The S&A Digest: GM's Poor Shareholders

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 06/26/2013

Nokia's big buy... A $9 dividend on a $16 stock... Miller sticks with homebuilders... Time to buy gold stocks... Grabber tax strategies... Seabridge was a bad recommendation?

Oh boy. That's trouble...

Long-time PSIA recommendation Nokia (NOK) will acquire navigation software maker Navteq for $8.1 billion. Nokia's CEO says location-based services are the "cornerstone" of the company's Internet services strategy. Navteq licenses its software to GPSs and websites. Chrysler, Ford, and Mercedes also offer the software in select models.

We're up 169% in three years on our recommendation of Nokia. One of the main reasons we bought was because the company has been extremely well disciplined with its capital spending and had always returned excess capital to shareholders. But... now it looks like the new CEO is trying to build an Internet services business. At first glance, it sure looks like Nokia waited too long to buy Navteq and is paying way too much – more than 50 times earnings.

Interested in getting a $9 dividend on a $16 stock? Our newest Dividend Grabber pick is an electronic device company that's paying out a $9 one-day dividend. The company competes with Apple and, in fact, is led by a bunch of ex-Apple employees. Its new cell phone is sleeker and far more affordable than the iPhone. Shares of the company rose more than 6% last week after it unveiled its new design. Sean Goldsmith recommends "grabbing" this special dividend immediately. Subscribers can refer to his October 2007 issue for an update on this situation. And if you're not a subscriber? Sign up before midnight to get in on this trade, and we'll give you almost half off the normal subscription rate. To learn more about it, click here. (Also... we answer Grabber-related tax questions in the mailbag, below.)

Are you having a tough year in the market? You're not alone. Bill Miller, famed manager of the $19.2 billion Legg Mason Value Trust, is only up 3.1% this year – behind 96% of his competition. Most of the underperformance stems from his ownership of homebuilders and mortgage companies (sounds familiar...). Miller is still bullish: "If we didn't own them now, we would be buying them like crazy."

Is it time to buy gold stocks? John Doody says yes. Doody has been studying gold production companies for longer than any other newsletter writer and has developed a proprietary valuation tool that compares the price of gold to the value of the gold producers' reserves, taking into account their production costs. Buying gold stocks when they're cheap relative to gold makes money – even in gold bear markets. In gold bull markets, the strategy makes a killing. According to Doody's August 31 evaluation, gold stocks were 10% cheaper than the metal itself, marking a significant discrepancy.

Despite the underperformance... and disappearance... of many hedge funds, the money keeps pouring in. Hedge-fund assets climbed to $2.48 trillion in the first half of 2007, up 19% since the beginning of the year.

New highs: BHP Billiton (BHP), CGG-Veritas (CGV), streetTRACKS Gold (GLD), Intel (INTC), Coca-Cola (KO), Oakley (OO), Provident Energy (PVX).

On Sunday nights, after everyone else has gone to bed, we open our laptop with trepidation and dive into the unvarnished humanity of our mailbag. It's better than the police blotter, better than the New York Times' obits... better even than the Page Six gossip. The mailbag is pure fear and greed, all the time... Send us your contribution: feedback@stansberryresearch.com.

"I do not think you are picking very good stocks ordinarily. Your pick of Seabridge (SA) i noticed had all kinds of problems on cash flow and income. However I did chose Icahn Enterprises – I have observed Icahn thru the years and he appears to be a level headed, honest person – totally opposite to Perelman and his miserable Marvel Entertainment corruption. Most of your stocks i would not bother with – not enough profit – if they don't a least double each year they are not worth fooling around with – those were wonderful days of 1990s when technology doubled every year... PS I think your worst overall analyst is Steve somebody, but recently he is showing promise of doing better." – Paid-up subscriber William Johnson

Porter comment: We'll pass your opinion of Steve Sjuggerud on to him... By the way, Steve's recommendation of Seabridge is the highest-returning recommendation in the history of our research group.

"I subscribe to PSIA and just read the special report, America's Secret Investment Society. One of the companies recommended is American Real Estate Partners ACP. When I try to look up the company and its chart I either get 'Symbol not found' or I get sent to Icahn Enterprises IEP. When I Google search I get sent there. Is IEP and ACP the same?"

– Paid-up subscriber Allen Schwalb

Porter comment: Yes. On September 17, American Real Estate Partners changed its name to Icahn Enterprises. You can read a press release about the change, here.

The change follows American Real Estate Partners decision to buy Icahn's fund-management business, which unified all of Icahn's investment interests under one roof. Frankly, we regret the name change. Yes, it will probably be good for the stock to be tied more directly to Icahn's name and reputation. On the other hand, a lot more investors will know what had been a relative secret for many years... that a nearly anonymous holding company (American Real Estate Partners) was in fact Icahn's main investment vehicle.

"The Dividend Grabber teaser ad indicates that you invest in the stock, grab the big 'Special Dividend' and generally the stock will rebound in 6 months to its pre-'Special Dividend' rate. That's great because dividends are taxed at 15% maximum while short-term gains are at the marginal rate, which could be as high as 35%. I'll take the dividend anytime; especially if my marginal tax rate is above 15%.

"OK, so I bit on the offer yesterday at the special rate. Last evening I read every single item in the archives under monthly reports, special reports and email. What I see is that except for the electronic device stock in the teaser ad, the Dividend Grabber does not really follow what it says it does in the teaser ad but goes about it a different way. It is a little misleading and because of that change in the technique, it does have a major tax ramification that impacts USA tax filers... Yes, I would get a 15% long term capital gains rate, but my money is tied up for a year or longer and I can make more than 15% a year through other sources as you'll see later."

– Paid-up subscriber Carl Snyder

Porter comment: Whether you choose to buy for the cash discount or for the capital gain depends on whether you're trading in a taxable account and whether you're interested in maximizing your total returns or your tax efficiency. We can't make this choice for you, of course, so our service allows you to pursue either variation on the strategy. Which should you choose? Well, that depends. But before we get to tax considerations... let's review what we're doing in the Dividend Grabber.

When cash-rich companies decide to expel equity from their balance sheets into the hands of their shareholders, they may do so in a variety of ways. They can raise their cash dividend and pay out the money over time. They can buy back shares – sometimes in large amounts. Or... they can distribute a one-time, large cash dividend. We are on the lookout for companies that have decided to distribute a large, one-time cash dividend.

Why? Because when companies pay out large amounts of cash, the "normal" rules of finance disappear.

Financial theory says that the stock market is relatively efficient. Paying out a large amount of cash should alter a company's market price – that is, the share price should be reduced by the exact amount of the dividend. Example: If a $10-per-share stock pays out a special $2 dividend, the value of the company should be reduced by $2, and the stock should open for trading at $8. Stock exchange rules have been set up to ensure that this is what occurs: Stocks must open at the "ex-dividend" price after the dividend is paid. And here is where the theory gets put on its ear.

The fact is, investors don't typically value operating businesses by the net value of their balance sheets. Instead, balance sheets are typically ignored in favor of valuations that focus on earnings per share. Thus, even cash-rich companies will typically trade for between 15 and 25 times earnings – before and after they pay a special dividend. That's why, as we have seen historically, companies that pay large, one-time dividends rebound quickly in price after being discounted for the dividend payment.

Now... as for the tactical question of how to profit from the tendency of special dividend paying companies to quickly rebound in price, there are several considerations. In developing the S&A Dividend Grabber, our paramount concern was total return. We don't pay taxes on our model portfolios. Many subscribers, trading inside IRAs, don't either. Depending on your situation, you can utilize our recommendations in one of two ways.

Let's assume a $10 stock is paying a $2 special, one-time dividend – which is a typical setup. You can buy the stock at $10 and collect the $2 dividend when it is paid. Or you may decide to wait until after the dividend is paid, the shares are discounted, and the same stock trades at $8. In either case, you won't truly make a profit until after the stock has rebounded in price back to $10.

If you choose to take the dividend, you will earn $2 minus the 15% tax on dividends ($0.30). Assuming the stock returns to $10 and is sold, you've made $1.70 after putting $10 at risk. That's a 17% return. On the other hand, if you buy the stock ex-dividend at $8 and the shares rebound to $10, you will have made a capital gain of $2 after putting $8 at risk. That's a 25% gain.

Obviously, absent the impact of taxes, it's much more profitable to buy after the dividend discount to earn the larger capital gain.

On the other hand, if you make this trade in a taxable account, you might incur capital gains taxes (35%) if you hold for less than one year. If so, the $2 capital gain will cost you $0.70 in taxes. Thus, you will have earned $1.30 after putting $8 at risk – a total after-tax return of 16%.

It's true, as the reader points out, that this is a slightly lower return than taking the cash dividend. However, our studies indicate that it often takes a full year for the stock price to rebound to the pre-dividend price, which means that most of the time you'll only incur the long-term capital gain rate. That rate is the same (15%) as the dividend tax rate. Assuming you hold the stock for one year, buying after the dividend is paid would earn you a $2 capital gain taxed at 15% – the same amount ($1.70) as getting the dividend in cash. The difference, though, is that you would have only had to pay $8 for this profit, not $10. Thus your gain would be much higher (21% versus 17%). This makes a big difference in the real world.

Our track record reflects the gains that could be made following our strategy in a tax-free account. As such, we aim to produce the highest possible total returns through a capital gain strategy. However, readers can pursue either strategy – cash dividend or capital gain – using our research. Which strategy you pick depends solely on your tax liabilities.

Regards,

Porter Stansberry

Baltimore, Maryland

October 1, 2007

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