The S&A Digest: Three Rules For New Investors

Looking for a condo in Miami… Three rules for all new investors… More signs of a top in oil… Is Tom Dyson real…? Is the dividend grab for real…? A great mailbag…

What would you do next week, if you could leave your family behind, take your work with you, and go anywhere you wanted to? My wife is visiting her family. She's taking our dog. With my laptop, I can work from almost anywhere. Next week, I've got a "free pass." What would you do?

I'm going to Miami to visit old friends, enjoy the warm sunshine, do some fishing, and look at buying a condo. I wonder what my wife will say if I buy one?

I used to live on Miami Beach in a huge apartment overlooking Biscayne Bay. I remember those days fondly and would love to have a second home on the beach. But prices skyrocketed soon after I moved away. I hope now the bust in the real estate market has created some bargains. We'll see.

If you're a real estate agent in Miami… or even better… if you have a condo in Miami you'd like to sell, send me a note.

The Pentagon is estimating that the 2007 war in Iraq will cost $8.4 billion a month. The figure is nearly double the cost of the war's first year.

A survey of the 30 member countries of the Organization for Economic Cooperation and Development showed that oil demand fell 0.6% in 2006. While this seems like a small number, this is the first time oil demand has dropped in developed countries, which use 60% of the world's oil, in 20 years.

Signs of a top in oil: In the past year, the number of energy-related hedge funds rose from 60 to 100. Money under management at energy-centric hedge funds increased to $24 billion from $14 billion. Some have generated huge returns: Centaurus Energy and Red Kite Management are both up more than 100%. Prediction: By this time next year, more than half of those new hedge funds will be closed.

New highs: Anheuser-Busch (BUD), Disney (DIS), Telstra (TLS).

Today's mailbag might be the best ever. We lead with my favorite… Send your comments here: feedback@stansberryresearch.com.

"Does the man Tom Dyson really exist? I would like a date with him. I once fried a couple of eggs on the highway just to see if it was really hot enough to 'fry an egg.'" – Subscriber Pamela Center

"I have managed one of my retirement accounts myself for three years and I have definitely learned what not to do. After earning zero for two years (and now realizing how fortunate I was not to have lost most of it), I stumbled onto your publications. I've been reading the S&A Digest and DailyWealth for about a year and I took advantage of your lifetime subscription offer in November. In the past six months my account has grown 14%. Not stellar by any means, but solid, and a good starting point. I now use your publications exclusively. I believe the education is starting to pay off, as I have built a healthier portfolio and a much better approach to managing my investments (and particularly, my exit strategies)… Thank you… now, I'm looking forward to my first triple-digit return on an investment!" – Private Alliance subscriber Travis Ferrell

Porter Comment: Travis, thanks for your note. Your success is what we wish for all of our subscribers… and the reason we got into publishing. By the way, being up 14% in six months is an outstanding, world-class result. Look at how many diversified mutual funds have done that well – not many.

"Hoping Porter gets well soon… I enjoy the vitriol dished out when the usual editor is around. I also miss the sarcasm... it has a healing effect…"

– Alliance subscriber Dave Quattrin

"Is this for real? You are telling me that a $20 stock is going to pay a $10 dividend in a month or so? What's the down side? I know that you think the price will return to 'normal,' but at least it shouldn't fall below $10, huh?"

– Subscriber "Marty"

Porter Comment: Yes… it's for real. And yes, there are certainly risks to this strategy. There is no guarantee the stock's price will return to $20. And it will certainly fall by about the same amount of the dividend the day it is paid. But, as I explained, we've found that, nine times out of 10, the stock's share price does recover fully within six months.

"I have been enjoying the rumble you started over GM and how you COGENTLY pointed out to everybody why GM will go down the tubes. In yesterday's Digest, you mentioned Magna International as a possible player in GM's demise. MGA trades at 80 and change at the close of market. However there is a symbol on the OTC of MAGBF which are listed as class B shares of Magna International, trading at 74.40 at closing. Which one or both?" – Subscriber Daniel Loughrey

Porter Comment: My analysis is based on the Magna common stock listed on the New York Stock Exchange (MGA), which are A shares. The company's B shares are tightly held by the company's founder, Frank Stronach. I doubt there's enough liquidity in the B shares to build a position. They have 500 times the voting rights as the A shares, which I don't like… but the company's charter requires separate votes and both A share and B share approval for major investments. Stronach, meanwhile, has a billion reasons to ensure the company continues to do well.

Three Rules For New Investors

Last week I got a call, out of the blue, from an old friend who has done very well in business.

He's now the CEO of a large, private company, which, were it public, would be valued at around $1 billion. He didn't mention what he wanted to talk about, but I knew it was important. This is the kind of man who values his time and measures his words.

He'd arranged for us to have a very private table, in the back of a nice Italian restaurant. After some small talk, he picked up a plastic folder packed with papers.

"Porter," he said, "while I've done well with my company, my personal finances are a mess. I don't have time to manage my money, so I keep stuffing cash into low-return savings accounts. I've got a few stocks – mostly your picks, actually – and they've done well. But not nearly as well as your S&A 16 did last year. How can I organize all of this, to finally put my money to work? Should I put all of my money into the new S&A 16?"

"Well, you could. It's a good portfolio. It's relatively diversified," I said. "But… you've bought and sold entire companies, some of which are worth hundreds of millions of dollars. You're an expert in accounting. You know more about a lot of businesses than I do, and you surely know more about accounting and valuation. Why wouldn't you put your expertise to work on your account?"

"I know you're right," he said. "But I simply don't have time. When I'm not at work, I don't want to think about money. I'm playing with my kids. The last thing I want to do is sit down at a spreadsheet and figure out what a public company is worth, what I should pay for it, etc. That's what you do. That's why I read your letters."

I have heard this explanation many, many times before. It's logical and reasonable. But it has always felt wrong to me to entrust your life's savings to another person… especially if you have the means and the skills to manage your own money. No, taking on this responsibility yourself doesn't ensure success… but it ensures that you deserve to succeed.

"As you know," I told my friend, "I can't give you any personal advice. And you also know that I put my best ideas in the newsletter, which you've already seen. But I don't think you should 'outsource' your investing, to my Advisory or any other person. You have the ability to make high, safe returns, even if you only spend 10 hours per month on your investments."

"Okay, okay… I know you're right. How should I get started?"

Here's what I told him:

There are three things you can do to greatly increase your chances at success, as an individual investor.

First, only invest in companies that pay a substantial dividend (say, at least 3%) and that have a long history of increasing their dividend. You may count money spent on share buybacks when measuring the dividend yield. This will do several things for you. It will narrow your possible choices substantially, giving you an investment "universe" that's more manageable. It also will automatically prevent you from buying stocks that are speculative or overpriced. And finally, it will greatly reduce the odds that your account will ever show a loss. Earning 3% a year isn't much, but it adds up, especially if the company continues to increase its dividend. After a year or two, even if the share price dips, you'll probably still show a gain, thanks to the dividend.

Second, out of the companies that are paying a good dividend, only buy companies whose businesses you're able to easily understand and that you judge to have a solid competitive advantage. As a test of your understanding, read the company's 10K (annual report) filed with the SEC. You can get a copy online for free. Or you can call the company and they'll send you a copy. If you're not willing to spend an hour or two reading a company's 10K, are you really ready to invest 4%-6% of your life savings in its stock? It baffles me that investors will readily pile money into companies that they don't understand… and that they make no effort to understand. (Keep in mind, I'm not talking about trading here. I'm talking about investing – buying a position and keeping it for years.)

Third, only buy stocks when they are very attractively priced, i.e. when there's a substantial margin of safety in the stock. This means waiting to buy until the company's shares are priced so low that the company could afford to buy back all of its shares. I perform this test on all of the stocks that make it into my "no risk" portfolio – which is almost always my best performing portfolio every year. This step makes it nearly impossible for you to lose money investing and will ensure you garner the benefits of compounding, because your entry price will be small relative to the company's assets and future earnings.

What I've learned about finance and investing has taught me that it's very hard, nearly impossible, for anyone to beat the compound returns of high-quality common stocks held for the long term. If you will follow these three rules – good dividends, understandable businesses with competitive advantages, and buying only at very safe prices – you can achieve world-class investment results.

You can do this without anyone's help (including ours) in about 10 hours per month.

Good investing,

Porter Stansberry

Baltimore, Maryland

January 19, 2007

P.S. Of course… if you read our letters… the chances of you finding such great investments are greatly increased.

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