The Mother Indicator returns...

 We begin with a personal story from one of our company's top executives...

 

"My mother texted me yesterday. Yes, that's right. She texted me. She wanted to know if she should buy stock in Alibaba. No kidding.

 

"The last time she asked me about buying a stock was the spring of 2000. The shares in question? AOL, after it announced the deal to merge with Time Warner.

 

"The Mother Indicator is the absolutely best way to pick a top in the market... Fair warning."

 

 AOL's merger with Time Warner was doomed from the beginning... AOL purchased Time Warner for $164 billion in early 2000. The Federal Trade Commission cleared the deal in December 2000.

 

Time Warner CEO Jeff Bewkes called it "the biggest mistake in corporate history."

 

 The tech bubble popped in 2000, sending the value of the AOL division plummeting.

 

Two years after the deal, the Securities and Exchange Commission (SEC) investigated the company for unorthodox advertising deals. A month later, the U.S. Department of Justice announced a criminal probe.

 

Two months after that, AOL Time Warner announced it was revising financial results after discovering it had overstated $190 million in advertising deals.

 

In 2002, AOL Time Warner took a goodwill write-off and announced a $99 billion loss for the year. Shares of the company dropped 90% from peak to trough.

 

In short, it was a disaster...

 

 A $99 billion loss makes software giant Microsoft's write-offs from bad acquisitions seem quaint. We'll touch on those mistakes in a minute.

 

 Two Microsoft directors announced they would step down by year's end. One of the directors is venture capitalist David Marquardt – an early investor in Microsoft who has been on the board since the company incorporated in 1981. The other is former JPMorgan executive Dina Dublon, who has served on the board since 2005.

 

Kraft Foods CFO Teri List-Stoll and Visa CEO Charles Scharf will join the board effective October 1.

 

 The two departures mark the third and fourth directors who have left Microsoft since Satya Nadella took over as CEO for Steve Ballmer in February.

 

 A recent study by Harvard Business Review shows some board turnover at companies is healthy. The authors studied board turnover and shareholder returns for S&P 500 companies from 2003 to 2013.

 

The study found that companies that replaced three or four directors over a three-year period outperformed peers. And the worst-performing companies either had no turnover in three years or five-plus changes...

 

New directors bring fresh perspectives and new skills, and they may be more likely than established members to challenge orthodoxy and raise previously unasked questions.

 

 Extreme Value editor Dan Ferris and his research analyst Mike Barrett think the board shakeup will benefit shareholders. (Dan holds shares of Microsoft in the Extreme Value portfolio.)

 

In an e-mail to me, Dan noted, "One outgoing director was a venture capitalist investor on Microsoft! He way overstayed his usefulness. Executives from Kraft and Visa should be much better for Microsoft."

 

 Under the old guard, Microsoft made some bad decisions... including overpaying for Internet communications firm Skype from auction house eBay, and most recently, cell-phone maker Nokia's handset division.

 

Porter shared his thoughts on Microsoft's corporate governance in the September 13, 2013 Digest Premium...

 

Microsoft is making a very bad decision in its $7.2 billion purchase of Nokia's handset division. And I'm disappointed to see it do these terrible acquisitions. It reminds me of chip maker Intel's decision to buy security software company McAfee a few years ago.   I can't imagine why spending billions on another obsolete business is likely to help Microsoft shares. But I hope the new regime at Microsoft – current CEO Steve Ballmer recently announced he's stepping down – will stop these idiotic expenditures. Unfortunately, that's unlikely. It's mind-boggling that the Board of Directors would have approved this kind of deal. If you look at the history of Microsoft's acquisitions, they're all horrible.

 

As Porter pointed out, one of Microsoft's worst acquisitions was a $6 billion purchase of advertising software company aQuantive back in 2007. Microsoft incorporated some of aQuantive's products before shifting strategies and selling a large portion of the company to advertising firm WPP Group for just $530 million. Porter continued...

 

Just imagine what Microsoft's share price would do if the board came out and said, "No matter what, we promise not to buy anything else for 10 years and we're going to return 60% of all the cash we make in the form of share buybacks or cash dividends."   Microsoft is going to make at least $30 billion in cash this year. If you throw a conservative 12 times multiple on that (high-quality businesses are worth about 20 times cash flow), you'd have a market cap of $360 billion.

 

 In that Digest Premium, Porter called Microsoft's management "the worst managers in all of the tech space... just abysmal."

 

Perhaps the new directors and dividend raise are a step in the right direction...

 

 Speaking of which, Microsoft just announced a 10.7% increase to its quarterly dividend, from $0.28 a share to $0.31. That's a yield of nearly 2.7% on today's share price.

 

The software giant has raised its quarterly dividend every year since 2006 – from $0.08 a share to $0.31. That's a compound annual growth rate of more than 16%.

 

If you rely on Microsoft shares for income, your payments have increased an average of 16% over the past nine years.

 

That's the beauty of buying World Dominators... They gush free cash flow and have strong balance sheets and durable competitive advantages. Because of these qualities, these companies are able to pay large and growing dividends to shareholders.

 

Dan explained the value of buying and holding these stocks in a DailyWealth essay last fall. Here's what he wrote...

 

As the years go by, the effects of dividend growth from elite businesses are extraordinary...   For example, an investor who bought dividend-paying cigarette-maker Altria back in May 2009 at $17 per share is now earning more than a 10% annual yield on his purchase price.   Do you think that an owner of Altria cares about a swing of 10% or 20% in the underlying shares? Do you think he cares about a 10% or 20% correction in the broad market?

 

 At the time, Dan noted that most of these blue-chip, dividend-paying stocks didn't sport huge yields – but still paid a healthy 3%-4%. But as these companies grew their dividends, sometimes as much as 20% in a single year, the yields on your original investments became massive (while still remaining safe). He used retail giant Wal-Mart as an example...

 

Wal-Mart's yield isn't gigantic right now. But remember... it has raised its dividend every year for the last 37 years. Since 1976, Wal-Mart's dividend has grown at a rate of 25.7% per year.   At that rate of dividend growth, you can hold the stock for five years, and you'll find yourself collecting dividends totaling 8% per year over today's cost. Hold it for another five years, and with that kind of dividend growth, you'll get 25% per year over today's share price.

 

 Extreme Value readers who purchased Microsoft on Dan's original recommendation in September 2006 are now earning a nearly 5% yield on their purchase price... And it's growing every year.

 

 In yesterday's Digest, we discussed another way companies reward shareholders: buying back stock.

 

As we explained, a company must consider its share price when repurchasing stock. Deploying capital when the share price is low can be a great way to add value for shareholders. On the other hand, buying back shares when the price is dear is a way to destroy shareholder value.

 

 Nobody understood this concept better than Henry Singleton, the former CEO of industrial conglomerate Teledyne. Between 1972 and 1984, Singleton repurchased 90% of Teledyne's outstanding stock... but only when it was cheap.

 

Singleton made acquisitions using stock when it was expensive and bought shares back when they were cheap. He never received more than $1 million a year in total compensation from Teledyne... But he became a billionaire by investing in his own company.

 

 In the May 17, 2013 Digest, Porter told readers about a book by author William Thorndike, titled The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success.

 

The book discusses a group of CEOs (Singleton included) who were masters at deploying capital. It's a must-read for any investor. As Porter explained...

 

The men and woman in Thorndike's book are the most successful CEOs in the history of modern capitalism. They include Tom Murphy (Capital Cities), Henry Singleton (Teledyne), Bill Anders (General Dynamics), John Malone (TCI), and Dick Smith (General Cinema).   Thorndike's CEOs all made 20%-30% a year for investors... for decades. That kind of performance made everyone who invested with them – even folks who put in as little as $10,000 – extremely rich.   And they all did it the same way. They all managed their companies (and their lives) in a similar fashion. They all looked at investing in the same way...   They spent their time allocating capital – investing. They delegated the operational responsibilities to junior executives. They spent all of their time deciding whether to invest in their existing businesses, whether to buy back their own shares, or whether to buy other businesses... They quantified everything.

 

 In closing, I'd like to tell you about something special we're doing this year at Stansberry Research... Something we've never done before.

 

We've hand-picked a small fraction of our subscribers to receive a personal FedEx package from Porter.

 

If you were chosen, you'll see a package arrive in the next few weeks. And you'll be invited to view a video Porter just filmed. Unfortunately, most of you will never see it...

 

What's inside that package could easily be worth tens of thousands of dollars. You can decide for yourself once you hear what Porter has to say.

 

We'll share more details about this package soon. For now, we wanted to alert those of you on the list to keep your eyes open. Those who have been selected will receive your FedEx package soon.

 

 

 New 52-week highs (as of 9/16/14): Berkshire Hathaway (BRK), CVS Health (CVS), Eli Lilly (LLY), Medtronic (MDT), Altria Group (MO), Union Pacific (UNP), and short position in Washington Prime Group (WPG).

 

 A few subscribers wrote in with their opinions on whether share buybacks are a good thing or bad thing. Do you think buybacks are a good use of extra cash? Share your thoughts with us at feedback@stansberryresearch.com.

 

 "The discussion of buybacks leaves out one important consideration. Not all of the buyback money actually reduces the number of shares. Try calculating the cost of the stock by dividing the number of shares outstanding by the money spent. Many times your answer is well above the price of the stock during the buyback period. Remember some companies use stock to pad the pay of executives and employees, not stock holders. Sorry but most of the time all the money did not go to reducing the number of shares. That is why I prefer the dividends." – Paid-up subscriber Pat Lynch

 

 "Regarding your commentary yesterday, I agree with your assessment that the total amount of share buybacks in the market today are probably too little to prop up the market alone... and I am a proponent of buybacks in general... but it's quite obvious that most individual companies are playing the buybacks game, with the amount of cheap capital available and companies unwilling to expend it on CapEx, what else are they going to do with it?

 

"The market today is filled with total irrationality... bad news is good news, because if things are bad, QE will roll on... good news is bad news, because that means the Fed will decom QE by mid next year, raise rates, and induce inflation... I think it's important to remember that at this point, market fundamentals mean basically nothing. The only thing that matters is what the Fed is doing. Wall Street, Mom and Pop, speculators who pretend to be investors... 95% of them trade solely off earnings. And if a company can keep its valuation high by (see this article from Zero Hedge today) in the face of rising costs, by artificially keeping earnings high via share buybacks, they will do it... and profit from it.

 

"The average investor equivocates earnings with profitability... and doesn't understand the accounting chicanery in play. Until it all ends, and interest rates rise, making money more expensive, and share buybacks more prohibitively expensive, we can expect to continue seeing this trend. After all, that's why [Steve Sjuggerud's] '9th inning' ends in April, right?" – Paid-up subscriber Jeremiah Workman

 

Regards,

 

Sean Goldsmith

September 17, 2014

 

 One reason for the underperformance is fees. The average investor pays way too much in fees to his broker or to his mutual funds. Another reason for underperformance is emotion. The American Association of Individual Investors asks investors a simple question every week: Are you bullish, neutral, or bearish on the stock market?

 

Right now, people are a little bit bullish, but nothing extreme. They were the most bullish in January 2000, the worst possible time, to the exact month, to be bullish. They were the most bearish in March 2009 – the absolute best time to be buying. This survey is a great demonstration of how bad people are with their emotions in the market.

 

 U.S. stocks are expensive today. The cheapest markets are the "who's who" of some of the worst geopolitical countries in the world: Greece, Russia, Ireland, Hungary, Austria, and Italy. The good news is, most of the world is really cheap. The bad news is, the U.S. is one of the most expensive markets in the world.

 

Why does this matter to you? You probably hold 70%-80% of your portfolio in U.S. stocks. That's called the "home-country bias." And it's not just you. Italians have most of their money in Italian stocks. Australians have most of their money in Australian stocks. Same thing in Japan.

 

It happens everywhere... But it can be a massive drag on your portfolio's performance. Not only should you have at least half your money in foreign stocks right now, but foreign stocks are generally much cheaper than U.S. stocks. So at a minimum, you should put half your money in foreign stocks.

 

– Meb Faber

 

 

Editor's note: Meb gave one of the best presentations at our recent Stansberry Conference event in Los Angeles. It was our best event so far. But our Nashville event on October 18 could be even better... We'll hear from former U.S. presidential candidate Ron Paul, Agora founder Bill Bonner, currency expert Jim Rickards, resource billionaire Rick Rule, and many more. And right now, we're offering our lowest-price tickets. Once we sell out, we're raising prices... so don't delay. Learn more here.

Why you're a terrible investor... and how to fix it...

 

Porter has called asset manager and friend of S&A Meb Faber "one of the most innovative guys in all of finance."

 

In today's Digest Premium, Meb explains why the average investor drastically underperforms the market... and offers a way to fix your portfolio immediately...

 

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