We're starting today's Digest with a bit from the mailbag... As longtime readers know, whenever we recommend shorting iconic American companies, we're flooded with hate mail. For whatever reason, these legacy stocks (like GM, GE, Fannie, and Freddie) cloud investors' ability to think rationally. Whether it be a friend or family member who worked at the company, that the company's stock has been passed down through generations, or simply that no one thinks such an iconic company could falter, people refuse to believe these companies can do any wrong.
Ironically, this train of thinking makes these companies good shorts... Eventually, fundamentals (usually in the form of default) will overcome sentiment. Also, in GE's case, the company became so dangerously levered because of its iconic status and triple-A credit rating (which it lost in March 2009). Cheap financing allowed GE to increase its leverage and pursue new businesses, like mortgage lending. But no matter how bad the numbers are, some people never wake up... Which leads us to today's e-mail:
HI. I cant believe all the time you spend writing about GE. DUDE. get some therapy!! ok so you think the company is run by morons, and has been given a silver spoon from the us Goverment (the creaters of money). my neighbour (a usaf captian) was bullish on GE and now i see why. after reading your advisement i chose not to invest... (well look who's laughing now & who has the long face). – Paid-up subscriber TURPS
What TURPS doesn't realize is we've been warning our readers about GE since 2002. Here's what Porter wrote back then:
Since 1992, GE has been a net borrower. How could America's best company be a net borrower for ten years? Well, look at what the company is doing to make money, and it's easy to figure out. About 50% of the company's total debt is in the form of short-term paper – the 90-day commercial paper market it can access thanks to an AAA rating by Moody's.
The company uses this debt, which carries a low interest rate, to finance credit cards, which carry a high interest rate. If you walk into J.C. Penney or Macy's and take out a credit card, chances are pretty good that you're on the hook to GE. In total, GE Capital has spent $43 billion on buying such receivables in the last three years alone.
And here's the scary part. Fifteen times since 1997, the company has sold a large batch of these securities (at a loss?) less than three weeks before the end of a quarter. That's how the company is able to match its earnings forecasts so precisely. Meanwhile, GE's debts have mounted. Today, its balance sheet stands precariously at four times debt to equity. Why take such risks? Because these debt-laden acquisitions accounted for 40% of GE's revenue growth from 1985 to 2000, according to Merrill Lynch analyst Jeanne Terrile (who retired immediately after publishing her study of GE's use of debt). – Porter Stansberry, The Debt Generation, November 26, 2002
What's important is where the company stands today. In November 2009, Porter reiterated his short position on GE. He wrote:
Since 2002, when I wrote that essay, General Electric has produced $140 billion in free cash flow – real profits. It has borrowed an additional $178 billion (not including unfunded pension liabilities). Thus, it has continued to be a net debtor. GE now owes its bondholders $435 billion. It has another $248 billion in current obligations. That is not a misprint: GE owes its creditors $683 billion.
Why would GE borrow so much money?
Like all of the companies we warned you about last year (Fannie, Freddie, Bear Stearns, Lehman, GM, etc.), GE's asset base produces only average returns. Over the last 20 years, GE's annual return on assets has averaged 5.7% and only exceeded 6% three times. For most of the period, an investor would have done better in Treasury bonds than in GE's assets. – Porter Stansberry's Investment Advisory, November 2009
And for the most recent update on GE's numbers, check out the July 26 Digest, where Porter reviews the company's latest earnings. In short, GE still has a huge debt load it can't afford. And the company decided to ramp up its research and development spending and boost its dividend, which it also can't afford. Buying GE just isn't worth the risk.
"You only need a few of these... heck, you really only need one of these sorts of deals to be set for life."
That's what our friend Doug Casey (one of the richest guys we know) recently told Dr. David Eifrig about a little-known investment he's used to amass a fortune. Doug was talking about "warrants."
Back in the early 1990s, Doug invested in a small mining company called Diamond Fields International. Doug took part in a deal where a group of private investors placed money directly into the company's coffers in exchange for stock.
To entice investors to buy its shares, some companies attach a special contract to each share that allows an investor to buy extra shares at an agreed-upon price in the future. These are warrants.
In Doug's case, he bought 50,000 "units" for $0.25 per unit. It cost him $12,500. Each unit represented one share of stock and one warrant.
Several years later, Diamond Fields found a large diamond deposit in Africa. The stock exploded in value... and so did Doug's warrants. Diamond Fields traded up to $150 a share... a 59,800% gain. But get this... his warrants (which he got for free) were now just as valuable as the stock... which more than doubled his payout. Doug made almost $15 million.
Warrants are commonplace in the small-cap mining sector... These companies don't have access to the credit markets because their prospects are so risky. They attract potential investors with warrants – essentially free stock. Now, deals like Doug's Diamond Fields investment are normally available only to mining insiders... and go to zero more often than not.
But David Eifrig, editor of our new Retirement Trader service, shows subscribers how regular investors can use warrants to reduce risk and maximize their gains while investing in a variety of companies... including blue-chip stocks (Wells Fargo, for example). It's a secret he learned as an elite Wall Street derivatives trader.
Before you scare yourself out of trying warrants, understand these are much safer than regular stock options. In fact, both the U.S. government and Warren Buffett are currently investing in warrants. And you can do the same with as little as a few hundred dollars. Warrants are probably the safest way to gain huge upside potential without taking massive risks. We'd encourage you to learn more about this little-known strategy here.
New highs: MFA Financial (MFA-PA), Realty Income (O), WD-40 (WDFC).
Surprisingly little GE venom in the mailbag... If you've got some, send it to feedback@stansberryresearch.com.
"GE and the greatest CEO of all time Jack Welch have done a great job fooling the CNBC crowd. It was under jack that GE became the financial power it is (was). I adhere to the following: The bigger they are the harder they fall. Everything goes in cycles. (or a 'to everything a season...) Now we see the charade GE and jack really are. (Can I believe in Porter?)" – Paid-up subscriber Art
"I have been retired for a number of years and I'm always interested in generating a little extra income. I am a subscriber to several of your services, High Yield Investing and Street Authority. How can an investor take advantage of high dividend yields when the prevailing market sentiment says you can't rely on a buy and hold strategy. If you don't 'hold' how can you generate dividend income?" – Paid-up subscriber Richard B. Girvin
Goldsmith comment: If you're looking to generate yield through alternative methods like selling options, I would recommend you check out Doc Eifrig's Retirement Trader (above). But if you just want dividend yields, the best thing for you to read is The 12% Letter written by Tom Dyson (two of his picks are in today's "new highs"). Tom is generating safe yields between 5% and 10%. You can learn more here.
Regards,
Sean Goldsmith
Baltimore, Maryland
July 28, 2010