Thu, Jan 31, 2013|Sean Goldsmith

The four pillars of hyper-innovation...

Porter details an actual Stansberry Alpha trade…

In today's Digest Premium… Porter describes how his Alpha trading strategy works by walking readers through an actual trade. In detailing the trade he recommended on one of our favorite "virtual banks" (a mortgage REIT), Porter shows how he uses options to both reduce risk and boost potential returns (compared with simply buying the recommended stock)…

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Porter details an actual Stansberry Alpha trade…

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The four pillars of hyper-innovation... A new (rare) Extreme Value pick... Another Sjug housing pick scores... Running out of silver!... Buy $1 of assets for just $0.88...

I (Dan Ferris) have had my head buried in research on the semiconductor industry for the past week.

It's incredible what's going on. And with Intel trading at just 10 times earnings, it's like the stock market has no idea what's coming...

There are four huge new technological developments rapidly changing the way computer chips are made. I call them the "four pillars of hyper-innovation." Just one of them is so disruptive, Intel's CEO said new developments could bankrupt up to half the industry. And that could happen within five years…

Implementing the new technologies will be expensive. That'll limit the number of industry players able to compete at the highest level. They'll also require large-volume orders to make them worth doing. That'll limit the number of firms able to justify new investment in these cutting-edge developments.

Since I have previously recommended the World Dominator of the microprocessor industry – Intel – you can guess which company I like the most. But it's not the only investment I'm recommending to take advantage of the trend…

I spell out the four pillars of hyper-innovation now transforming the computer-chip industry in the February issue of Extreme Value, which comes out tomorrow after market close.

We're also doing something I never thought we'd be able to do with the S&P 500 trading above 17 times earnings – we're recommending a brand-new technology firm. In fact, we'd buy it at its current valuation even without the four pillars of hyper-innovation we're seeing. It's that good of a business.

This company has dominated its technology niche since the 1990s. It gushes free cash flow and has a fortress balance sheet. And the four pillars of hyper-innovation now sweeping the semiconductor industry can't happen without its market-dominating products and services. (No, the stock is not IBM.)

My research partner, Mike Barrett, and I are the pickiest stock-pickers at S&A (and among the pickiest in the whole financial industry). This is our first new Extreme Value recommendation since September and only our fourth since December 2011.

New bargains have been scarce, so we've refrained from making new recommendations. We're shocked to find such a high-quality business trading at such a cheap price.

Extreme Value readers can access our new pick tomorrow after market close. And we will be talking more about these new technological developments – and what they mean for the sector – in future Digests. Stay tuned.

Private-equity giant Blackstone, a True Wealth portfolio stock, announced blockbuster earnings yesterday...

Steve recommended Blackstone because it's one of the "most successful investors of all time." Over the firm's 27-year history, it has generated net annualized returns on realized investments of 23% in private equity and 28% in real estate.

More specifically, Steve likes Blackstone because the firm has spent $2.5 billion on single-family homes in the U.S. It's one of the best ways to play the housing market through a publicly traded equity.

You can read about Blackstone's housing investments here.

As of the end of the fourth quarter, Blackstone's assets under management hit a record $210.22 billion. (More money under management means more fees for Blackstone.) And all of its businesses saw net inflows and carrying-value appreciation.

On a side note... Inflation is great for a business like Blackstone. Increased money printing means more money will find its way to the best capital allocators, like Blackstone. And inflation will push up the value of Blackstone's assets (companies, equities, and real estate).

CEO Steve Schwarzman said the last quarter "capped a year of record financial performance for Blackstone." The results were the firm's best since becoming a public company nearly six years ago.

Blackstone earned $106.4 million in the fourth quarter, up from a loss of $22.7 million a year ago. Revenue jumped 33% to $1.23 billion... Performance fees increased 31% and advisory fees increased 27%. The firm's investment income doubled to $111.7 million.

True Wealth readers are up nearly 30% since November on Blackstone.

In a recent Digest Premium, Porter discussed how the U.S. Mint ran out of silver Eagle coins a couple weeks ago... The government had to suspend sales. As Porter wrote…

When the mint cannot keep up with demand for physical bullion (gold and silver), something is totally wrong with the spot prices. It makes no sense that there would be so much preference for physical bullion that the mint can't keep up with demand, unless the spot price is being manipulated to keep it artificially low.

Now I'm not a giant conspiracy theorist. But I know how economics work. The demand for physical bullion is a sure sign that the marketplace does not trust the futures price, period. The futures market pricing for gold and silver is becoming more and more irrelevant. And the shortages you're seeing in physical gold are sure signs that something has gone terribly wrong...

To date in January, U.S. Mint sales of American Eagle silver coins jumped to a record 7.4 million ounces – the largest monthly total since 1986, when the Mint began selling the coins. That compares with 1.6 million ounces sold in December. And remember... the Mint suspended sales for over a week (resuming on January 28).

Sales of American Eagle gold coins are also soaring... The Mint sold 140,000 ounces of gold coins so far this month, up 84% from December and the highest monthly total since July 2010.

Gold and silver sales are soaring (in the case of silver, to the point where the government can't keep up with demand)... But prices aren't budging. It makes no economic sense. If you're looking to add to your bullion position, now is a good time to consider doing so...

Finally… Porter designed his Stansberry Alpha strategy to take advantage of one of the biggest anomalies in the market. It's a way for individual investors to get "unfair" deals like those some of the biggest and best investors in the world get.

We can't give away the details of the strategy in these pages, but it involves trading the safest stocks in the world (World Dominators for example) and making triple-digit gains in one year... And this strategy involves less risk than if you were to just buy the stock. We're outlining an entire recommendation in today's Digest Premium, but here is an excerpt…

Simply put... thanks to unwarranted fear... buying the stock today would get you $1 of assets for just $0.88 – again, guaranteed by the U.S. government. Not bad... But using our Alpha strategy, we'll get an even better deal...

We'll put at least 38% in our pocket up front, while the market overlooks this inefficiency. And with a little patience, we could pocket roughly 100% just by waiting for the market to realize the value of this company's assets.

Also, make sure to read below in today's mailbag... One subscriber analyzed the Alpha strategy using advanced mathematics. He found using the Alpha strategy not only increases your returns, it nearly doubles the probability of a gain.

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New 52-week highs (as of 1/30/13): WisdomTree Japan Hedged Equity Fund (DXJ), SPDR International Health Care Fund (IRY), Anheuser-Busch InBev (BUD), CF Industries (CF), Alleghany (Y), Medtronic (MDT), Cheniere Energy (LNG), and Procter & Gamble (PG).

In today's mailbag, one reader offers his detailed review of our Alpha strategy. Send your comments to feedback@stansberryresearch.com.

"As a longtime member of the Alliance and author of The Mathematics of Option Trading (published by McGraw-Hill in 2005), I became very interested in Your Alpha strategy. In an effort to gain more understanding of the strategy, I undertook a detailed mathematical analysis of a recent suggested trade. The analysis employed the probability techniques set forth in my book and the details need not be reproduced here. I was interested in comparing the expected results of the Alpha strategy versus an outright stock purchase. I used your [latest] example to illustrate the results as follows:

Trade date 1/27/13

Expiration date 3/15/13

Current price of the stock 26

Purchased call strike 27

Purchased call price $0.85

Sold put strike 25

Sold put price $2.75

"The results of the comparison are quite dramatic! The Alpha strategy produced an overall per share expected gain of $1.92 versus an essentially breakeven for the outright purchase. One of the main reasons for the large difference is the lowering of the breakeven point from $26 to $23.10.

"As may be seen from the chart, a large part of the Alpha results curve is a gain. If we construct a log-normal probability distribution with the mean set at the current stock price and the annual volatility at .10934 (calculated from the 52 week high and low), we can estimate the probability of a gain and the expected value of the Alpha trade. The probability of a gain from using the Alpha strategy in this example is 99.87%. The probability of a gain from an outright purchase is only 50%." – Paid-up subscriber C.B. Reehl

Regards,

Dan Ferris and Sean Goldsmith

Medford, Oregon and New York, New York

January 31, 2013

Porter details an actual Stansberry Alpha trade…

Editor's note: Today's Digest Premium is excerpted from the January 8 issue of Stansberry Alpha. It's longer than usual... but Porter wanted to share an actual trade he gave to subscribers.

The trade Porter describes is based on the "virtual bank" Hatteras Financial.

At the time he recommended the trade, Hatteras' shares had slumped. Interest rate spreads – the difference between what Hatteras pays to borrow money and what it earns lending that money out – had narrowed. Investors often sell when that happens... But the company's book value told another story... that it was time to invest in the company. (As we've explained before... book value is the true test of when to buy stocks like Hatteras.)

It's an excellent example of how Porter finds high-quality stocks he'd want to own outright... then uses options to both reduce his risk and create the opportunity for outsized, triple-digit gains...

Please note… we are republishing this trade solely as educational material (so you can better understand how his strategy works). The options Porter recommends below are no longer trading within buy range.

Hatteras' book value is currently $29.70 per share. That's what it's worth. It could liquidate its book of mortgages on the market today and end up with around $29.70 a share.

But its shares currently trade closer to $27 a share, about 90% of book value. Our research and experience has shown that whenever Hatteras is trading below book value, you should buy...

Let's say Hatteras pays an 11% dividend in the next year. That's lower than the past 12 months' payout. But it's still excellent, considering the alternatives.

We're certain Hatteras will continue to pay a dividend that's multiples higher than most other alternatives. And this is what we believe the market will begin to realize during the course of this year. Hatteras is one of the safest and best-run financial companies we know. Its mortgages are 100% guaranteed by the government. And the market has already priced in the downside.

Now, even though the shares have popped up more than $1 since January 1, the company is still a great buy and trading at a 12% discount to book value. Remember... its book value is like cash, so we're effectively getting $1 for $0.88.

As traditional investors, we'd be happy holding Hatteras shares here and collecting double-digit income.

But when you find a situation like this – where you know the market has overreacted to temporary conditions – it makes sense to take a more aggressive position.

This is an anomaly in the market, and we can do even better with an Alpha trade – a lot better.

We have no doubt there will be volatility with this trade. You can see in the above charts the share price sometimes moves around radically. But remember... with Alpha trades, we don't need to concern ourselves with day-to-day volatility. We're going to open a position... forget it... and let it play out over the course of several months.

We'll take a generous payment up front to place the trade. And when the market decides to return the stock to its true value, we'll take 100%-plus profits, giving us the Alpha return we're looking for.

As we said, we expect volatility. So we're going to provide an extra margin of safety on the downside. Remember, the stock already trades at a 12% discount to its book value. We're going to apply a 20% discount for safe measure. We think that's an excellent entry price if we're put the stock.

On the upside, we'll buy a call at just a little less than book value so when the shares return to its true value, we can enjoy the upside gain and book profits of 100%-plus on our margin.

Here's the trade we like best...

Buy, to open the January 2014 Hatteras (HTS) $27 call for about $0.85, and

Sell, to open the January 2014 HTS $25 put for about $2.75.

This reflects prices as of midday January 8.

As always... selling the put means you accept the potential obligation to buy shares of HTS at $25 each, if they trade for less than that by January 17, 2014 (when the options expire). That's a $2,500 potential obligation. Buying the call gives you the right (but not the obligation) to buy shares at $27 until that same deadline.

This trade puts a minimum net credit of $1.90 per share of cash in your account. Remember, option contracts control 100 shares. That means for every option pair you trade... you'll receive $190 in your account.

Please keep this 1:100 relationship in mind... and NEVER sell contracts for more shares than you can afford to buy. For example, if you are prepared to buy 400 shares, the total investment is $10,000. If that is the total amount you are willing to invest in Hatteras, ONLY sell four contracts.

To open this position, your broker will require a margin deposit equal to about 20% of the potential obligation represented by the puts. In this case, that's a $2,500 potential obligation. So your margin requirement is $500 per option contract.

Based on that margin requirement, our $190 per contract net credit gives us a massive 38% return right off the bat. The trade can work out one of three ways by January 2014...

1. HTS trades for less than $25. In that case, our calls will expire worthless. The puts will be exercised, and we'll be required to buy HTS shares at $25 each. When you account for the $1.90-a-share net credit, we will own the stock for a net cost of $23.10 a share. That is 22% below Hatteras' current book value of $29.70. That's a considerable discount, and a big margin of safety. Sooner or later, the market will recognize Hatteras' share price is too low and price the stock accordingly. At a net cost of $23.10 a share, we're taking less risk than if we bought shares today...

2. HTS trades between $25 and $27 per share. In that case, both options expire worthless. We would keep the $1.90 per share ($190). This would give us a 38% return on the margin requirement ($500). That's better than buying the stock outright (even accounting for its 10% dividend). And it's a whole lot better than you would receive in most alternative investments, not to mention money in the bank, which pays close to zero.

3. HTS trades for more than $27 per share. This is when the upside potential of our Alpha trade kicks in. Let's say the shares return to book value... To keep the number simple, we'll round up to $30 per share. We would exercise the calls... buying the stock at $27 per share for an immediate $3-per-share profit. Add that to our initial $1.90 net credit (which we keep), and we have $4.90 per share ($490 per contract). That's a 98% return on margin of $5 – roughly a double.

And of course, the higher shares rise, the better we do... If the stock returns to historical highs of 1.25 times book value, we're looking at approximately $32.50 per share. Exercising our calls would give us a $5.50 profit on the stock. Added to our initial $1.90, we'd have $7.40 per share – or 148% on margin.

This trade has exactly the same risk parameters as buying the stock at $23.10... But of course, you can't get shares at that price right now. But if you could – and assuming the stock did go to $30 – you would make a roughly 30% capital gain on your investment.

Finally, we recommend that you place a 25% trailing stop on this position to protect your capital in the event the trade moves against us. Trailing stops should be measured by the amount of capital at risk. In the Hatteras trade mentioned above, we have $2,500 per contract at risk... in other words, $25 per share.