The annual Report Card: How did we do...?

Today's Digest contains part one of our long-awaited annual ritual – our frank evaluation of the work we've done on your behalf.

You'll find numerical results and grades for our 10 monthly newsletters below. (We'll tackle the trading services next week.) We began this tradition several years ago... much to the annoyance of many of our peers. You see, each year, we call on our fellow newsletter publishers to match our openness and transparency. To date, none have answered our challenge… not even our "sister" publishers in the Agora Inc. network.

Why not? Oh, you know quite well, dear subscriber. It's vastly easier to sell an investment idea (in the form of a report or a newsletter) than it is to actually attain an investment result.

Before we get to the numbers (and the grades), a word must be said about the math behind our Report Card and its intended purpose. As you know, there are lies… damn lies... and then statistics.

Newsletter publishers are rightly famed for being the world's most adept number twisters. Like the degenerate gambler, they never admit to losing. But we've always taken a completely different approach to our self-analysis: We highlight our failures with a bright light. We do so in two ways.

First, we use the most conservative math to show you our results (I'll explain the details behind the math in a moment). Second, we assign not just a number to our performance, but a grade.

Investment performance should not be considered in a vacuum. The circumstances of the portfolio's performance matter a great deal. For example, if you were told – without any supporting information – that a newsletter averaged a 0% return for the last two years, you would immediately think the result was subpar. But... if you knew the time period was 2007 and 2008 and you knew stocks had fallen 50% on average in the period, a breakeven result would actually deserve an A+ grade.

The other consideration that goes into our grades is risk. Risk is notoriously difficult to quantify. Risk is not volatility, as most academics claim. Risk is the possibility of a permanent impairment of value. Evaluating risk in a portfolio requires experience and judgment. Unfortunately for my analysts, I believe I have enough of both to judge their portfolios honestly. Thus, an analyst who achieves a good result merely by picking the riskiest companies, which happen to go up a lot in a given year, will not necessarily earn an "A." Believe me, this causes the folks who work with me a great deal of consternation. But I believe it's the only realistic way to judge performance.

One more point in prelude… You might rightfully wonder why we spend so much time and effort to point out our failures to our customers. After all, you don't walk into a restaurant and expect the maître d' to show you the entrée the chef burnt the night before. We make this effort for three good reasons, which we hope you'll take the time to consider...

First and foremost, we have no interest in selling an advisory that cannot produce good results. We routinely kill successful products if they can't produce at least satisfactory results. Likewise, we routinely fire analysts if we lose confidence in their ability to do good work.

Our passion for these principles stems from our personal experiences. One of the first things I was told at my first job in this industry was not to let my family or any of my close friends invest in the recommendations of the newsletter I was working on at the time. It soon became clear to me why... our portfolio was a disaster.

There's a strange paradox in financial newsletter publishing: Frequently, the best-selling letters produce the worst results. That's never bothered many of my peers in the industry, who care more about their subscriber rolls than their subscribers.

We've never done business that way and we never will, as long as my name is on the masthead. Our friends do read our newsletters – and they invest heavily in the recommendations. Our parents do read our newsletters – and they invest heavily in our recommendations.

When the time comes for me to put down my pen (which should be several decades from now), what will I value more: the money in my bank account or the quality of our track record? True, money is important. But beyond a certain point, money carries no real value whatsoever. At this point in my life, another million dollars will not change the way I live. On the other hand, a hard-won reputation for quality is priceless. That's my goal.

The second reason we insist on publishing a report card each year is because it is an excellent management tool. We have over 70 employees now at Stansberry & Associates. We have close to two-dozen different products. We have hundreds of reports. We have a platoon of analysts and another platoon of associate writers. I can't personally manage all of these people. Nor have I ever wanted to spend my time telling other people what to do.

They all know that after the year is finished, all of our products will receive a grade. And if it's not a good grade, they could be out of a job.

Finally... these report cards give us a terrific advantage in business. Our peers will not produce them. That we do allows us to attract both the most sophisticated customers and the most talented analysts. Everyone wants to do business with someone who is relentlessly dedicated to actual achievement.

And so... how did we do in 2010?

The numbers you'll find below come in two simple forms – a plain vanilla average and an annualized figure.

The average is nothing more than it appears. It's simply the average result the recommendations produced. It does not take time or the likelihood of compounding returns into account. Because there's no reinvestment of gains, this severely handicaps the results actual investors might have achieved.

The annualized figure attempts to replicate the actual results that might have been achieved if reinvestment was maximized. But you should know that annualized results are exaggerated. No one could actually reinvest immediately or perfectly across an entire portfolio. Thus, the real results lie somewhere in between the plain average and the annualized figure. That's why we give you both.

We also offer you a comparison to the S&P 500, which is simply a broad index of large-cap stocks. This comparison assumes you'd bought the S&P instead of our recommendation at the time of each recommendation.

We based this year's Report Card on the period between March 1, 2009 and December 31, 2010. This gives us a 21-month window, which we believe is long enough to be significant. Also, this period matches the beginning of the big bull move in stocks.

You might recall that last year's Report Card covered the period from March 2008 until the end of 2009, a period of time that included the collapse in stocks following the demise of Bear Stearns. Since last year's report card featured a bear market evaluation, I thought it would be appropriate to feature a bull market evaluation this year.

REPORT CARD 2009-2010 Monthly Newsletters

Key
Win %: the percentage of recommendations that led to gains.
Average Gain: the plain average of all of the recommendations.
Ann. Gain: the annualized gains of all of the recommendations.
S&P Comp.: the average return of the S&P 500 assuming you'd bought the S&P at the same time as each of the newsletter's recommendations.
Grade: my personal evaluation of these results.

The first thing that I hope jumps out at you are the results from True Income. True Income is unique among our newsletters. It recommends corporate bonds, not stocks. Ordinarily, you'd expect a bond newsletter to vastly underperform stock newsletters during a raging bull market in stocks. But not True Income.

True Income's editor, Mike Williams, is the most experienced analyst on our staff. He proves, year after year, that most individual investors should focus on investing in corporate bonds, not stocks. I've explained this repeatedly in the Digest. If you're not reading True Income, you're missing out on the very best research we offer – research that's particularly well suited for individual investors. Why? Because as a bond investor, the company has a legal obligation to pay you back, with interest. Thus, you're protected in the event of a bankruptcy. And in general, bonds are much less volatile than stocks.

Think about it this way... If you can make a profit 90% of the time in bonds (as Mike does), and if you can achieve average annualized gains above 40% in bonds (as Mike does)... why would you ever buy a stock? Answer: You wouldn't.

I'll never understand why individual investors aren't breaking down our doors trying to get Mike's letter. But they're not. In fact, we have a very difficult time selling his advice, which is, quite simply, the very best we offer.

If I could give a gift of immediate knowledge to you, it would be to understand corporate bonds. Once you understand these investments, achieving your financial goals becomes simple and nearly risk-free. Said another way, once you understand bonds, you'll never want to own a stock again. Please, if you do nothing else with this Report Card, let it serve as a critical reminder that if you're not invested in bonds yet, you're making a HUGE mistake. To learn more about True Income, click here...

True Income: A++

I'm also extremely impressed with the work Steve Sjuggerud has done in this bull market, which he accurately forecast in the spring of 2009. His track record is nearly perfect. Out of 31 recommendations spanning the period, he only has one significant loss. Meanwhile, he has successfully invested in dozens of world-class investments that are extremely safe – like the Fairholme Fund, Washington REIT, the Hong Kong ETF, and Berkshire Hathaway.

While Steve has achieved a very high average return (26.2%) and a world-class annualized return (46.5%), he didn't produce any triple-digit winners. In other words, his results were driven by an incredibly consistent performance, not one or two big winners. In fact, 20 of his recommendations produced gains in excess of 20%. Steve's results prove that putting safety first doesn't necessarily mean a below-average performance. To learn more about True Wealth, click here...

True Wealth: A+

You'll find a similar performance in The 12% Letter, which is designed to help our subscribers earn consistent double-digit returns with income-producing stocks. Out of 33 recommendations, almost 90% were winners. There were only two significant losses. And as with Steve's portfolio, there were no triple-digit winners.

What you got here was what we promised: consistent results, led by income-producing stocks. The bull market pushed our average returns here up to nearly 20%. With the annualized results at 22.5%, you can see that these recommendations tend to be long term. In fact, the average duration here is over 300 days. This is almost a buy-and-hold approach that's driven by safe, income-producing stocks. And that's exactly what it is supposed to be. To learn more, click here...

The 12% Letter: A+

The next two letters – Retirement Millionaire and Advanced Income – only earned "A"s not "A+"s. They didn't get the "+" because, in my opinion, their average returns simply weren't high enough, given the bull market we experienced.

In the case of Advanced Income, slightly reduced returns during a bull market is to be expected, because this service generates income by selling covered calls. (That's why there's no S&P 500 comparison: The index doesn't generate covered call revenue.) This strategy is designed to protect investors during bear markets, while still making double-digit returns during bull markets. And Jeff did a great job with his portfolio, winning nearly 85% of the time.

Advanced Income: A

Retirement Millionaire likewise offered excellent advice, winning 84% of the time and trouncing the S&P 500. Doc Eifrig's portfolio was perhaps our safest. All his losses were tiny – less than 5%, with the exception of one pick (MELA) that was clearly labeled a speculation, not an investment.

If you stuck with Doc's investment recommendations, you went nearly two years without any significant losses. That's great work... but I didn't give Doc the "+" because I believe average results could have been above 20% in this portfolio, given the scope of the bull move in stocks. Doc was perhaps slightly too conservative during the early stages of the bull move in 2009. Nevertheless, his letter did produce 11 separate recommendations that resulted in better-than-20% gains. That's great work, given the extremely low risk of this portfolio.

Retirement Millionaire: A

Given my focus on winning percentage and average returns, you might rightfully wonder why our S&A Resource Report wasn't awarded an "A+" grade. It produced winning recommendations more than 75% of the time and ran away from the field with an average gain in excess of 50%. It's difficult to imagine there's a newsletter with a better performance over the period anywhere. I expect the editor, Matt Badiali, will throw his laptop across the room when he sees this grade and exclaim, "If that's not an A+ performance, what is?"

Please understand... I think Matt has done a world-class job with his letter. Many of the profits have been stupendous. Over 400% gains on Silver Wheaton. Over 300% gains on Jinshan Gold. Just shy of 300% gains in Silvercorp and Northern Dynasty. Matt's letter was definitely the place to be in the period. I'm extremely proud of this letter and its performance. (I'm also proud of the way Matt handled the terrible bear market in these stocks back in 2008. He got our readers out with minor losses instead of catastrophic losses – and that's even more important to me.)

But he doesn't get an A+ because these results were only accomplished by taking very big risks. Those risks become apparent when you see the size of the losses Matt took on the 13 losses he recorded. They were big… including a real whopper, down 50.1% on Camac Energy. Altogether, there were seven losses in excess of 20%. In my view, that's just too many to get the coveted A+.

I expect a big correction in Matt's portfolio at some point in 2011. The resource markets have run far too high, far too fast. I'd recommend our new subscribers keep an eye on this letter if, as I expect, we get a big correction in 2011. Matt is the guy to follow as the resource markets continue to overheat, thanks to the ongoing global inflation.

S&A Resource Report: A

My letter (Stansberry's Investment Advisory) and Dan Ferris' flagship (Extreme Value) both fell just short of an "A" level performance for the same reason. In an effort to reduce the overall risk of our portfolios, we both recommend short positions in stocks. During a bear market, this will provide big profits... But during a raging bull market, it will usually result in losses. As a result, our winning percentage was greatly reduced.

In my portfolio, half of my 10 losing positions were short recommendations. In Dan's portfolio, five out of his eight losing positions were shorts. While this had the impact of reducing our win percentage and lowering our average gains, both our letters still produced very good results. And I believe including shorts in these portfolios provides our readers with a strategy with vastly lower risk than a long-only portfolio. This strategy is designed to produce "B" level returns year-in and year-out, regardless of what the market does. For "real money" investors, the insurance our short positions provide is worth the short-term reduction in performance.

One other note about these portfolios... Dan deserves special recognition for his world-class recommendation of International Royalty and Altius Minerals, both of which he "pounded the table on" repeatedly. International Royalty led to gains of 239% and Altius was up 106% in the period. If you judged Dan's work solely by his long recommendations, his average return would have been 41.5% – which is simply superb.

As I've said many times over the years, Extreme Value is the most consistent, highest-quality investment newsletter focused on stocks, anywhere. If you're not reading it, you're not a serious investor.

Stansberry's Investment Advisory: B

Extreme Value: B

Two of our monthly newsletters booked "C"s this year – Penny Stock Specialist and Inside Strategist. They did so because their win percentage was too close to the "Mendoza line" – which in stocks is 50% – and because their average returns were marginal considering it was a bull market period.

However, if you only looked at their annualized results – both in the 20% range – you would probably award these letters a "B" not a "C." And in fairness to my analysts, there's a reasonable argument for doing so.

You see, these products both make lots of fast trades. That's why their S&P comparisons are so low and why there's a big difference between the average results and their annualized results. Penny stocks, in particular, require fast trading. And any penny strategy will typically have a lower win percentage but a much higher annualized return.

This kind of fast trading is also very safe, because you never allow losses to get big. Looking at the results, I'd recommend cutting losses even faster in the future and trying to do slightly less trading. I know our penny stock analyst Frank Curzio is the best penny trader in the newsletter world. And I'm certain he'll continue to improve these results.

In regards to Inside Strategist, it's much more difficult to say what went wrong or how, exactly, to improve the performance. This strategy is designed to take advantage of insider buying. Last year, the insiders simply got it wrong time and time again. What wrecked the performance of this letter last year was the poor choices insiders made at a handful of companies that blew up, in particular MELA Sciences and CardioNet.

For many years, Inside Strategist was one of our highest-ranked products, delivering consistent profits – even in the bear market of 2008. Perhaps last year was just the anomaly. We're going to keep a close eye on it this year and see what we can do to make improvements.

Penny Stock Specialist: C

Inside Strategist: C

In conclusion... I hope you'll appreciate what Mike Williams and Steve Sjuggerud have accomplished over this last market cycle. Their work has been nearly flawless. Not only have they've helped thousands of investors recover from the losses of the last bear market, they've taught them investing skills along the way that will prevent them from experiencing losses in the future. There's no reason for you to invest in anything without the aid of these two world-class analysts in True Wealth and True Income. Keep that in mind before you make your next investment.

And if you're seeking investment income, I would urge to you subscribe to both The 12% Letter and Advanced Income. As you can see from these results, they have truly delivered for their subscribers. I helped design these products, and I've measured their performance for many years. I know they work and I recommend them strongly.

We would love to hear from you regarding this Report Card. We want to know if you thought our grades were fair. We want to know how you did using our advice in the period we examined. Please, do not let your subscription expire without sending us at least a brief note. Nothing motivates us more than knowing our work isn't in vain… that our subscribers are doing better in the markets because of our letters. Send your comments to feedback@stansberryresearch.com.

Thanks for your support over these many years,

Porter Stansberry
Miami Beach, Florida
January 14, 2011