get e-mails telling me how stupid I am and how awful the company is. There's no more bullish sentiment than pure revulsion. Microsoft could be the safest, cheapest stock in the world right now... but nobody seems to want it. Well, almost nobody...
Microsoft is one of an elite group of high-quality U.S. stocks that more and more professional investors and advisors are becoming bullish on today. Jeremy Grantham of investment group GMO says high-quality U.S. stocks are now priced to provide better returns over the next seven years than small- and large-cap U.S. and international stocks, bonds of every stripe, and managed timber.
According to Grantham, the only thing set to outperform high-quality U.S. stocks over the next seven years is emerging-market stocks. Grantham predicts 9.1% per year average annual real returns from high-quality U.S. stocks and 10.3% a year from emerging markets. I bet you're taking more risk to get 10.3% in emerging markets than to get 9.1% from high-quality U.S. stocks.
More recently, Barton Biggs from investment advisory firm Traxis Partners said in a Bloomberg interview high-quality U.S. stocks are the most attractive bargain around today. No fewer than five S&A editors, not including me, have recently recommended positions in large, high-quality U.S. stocks.
That's why I keep repeating myself ad nauseam here in The Digest. I don't want to irritate anyone, but I have a job to do. And I really, truly believe deep down in my soul that if you don't own the high-quality stocks – the World Dominators I cover in Extreme Value – you're going to lose money or at least fail to make any over the next several years.
You will get killed in bonds and in most stocks. But not the World Dominators. They're going to take care of you. They rarely get this cheap. When they do, you should buy them and hold them.
Right now, four of my World Dominator picks are cheap enough to buy. Microsoft is obviously one of them. If you want to know what the other three are (and I promise you definitely want to know), click here to sign up for Extreme Value. If you're tired of hearing about this, I hope it's because you already own these stocks. If you don't already own them, I have tons of work to do and miles to go before I put this idea to bed.
How much will it cost to solve Europe's financial problems? Only $4.5 billion, according to the recent stress tests administered to EU banks. The tests' results showed 91 banks in 20 European countries could face $730 billion in potential losses. But only seven banks failed the test, lacking only 3.5 billion euros (or $4.5 billion U.S.).
Five of the failed banks were in Spain. There was also one each in Germany and Greece. For comparison, 10 of the 19 U.S. banks failed our stress tests last year, requiring $75 billion of additional capital.
Though the European results were better than expected, we're not surprised at them... After all, look who was administering the test. A loss of faith in Europe's banks would be a nightmare for the EU.
Take Italy, for example. Italy's largest bank, and a favorite topic of Porter's (see the March 2010 issue of Stansberry's Investment Advisory), is UniCredit. UniCredit holds some $500 billion in deposits. If the stress test showed UniCredit was insolvent, and the bank wasn't able to raise capital, the Italian government would have to guarantee those $500 billion in deposits. But where would it get the money?
Italy, the world's seventh-largest economy, has a public debt of 1.7 trillion euro... Total public debt will soon exceed 120% of GDP. And 25% of its debt is due within the year. Another third comes due next year. And those figures don't include additional deficit spending, which will undoubtedly expand. In other words, Italy is doomed. It can't afford its own debt, much less hundreds of billions of dollars in its citizens' deposits. That leads me to another point...
The stress tests did not account for a sovereign default, which we all know is a near certainty. For a great analysis of European sovereign defaults, and Porter's favorite way to play the European crisis, make sure you read the June 2010 issue of Stansberry's Investment Advisory. To sign up for Stansberry's Investment Advisory and get access to both of these issues and more, click here.
Many of the articles on the stress tests highlight that the U.S. economy improved following the stress tests of its major banks. That's like saying Arnold Schwarzenegger got buff solely as a result of his weightlifting.
The U.S. economy improved because the government injected trillions of dollars into the system, backstopped nearly every large financial institution, and lowered the federal-funds rate to zero (thereby allowing banks to borrow money nearly for free).
As market guru Jim Rogers told CNBC yesterday, the European stress tests are merely "a PR exercise." Rogers also told CNBC, "There are more problems coming in the currency markets, pension funds, US states and cities, etc. None of this was considered although the latter is only indirect for the European banks."
Meanwhile, following the U.S. stress tests, bank failures are still accelerating... Regulators closed seven banks around the U.S. over the weekend, bringing the total failures this year to 103 – far outpacing the 140 total closures in 2009. The seven failures will cost the FDIC $431 million.
With all of these banks collecting trillions of dollars from the government, shouldn't you get your share? After all, these very banks damaged your portfolio over the past few years.
We asked our top analyst, Steve Sjuggerud, how our readers could take part in the cash-printing bonanza our government is sponsoring. Steve has spent decades uncovering off-the-beaten-path investments for his True Wealth readers... And he's always the first to know about government boondoggles that can make you thousands of extra dollars a year...
We think one of Steve's latest discoveries could be his best yet. He's uncovered several Social Security "loopholes," which we've put together for our latest video presentation. In this video, we discuss how to receive an interest-free loan from the government, how to collect Social Security at any age, and how to eliminate taxes on Social Security income. Not everyone will be able to take part in these government-sponsored programs. But if you qualify, you could immediately start receiving thousands more dollars a year. To watch the video, click here.
New highs: Keyera Facilities Income Trust (KEY-UN.TO), Anheuser-Busch InBev (BUD), WD-40 (WDFC), Carbo Ceramics (CRR), AmeriGas Partners (APU), EV Energy Partners (EVEP), Applied Micro Circuits (AMCC).
Happy subscribers in today's mailbag. Thanks for the compliments... but the angry stuff is more entertaining. Send some here: feedback@stansberryresearch.com.
"This was outstanding! Why not send it to Immelt and ask him to respond point by point? Alternatively send it to the WSJ and ask them to publish it in their infamous last 2 pages of Section A. It just frosts the hell out of me that a company like GE think that they can continue to get away with a charade like this. And the mainstream press won't pick up on it! You'll never hear it critiqued on the NBC Nightly News by the dolt Brian Williams." – Paid-up subscriber Ron Martin
Goldsmith comment: You definitely won't hear it on NBC... GE owns the network.
"I joined the Flex Alliance about 2 months ago. I started testing the waters of option trading with a $1500 account which is a fraction of my total net worth. This ensured that if the whole thing got wiped out, I wouldn't have been devastated. Now two months later, I have learned more about markets than in 2 years in business school, and having a whole lot more fun doing it.
"Not to mention being up 10%. I would have been more, but I made a crucial mistake which cost me, but the mistake was relatively small considering the position sizing I am using. I am still going to maintain a small account size while I learn more so that I don't make that mistake (and others I am sure) again. I figure it is a hobby with the potential to earn some money.
"Thanks for all the great research and looking forward to Retirement Trader. A chance to learn from a master is something no one should pass up regardless of age." – Paid-up subscriber Beau
"As an original Alliance member, I have seen many Investment Letters come and go from the Stansberry portfolio. One thing Porter does quite well is monitor what is working and what is not. And right now, I would say most are working very well. Many investors should note that shorting a stock is very easy and can be done really in a couple of different ways. I happen to have made very generous gains from selling calls against the Western Digital trade. When first mentioned by Porter I sold $40 calls and then a few weeks later, sold another batch of $35 calls. Needless to say, things have gone well. One doesn't have to borrow and then buy back the shares to make some nice profits. BTW... doing the same with GE." – Paid-up subscriber Jeff
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
July 27, 2010