The Only Stocks I'll Teach My Kids to Buy
The only stocks I'll teach my kids to buy... The unbeatable advantage of profitable underwriting... Our insurance monitor turns six... The biggest mistake of their careers: How David Einhorn and Daniel Loeb screwed the pooch in insurance...
Today... I (Porter) have a story you probably won't believe about the best way I know how to grow rich – wildly rich...
The investment secrets in today's Friday Digest are the only ones I will ever teach my children, directly. And the only kind of investing I will urge them to stick with, no matter what. This is also the only kind of investing I believe anyone can do successfully without using trailing stops.
As always, before we begin, my familiar warning...
There is no such thing as teaching, there's only learning...
Virtually everyone reading today's Digest will find a reason not to pursue this strategy: It takes too long... It's not exciting... Nobody I know invests this way... Or – the most likely reason – I don't understand the jargon at first glance.
It's fine by me if you never, ever make an investment using the strategy I outline below. But if you're not willing to make these investments, you should really ask yourself why you're in the markets in the first place.
His name was Shelby Davis...
His life, until he was almost 40 years old, had mostly been a failure. He'd been given every advantage in life, including an education at the exclusive Lawrenceville School, then Princeton for college. He'd gotten a master's degree at Columbia and then a doctorate in Geneva. He, like so many other young men of his class and upbringing, then headed to Wall Street.
It was the Roaring '20s and stocks were soaring. He worked as an investment analyst for a brokerage firm and, I'm sure, thought he was a genius. But he didn't avoid the crash. And by the mid-1930s, he was wiped out, just like almost everyone else.
To survive, he got a job in politics, writing speeches. But his candidate, Thomas Dewey, lost. Twice. By the mid-1940s, he was completely washed up. Finally, at 35 years old, he found himself working as the deputy superintendent of insurance for the state of New York – about the darkest hole you can fall into in politics. He had virtually no savings and no prospects.
Nevertheless, after making just one investment in 1947, Shelby Davis became a billionaire. His fortune required no trading. He simply bought a handful of stocks (using money borrowed from his wife's family) and sat on them, reinvesting dividends along the way. Today, his family continues to own these investments and are among Wall Street's most elite private money managers.
Shelby Davis is the only investor I know of who actually became a billionaire solely through the long-term ownership of passive interests in public companies. Yes, plenty of investors have used other people's money and lots of trading to become wealthy in the markets. But Shelby was using his own money. And he didn't do any trading. All he did was hang on. He almost got wiped out in the early 1970s bear market ('73-'74) because he routinely employed as much margin as his brokers would allow, but he survived the storm. By the early 1980s, he was on the Forbes 400 list of the richest people in America.
What did Shelby Davis invest in?
Insurance stocks.
But not just any kind of insurance stocks... he specifically bought property and casualty (P&C) insurance companies that focused on unregulated insurance markets.
Sitting at his desk – remember he was the deputy superintendent of insurance for New York – he had access to the books of all the insurance companies that operated in the state, which was virtually every large insurance company in America. He could see that some of these companies were simply minting money.
Insurance, as I'm sure you realize, isn't normally that great of a business. For example, on the whole, the companies involved in auto insurance don't collect enough money in premiums to cover the claims their policyholders file each year. That's in part because auto insurance is heavily regulated. And it's also because there's so much competition. To make money these companies have to invest their "float" – the money they're holding in paid premiums before claims are submitted – wisely and earn enough on those investments to cover their underwriting shortfall.
Shelby's key insight was that not all insurance companies suffer from this expected outcome. Some insurance companies, the ones that focused on unregulated sectors of P&C, could earn far more in premiums than they had to pay out in claims. For these companies, capital was flooding in the door and staying. These firms had a completely legal way to virtually steal enormous amounts of money by routinely overcharging, by large amounts, for the insurance they were providing. And thanks to his position as deputy superintendent of insurance, he knew exactly which ones. In 1947, he bought a dozen of them and promptly retired from politics.
What's the 'rest of the story,' as Paul Harvey used to say?
After Shelby retired from politics, he started a small boutique brokerage firm. He was trying to get other investors interested in these companies – because nobody on Wall Street understood the economics of these businesses. Among the investors Shelby met with was Benjamin Graham – the famous value investor and mentor to Warren Buffett. Shortly after Shelby purchased his portfolio of insurance stocks, Graham decided to follow him into one of the companies in his portfolio, a company called Government Employees Insurance Co. You know the firm today as GEICO, a wholly owned subsidiary of Berkshire Hathaway (BRK-B).
Graham started buying GEICO in 1948. He kept buying and eventually owned half of the stock, investing about $700,000 in the late 1940s. GEICO was, by far, the largest investment he'd ever made with his investment partnership. Within 10 years, Graham made 200 times his capital. He made so much money from his investment in GEICO that he retired from active management and lived comfortably on GEICO dividends. Within 25 years, Graham had made 500 times his initial investment.
Graham, who is probably the second-most famous investor of all time after Warren Buffett, was an active investor and money manager from the early 1920s until the late 1950s. He made hundreds of good investments over the span of his career. But it was GEICO, a P&C insurance company, which made him rich. Graham made more money on GEICO than he made on all of his other investments combined.
As Graham said about the deal: "In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people."
The story of Shelby Davis and our knowledge of Graham and Buffett's involvement with GEICO led me to ask a simple question...
If the world's best investors made their very best investments in P&C, do those kinds of opportunities exist anymore?
To find out, I had to build an analytical team that was capable of analyzing the entire industry. I knew the key to our success would be finding companies that could successfully grow their book of business without losing underwriting discipline. To achieve extremely good financial results, you must find companies that consistently take in more in premiums than they pay out in claims. It's the compounding nature of these businesses – their investment capital just grows and grows and grows – that leads to massive wealth.
Our insurance team is led by Bryan Beach, a former auditor and corporate controller who has been an active investor his entire adult life. I'd argue no one in the world is more passionate about insurance stocks or knows more about the publicly traded equity in the space. In 2012, Beach began building our own proprietary database (our P&C Insurance Monitor) and carefully studying the quarterly results from every company in the sector.
I'd urge you to read everything Beach has ever written about the P&C insurance sector. Subscribers to my Investment Advisory can find a good introduction to the space in our special report "The Money Guarantors." (Subscribers can find it here.)
Our P&C Insurance Monitor has just turned six years old...
We now have enough data and time to know with a lot of confidence that our approach is working. So far, our recommended stocks from the sector have beat the S&P 500 by 2.4% annually – with far, far less risk. Our approach also is beating the S&P 500 Insurance Industry fund by 3.1% annually, and again, with less risk.
Over the last six years, our recommended insurance stocks have produced annualized gains of 20%. I do not believe another investment strategy anywhere in the world will deliver gains of this magnitude, this consistently, with so little risk. Our investments in P&C insurance stocks have a built-in winning advantage: They're consistently taking in more money in premiums than they are paying out. Over time, this advantage simply becomes unbeatable.
Interestingly, our results would have been even better if, like Shelby Davis, we'd simply hung on. Using trailing stops on this sector doesn't work. That's because investors always overreact to short-term news about the size of potential claims. Meanwhile, of course, increases to claims in one year simply lead to higher premiums in the next.
One more point about our approach...
First, our highest-rated P&C stock – American Financial Group (AFG) – was the best performer over the past five years. It's clear that we can pick winners: We picked the best stock to own and our recommended stocks beat the market and the insurance index.
But our team faces another test: Just as we were building our research in the space, two famous billionaire investors did the same thing. David Einhorn (Greenlight Capital) and Daniel Loeb (Third Point) are two of the best-known and most respected hedge-fund managers in the world. At virtually the same time we started our coverage of the insurance sector, they launched their own new insurance companies.
Dozens of articles have featured these new insurance companies, and a lot of newsletter writers (even a few we know well) have recommended these insurance stocks. The story was irresistible: Hedge-fund geniuses are applying Buffett's proven formula to make massive wealth in insurance. Who wouldn't want to own these stocks? Well, us.
We knew something the market didn't...
When we launched our P&C Insurance Monitor in 2012, there were 40 large U.S.-based P&C and reinsurers (give or take). In the six years since, Third Point and Greenlight have ranked 38th and 40th, respectively, in terms of share-price appreciation. That is, these super-popular stocks are the worst and third worst-performing stocks in the P&C universe.
Greenlight is one of just two companies on our Monitor to have its shares lose value from 2012 to today – down 34%. We've continuously told people (including several peers in the newsletter world) to avoid these stocks. Our contrarian view was fully based on the clear evidence presented to us through our proprietary research.
That's pretty impressive. We were not only able to predict which stocks would do the best... But our monitor told us to avoid the ones that did the worst, even when they're the most popular and had the best reputation.
There's one more thing to point out about the Greenlight/Third Point insurance debacle...
You'll notice that Shelby Davis, Ben Graham, and Warren Buffett did not break into P&C insurance by starting an insurance company from scratch. Shelby Davis bought a handful of good underwriters, including GEICO. Graham bought half of GEICO. And Buffett started by buying National Indemnity.
It's a lot harder than it looks to start a new insurance company. Relationships with insurance brokers are a key advantage, as is understanding which operators are likely to have the smallest claims. We don't recommend insurance stocks until they can prove themselves. Remember that the next time a Wall Street tycoon announces a new venture in insurance.
(If you want to read our specific warnings about Einhorn and Loeb's insurance ventures, just click here, here, and here.)
My advice is simple to follow. And it's exactly what I'm going to teach my children...
Make profitable underwriting (via well-run P&C insurance companies) the core of your portfolio. In bull markets or bear markets, these companies will continue to have a huge advantage over every other company that must pay for capital. That's an unbeatable advantage.
And, how do you know which insurance stocks to buy? Couldn't be any easier: Just use our P&C Insurance Monitor. You can get access to it by becoming a lifetime subscriber to my newsletter or joining any of our Alliance offers. To find out more about the lifetime membership, click here.
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In today's mailbag, it seems least one loyal subscriber is a fan of our bond research. Do you agree? Let us know at feedback@stansberryresearch.com.
"Hi, this morning I'm listening to the Stansberry Investor Hour and Porter mildly complaining about how so few subscribers read and use Stansberry's Credit Opportunities.
"Please, please, please don't decide to drop Credit Opportunities just because you have so few readers. I use and love this newsletter.
"The only complaint I have is that most of your subscribers ignore the buy-up-to or sell-for-no-less-than prices and I can't get in or out of positions and have to be painfully patient. I'm still waiting to get filled on [three recommendations] because of that. But that's not your fault. I'm trying to build up one of my IRAs to the point where it has a majority of the Credit Opportunity bonds, as I'm also convinced it's the safest way to build my wealth.
"I was also an admirer of True Income when that newsletter was being published, and reluctantly sold all those bonds when you shut that down. Again, I hope you're not having thoughts of shutting Credit Opportunities down because of low readership..." – Paid-up Stansberry Alliance member Christopher Karpenko
Brill comment: Don't worry, Christopher. We plan to continue publishing Stansberry's Credit Opportunities as long as we can find safe, compelling opportunities in discounted corporate bonds. And frankly, we've greatly improved our ability to do so since our True Income days, as our recent performance in the most expensive bond market in history clearly shows.
But remember, we relaunched this service to take advantage of the massive credit default cycle ahead. This has yet to begin in earnest... which means that despite our impressive track record to date, we're likely to do much, much better in the years ahead.
Regards,
Porter Stansberry
Baltimore, Maryland
February 23, 2018