THE S&A DIGEST: Short-Term Trade in Retail Home Improvement Stocks

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

As of 07/05/2013

Another thieving CEO goes down... notes from the Value Investors Conference... what you can expect from Nancy Pelosi... the hottest market in the world

Good news… our resident quant, Ian Davis, has another very contrarian investment play. Ian’s numbers say this stock will be good for a quick profit over the next six months (see today’s essay). We’re going to publish Ian’s picks weekly for a while… to prove that his approach works. If it works well enough, we might ask you to pay for it.

Now… let’s talk about one of my favorite topics: The feckless, immoral, and outrageous behavior of hundreds of our country’s top corporate executives…

The now familiar news flashed across a TV in the gym this morning. Bruce Karatz, CEO of KB Home, was discovered backdating his own options. There are now more than 130 ongoing investigations of senior executives illegally backdating their employee stock options. By retroactively (and illegally) picking grant dates to match low points in the stock price, they inflated the value of their grants by a few percentage points. Why do I find the story so fascinating? Well, everyone likes to see the rich and powerful laid low by hubris.

But what I find most compelling is the scale of their stupidity. Why bother backdating your options when, as a CEO with a compliant board of directors, you can legally rob your shareholders blind with huge options grants? Since 1992, Karatz has cashed in more than $180 million worth of stock options, making him one of the highest paid executives in America. In 2000, Karatz granted himself 500,000 options – more than 30% of all the options received by all employees. The guy was robbing the bank, and the shareholders didn’t care. Even without backdating, these options would have been worth hundreds of millions of dollars. There’s simply no explanation for what these men did… other than raw, unadulterated stupidity and greed.

I sent our new recruit, Sean Goldsmith to attend last week’s Value Investors Conference in New York. Dan Ferris also went… and said it was the best line-up of speakers he’d ever seen. I’m sure we’ll hear from Dan shortly about what he learned. For now, you’ll have to make do with Goldsmith’s observations…

"Summing up the congress in one word: BlackBerrys. I have never seen so many people continuously pummeling the keys of BlackBerrys before…

"Watching the dozens and dozens of investment bankers nervously fondle their BlackBerrys like they were on their first date, I had to wonder what rich investors pay these people for… These big Wall Street firms employ legions of their own researchers, they have contacts and offices around the world… and yet… here they sat, thumbs in a lather, translating every word these dozen value managers spoke into digital messages to their offices…"

That’s great, Sean… but what stock was everyone talking about?

"Oh… Berkshire Hathaway. Everyone was talking about Berkshire Hathaway."

It’s harder to make money in China than most people realize. Especially if you’re not Chinese. Many companies have discovered this the hard way… Jim Mann’s book, Beijing Jeep: The Short, Unhappy Romance of American Business in China is the seminal work on the phenomenon. And now News Corp (NWS) is figuring out how the local market "works." Changing its strategy to deal with pirates, News Corp will team with Zoke, a low-cost DVD producer, to release DVDs in China at the same time and at essentially the same price as the pirated DVDs. X-Men, for example, which costs $24 in the U.S., will only cost $3.80 in China. How much would you bet that prior to its News Corp engagement, Zoke was the leading provider of pirated DVDs?

Folks are making a lot of big bets right now on Chinese stocks. The Chinese stock markets are on fire. Most folks aren’t going to get what they expect from those investments…

Nancy Pelosi is to be the next speaker of the House… and thanks to Democratic control of both the House and the Senate, she’s going to control the legislative agenda. What should we expect over the next two years? I went looking for her track record on taxes… Oh boy. It’s unanimous.

Pelosi’s Tax Vote Record:

* Voted "NO" on retaining reduced taxes on capital gains and dividends. (December 2005)

* Voted "NO" on providing tax relief. (September 2004)

* Voted "NO" on making permanent an increase in the child tax credit. (May 2004)

* Voted "NO" on permanently eliminating the marriage penalty. (April 2004)

* Voted "NO" on making the Bush tax cuts permanent. (April 2002)

* Voted "NO" on a $99 billion economic stimulus package that included capital gains & income tax cuts. (October 2001)

* Voted "NO" on tax cut package of $958 billion over 10 years. (May 2001)

* Voted "NO" on eliminating the estate tax (death tax). (April 2001)

* Voted "NO" on eliminating the marriage penalty. (July 2000)

* Voted "NO" on $46 billion in tax cuts for small business. (March 2000)

What’s the hottest market in the world? Corn. From Bloomberg: "Corn was the best-performing commodity in the past three months. Its 44 percent gain topped zinc and nickel. Trading in agricultural futures including corn more than doubled last month to a record at the Chicago Board of Trade."

About six months ago, my friend Chris Weber (www.weberglobal.net) recommended corn futures in his newsletter for the first time. I thought he was nuts. Corn futures? I should have known. Chris is the best investor I’ve ever met. He’s right so often I think he must have cut a deal with the devil.

On the way home from Virginia yesterday, my wife and I stumbled onto a gem of a restaurant, The Iron Bridge Wine Co. Set in a small clapboard farmhouse overlooking beautiful rolling farm land, the place has an amazing assortment of fantastic wines and a world-class chef. While most of you won’t be able to visit the restaurant, you all should look for the wine we ordered: 2002 Santa Ema Reserve Cabernet. It’s Chilean. And though it says Cab on the label, it’s really a blend. It’s superb… one of the best wines I’ve ever tasted, anywhere, at any price. It’s imported by TGIC Importers Inc. of Woodland Hills, California… and it’s cheap.

And now… the mail bag.

Paid-up subscriber Ralph Anderson says, "The only ignorant person is you. I have found that individuals who criticize others do so because they can not (sic) deal with them one on one or are very insecure. My guess is you are both..."

Lt. Col. Ron Gentzler, Retired USAF, questions my bona fides for comparing Rumsfeld’s picture to McNamara’s.

"Do you really believe you can write a newsletter and include that kind of political bashing? Who was impeached, Nixon or Rumsfeld? Have you served your country in any way? It’s so easy to criticize when you’ve never been there."

Porter Comment: I certainly agree… and speaking of having "been there"… did George Bush, Dick Cheney, or Don Rumsfeld ever see even a single day of combat?

Paid-up subscriber Ken Mosher has a new hero. "Doug Casey is my new hero! And you're right that there's nothing sadder than a libertarian who becomes a Republican."

Paid-up subscriber Doug Eatough threatens: "Remember, you’re not the only game in town!"

Porter Comment: Thank God. What would we read?

Tell us how you really feel. Don't hold back: feedback@stansberryresearch.com

Short-Term Trade in Retail Home

Improvement Stocks

by Ian Davis

The best contrarian play in the stock market right now is in the housing sector. I’m continuing to research this sector to provide the best opportunities to my readers. This week, I’ve come up with another great way to speculate in housing related stocks.

As a sector, retail home-improvement stocks have fared poorly since 1999.

From mid July 2005 to mid July 2006, retail home-improvement stocks fell by 25%. They have since rallied by 8%.

Buy Home Depot (NYSE: HD) below $38 and hold for the next six months or until the stock price hits $50; use a 10% trailing stop.

BULLISH INDICATORS:

1. Sentiment: Last week, we noted that sentiment in the housing market, as measured by the National Association of Homebuilders index, reached an extreme low in September 2006. This indicator has reached an extreme low three times since it was introduced in 1985. Each of these extreme lows has correctly signaled the beginning of a rally in retail home improvement stocks, producing six-month returns of 58.8%, 22.2%, and 14.6%, respectively.

2. Affordability: Housing affordability has risen in the last two months, according to the National Association of Realtors affordability index. A measure of 100 means a family making the median income can afford a median priced home at the current mortgage rate. As housing affordability rises, retail home improvement stocks have historically rallied.

**Datastream Retail Home Improvement Index consists of the stocks Home Depot and Lowes.

WHY HOME DEPOT:

Home Depot is about as cheap as it has ever been on a price-to-earnings or a price-to-book value basis. At Home Depot’s current earnings, the stock’s price would have to rise by about 18% for its valuation to be in line with Lowe’s.

Home Depot is undervalued compared to its historic measures as well as its fellow home improvement stocks.

Update on Previous Picks:

Last week, I recommended Toll Brothers (NYSE: TOL) as another speculative housing play. Toll Brothers is down 2% from last week, partly due to analysts revising their 12-month target price for the stock downwards from $37 to $35. My recommendation for Toll Brothers remains the same. Buy Toll Brothers (NYSE: TOL) below $30.

Good Investing,

Ian Davis

November 13, 2006

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