The most important country in the world, part deux... Euro banks loaded with cash deposits... 'Buy the rumor, sell the news'... Porter's latest... Our six years with Microsoft... European bailouts...
The most important country in the world is stealing the global headlines again... Yes, we're talking about Greece. The European Union (EU), European Central Bank (ECB), and the International Monetary Fund (IMF) agreed this morning to grant Greece a $170 billion bailout (on top of the $146 billion it has already received). This is yet another flimsy announcement, as Greece has yet to implement austerity measures. And German, Finnish, and Dutch parliaments still must approve the deal.
In addition to the bailout cash, Greece is asking its private creditors to forgive $142 billion in debt... They'll take an effective 70% write-down on their holdings. The ECB and other European central banks will forgo profits on their Greek debt.
The deal "closes the door to an uncontrolled default that would be chaos for Greece and Greek people," European Commission President Jose Manuel Barroso said. We'd argue the deal pushes an uncontrolled default down the road a ways... The best-case scenario for this bailout is that Greece's debt to GDP will hit 120% by 2020, down from more than 160% today.
IMF chief Christine Lagarde said no one should think the bailout and the related bond write-downs and austerity programs are easy... "It's an ambitious [program]," Lagarde said. She's worried Greece's economy won't grow as much as hoped. (If this new bailout goes through, every Greek citizen will owe the EU and IMF around $29,000.)
If European banks don't start lending, growth will certainly falter. And right now, they're parking all their cash in the safest place possible...
In recent weeks, eight large European banks have reported deposits totaling around $816 billion in cash and deposits at global central banks as of December 31, according to the Wall Street Journal. That's up from $543 billion a year earlier, a 50% increase.
Banks depositing cash with central banks has two immediate side effects... First, it limits the commercial banks' ability to earn money, as those deposits accrue little interest. Second and most important for a European recovery, it means banks aren't lending that money.
Andrea Filtri, a banking analyst at Mediobana SpA in London, said European bank deposits with central banks is likely the largest in at least 15 years. Deutsche Bank, Europe's largest bank, had 136 billion euros deposited with central banks at the end of December, up from 94 billion euros three months earlier. Deutsche CEO Josef Ackermann said earlier this month that the bank's liquidity reserves "are the highest ever in the history of the bank."
The other seven banks are Spain's Banco Bilbao Vizcaya Argentaria and Banco Santander, Switzerland's UBS and Credit Suisse, Britain's Barclays, and France's BNP Paribas and Societe Generale.
Today's market is classic "buy the rumor, sell the news." We knew Europe would bail out Greece... Apparently, so did everyone else. Markets are flat today. The euro normally yo-yos with the alternating good and horrible news from Europe. Today, it didn't budge. We do see liquidity flowing into U.S. Treasurys, up 1.24% today – 10-years are yielding 2.03%. Gold is the big winner, up 1.5% to more than $1,750 an ounce. And oil is up more than 1% to top $104 a barrel.
In the latest issue of Stansberry's Investment Advisory, Porter discussed the importance of buying companies that earn large returns on tangible assets without large capital expenditures – what he calls "capital-efficient" businesses. He recommended shares of Microsoft. "Over the last three years, the company has returned almost $40 billion to investors – or roughly 15% of the value of the entire company," Porter told subscribers. "Paying only seven years of cash earnings for a company like this seems awfully cheap."
We have quite a history with Microsoft around here. Back in the summer of 2006, I (Dan Ferris) circulated some research showing how Microsoft had so much cash on hand, generated so much cash flow, and was so cheap that it could afford the bonds it would need to buy all its outstanding shares. Porter recommended the stock in September 2006, and I followed up with a more detailed rendering of my original idea in the October 2006 issue of Extreme Value.
Microsoft has remained in the Extreme Value model portfolio (it's an original World Dominator) since that initial recommendation. It's up 34% since then. But had you kept buying it, you'd obviously have lowered your cost (especially in late-2008/early-2009) and would be much further ahead today.
Overall, investors simply fail to appreciate the huge value of Microsoft Windows. Most people say they hate it, including many IT professionals... yet they all continue using it and buying the upgrades. And nobody seems to be able to come up with anything much better.
Ditto Microsoft Word. I know one analyst who says Microsoft will cease to exist because "in the cloud," you don't need to own software and load it onto your hard drive. I find that comment funny. Both Intel and Microsoft have been generating record results the past couple years, selling more and more of the higher value parts of PCs and other hardware devices that all require some type of operating system.
I can't even count the number of times I urged subscribers to buy Microsoft shares. In late 2008, I told our Alliance members at the annual meeting in Hong Kong that if the stock market scared them, they should buy safe, cash-gushing stocks like Microsoft. The quarterly dividend is up 54% since then. Sales are up 16%, net income is up 31%, and earnings per share have risen 44% since 2008... And that's based on fiscal 2011 results. The 2012 fiscal year will end in June. So it probably understates the company's stellar performance since that Alliance meeting.
I have recommended Microsoft constantly in weekly updates and monthly issues of Extreme Value and The 12% Letter, as it remained solidly below my maximum buy price for most of the last three years. When the stock price cratered during the 2008 market plunge, I just kept recommending it. Since that first little piece I circulated among Stansberry & Associates editors in the summer of 2006, I think nearly every S&A analyst has found something good to say about Microsoft. It's one of the most successful recommendations I've ever made, even though it hasn't yet produced a big, triple-digit return.
What it has produced is a secure return, with a rapidly growing cash income stream. I never doubted the stock. I never wavered on the recommendation. It was a giant, well-known company sitting in plain sight for all to see. It's an even bigger company today and still well known (and still not well-liked by a lot of investors). And yes, it's still pretty cheap with an enterprise value of about 8.4 times trailing free cash flow.
Today, Microsoft is a bit more popular than when I first found it and certainly more than it was last fall. Microsoft is up 31% since Thanksgiving. It's up 4%, not including a $0.20 quarterly dividend, since Porter's February 10 recommendation. We may soon see shares of this technology giant soar even higher... According to Morgan Stanley analyst Adam Holt, Microsoft insiders – including CEO Steve Ballmer and founder Bill Gates – will soon own less than 10% of the company. (Gates sells around 20 million Microsoft shares per quarter to diversify his portfolio and raise cash.)
Holt believes the index discounts Microsoft's value by 12% because of the high insider ownership. When insider ownership drops below 10%, Standard and Poor's will add more Microsoft stock to the index... And so will every index fund in the country. This isn't a reason to make a long-term investment. We've been giving you those reasons for the last six years. But if you're looking for a reason for the stock to perform well in the near term, buying by index funds might give it a lift.
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New 52-week highs (as of 2/20/12): None. (Markets were closed.)
Were you in the audience in Hong Kong when Dan talked about Microsoft? Did you buy in 2006 when he and Porter first recommended it? We'd enjoy hearing from anyone who benefited from our advice to buy the tech giant at any time over the last six years. Please write us at feedback@stansberryresarch.com.
"After something less than a year with Stansberry Research, my whole way of thinking about investments has changed.
"Trailing stops? Got it. Position sizing? Got it. Core positions in World Dominators? Got 'em. (However, I'm 68 years old, not even thinking about retiring, and so I don't have the time horizon to make compounding work to the max.)
"I've even grown comfortable enough with options trading that when one newsletter suggested a purchase but to 'wait for the market to come back to you,' I promptly sold a couple of puts on the position, and made money when they expired, without ever buying the stock. (In my pre-Stansberry days, I would have waited and never taken any action, and thus made nothing.)
"But in everyday trading, where I'm not holding chiefly for the compounding dividends, how do I know when to take profits? (Example: I've got a couple of small positions in various shale and other natural gas plays; some are up 20% or 40% or even 60% in well under a year.) I could wait until they fall below the rising trailing stop, but that seems a shame. If some similar play comes along, and I can't free up new money to invest, when is it right to take profits and use some or all of the cash to move into a new position?" – Paid-up subscriber Bill Hodes
"I can not disagree more than your recent comments and suggestions on homebuilders. I see no basis to be bullish in any reasoning. Huge inventories and lack of jobs do not add up to bullishnes and of course the indicators you point to are gov figures? Are UE #s real, is GDP real? I could go on and on but I won't. Not sure why or where you are going with this, but it defies not only logic and data, but your own musings previously. Nothing has changed except your thesis. All underlying fundamentals are still existing and NOT pointing out bullishness? Quite the opposite?" – Paid-up subscriber Steve Baze
Goldsmith comment: I won't speak for Steve... You can read his analysis of the housing situation in numerous DailyWealth essays (for example... here, here, and here). In general, we're still long-term bearish. But when governments are pumping trillions of dollars into the economy, you're going to see bursts to the upside. This is one of those times...
Naturally, everyone can form his own conclusion... It's worth noting that Steve has made readers solid returns on his housing recommendations.
Regards,
Sean Goldsmith and Dan Ferris
New York, New York and Medford, Oregon
February 21, 2012