The S&A Digest: You are Uncle Sam's property

You are Uncle Sam's property... Yahoo and Microsoft: 0 + 0 = 1... China's tragedy... The new bottom feeders... Bear Stearns on hygiene (really!)... Gambling on the Vegas Strip, Wall Street, and Main Street...

 The U.S. government is hard at work, staking out its claim on you and your wealth. It wants you to know any efforts to the contrary will not be taken lightly. Federal prosecutors are expected to issue a subpoena to UBS, the Swiss banking giant, for the names of wealthy American clients who allegedly used UBS services to avoid paying income taxes.

A UBS banker pleaded guilty to charges in a federal court on Tuesday. His alleged accomplice is at large in Lichtenstein, a well-known European tax haven. Unlike the People's Republic of Amerika, not all countries believe they own their citizens. Lichtenstein isn't expected to turn him over to the U.S. I encourage you to join Lichtenstein and me in inviting the U.S. government to shove it high and hard.

If you think the U.S. doesn't own you, try moving to another country and not paying U.S. income taxes. The government will come after you.

 In a letter to the chairman of Yahoo, Carl Icahn wrote, "It is quite obvious that Microsoft's bid of $33 per share is a superior alternative to Yahoo's prospects on a standalone basis."

Icahn thinks Yahoo can't make it alone. Last week, we reported that Legg Mason's Robert Hagstrom says Microsoft can't make it alone. Yet both Hagstrom and Icahn agree that, as Icahn wrote, "A combination between Yahoo and Microsoft would form a dynamic company and more importantly would be a force strong enough to compete with Google on the Internet." If they're both right, does that mean 0 + 0 = 1?

 The death toll in China will reach 50,000, a staggering human cost. Aspects of the situation recall China's former – and fairly recent – xenophobia and isolationism. Workers are having trouble getting to earthquake victims in remote mountainous areas near the epicenter. China's communist government is trying to keep a tight lid on media coverage, wasting valuable manpower it could be using to help victims. Apparently, you don't just wake up one day and suddenly become a free-thinking capitalist culture. Whoda thunk it?

 The mortgage crisis has given birth to a new kind of bottom feeder... A man named Angel Gutierrez is buying discounted mortgages dozens at a time, then going door-to-door to negotiate with the homeowners. If Gutierrez can't negotiate a new monthly payment, he will pay the tenants to leave, then quickly sell the house. Besides making a quick profit for himself, Gutierrez is helping to establish a market-clearing price. He wants to "buy them cheap, sell them fast." Actions of Gutierrez and other small-timers caught the attention of the best-known bottom feeder, Sam Zell: "At this stage of the game, they're playing a very small role. But I expect that that role will accelerate, as more people are willing to accept reality. The single-family market has to be cleared. No market works unless it clears. If banks can't clear, they can't make new loans. Anything you do to keep people who can't afford it in their houses is another way of delaying the market clearing."

 Mortgages, of course, aren't the only lending market that's in trouble. Michele Leder at footnoted.org today sent us this snippet from First Marblehead's last quarterly filing. First Marblehead is, or was, in the student loan business:

"Our inability to access the securitization markets... together with the reorganization of The Education Resources Institute, Inc., or TERI, has strained our client relationships, resulted in the termination of several material client agreements, reduced our facilitated loan volume and created uncertainty about our business prospects. We will need to change our business model significantly in order to overcome the challenges currently facing us."

 The bull market in art rages on. Francis Bacon's three-panel painting of a headless man eaten by vultures sold for $86.3 million in New York last night, breaking the auction record for contemporary art. The $362 million auction was Sotheby's biggest ever, beating its $356.7 million estimate for the 83 lots. One Chicago gallery owner put the sale's success in a simplistic perspective, "There are fewer people in the market, but those who are in have plenty of confidence, exuberance, and lots of dough."

 It's easy to see why Bear Stearns failed when you take a look at this memo [You can view the original on the financial blog dealbreaker.com.]

Date: December 13, 2007

To: All 24th Floor Male Employees

From: Jeanne Orgon, R.N.

Subject: Infection Control & Hygiene

In order to prevent the spread of infection and disease, here are a few reminders you should follow to protect yourself and others:

• Flush the toilet and urinal after use.

• Do not use the urinal for disposal of solid matter.

• Clean up after yourself.

• Wash your hands with soap and warm water.

It's the nature of our business to want to rush through things to get back to our desks. However, it is the responsibility of everyone to use the fundamental rules of good hygiene and do their part to ensure that the restroom is kept clean and disease-free.

 "Everyone is gambling their money away."

That's what hit me as I looked out at the sea of slot machines and table games at the Mandalay Bay Hotel & Casino earlier this week. I went to Las Vegas to attend the Money Show investor conference. It's a huge event. There must have been 10,000 people there.

I walked past the Crystal Room, which I assumed was for high rollers only, and noticed it was generally deserted.

As I made my way over to Mandalay Bay's convention center, the smell of gambling was no less pungent on the exhibit hall floor. Every other booth was dedicated to the sale of some options-trading strategy or computer program that provides you with reams of useless information in real time.

The best investing idea I heard all week was by Mike Williams of Genesis Asset Management. He's rolling up outdoor billboards into a limited partnership, then converting them to digital format, which he says causes the cash flows to soar. Very few of these digital conversions have taken place. Big companies like Clear Channel, Lamar, and CBS own lots of billboards. But most of them are owned by small mom-and-pop outfits, many of whom don't want to spend $300,000 per billboard to upgrade.

I also liked the comments from Mark Skousen, the Money Show's progenitor. Skousen observed, correctly I believe, that interest rates, at 2%, are way too low. Betting on rising interest rates over the next several years looks like a smart trade.

Most of the Money Show seminars were on energy stocks or options trading. I think options are the lottery tickets of the investment world. As for energy, well, everyone just knows we're going to run out of oil and natural gas one day. Even the great and wise Charlie Munger has fallen for this ruse. No one ever bothers to explain why it is that these predictions never, ever come true. The reason was given by the late, great Julian Simon: With every new human mouth to feed comes a new human brain that thinks.

 New highs: Valhi (VHI), Eni (E).

 Please write in about something other than how wonderful I am. E-mail us at feedback@stansberryresearch.com.

 "Your advice for stop losses and trailing stop losses are clear. What is your advice on how long to hold a nonperforming stock? Case in point is Ferris's reccomendation re HR Block. Paraphrasing him, it sat there for three years and then became an overnight success. Would a prudent investor allowed his money to sit dead for that period of time?" – Paid-up subscriber Neil A. Bourjaily

Ferris comment: Your money isn't dead because the market disagrees with you. A prudent investor doesn't sell stocks below intrinsic value, nor does he accept the market's assessment of intrinsic value as meaningful.

I recommended Wal-Mart for the first time in October 2006, but it didn't start performing until earlier this year. However, at no time was it dead money. It was obvious to anyone who cared to look that the business was (and still is) worth much more than the market cap.

American Express is another example. It's a fantastic business with a huge moat around it. It was cheap when I recommended it, and now it's 12% below that level. Is it dead money? Warren Buffett says Amex grew its competitive advantage last year. That means its business is more valuable than the year before. What if the stock price does nothing for three years, while the business value increases? That's not dead money. It's a gift from the gods. It's a spring, coiling tighter and tighter. Today, Amex is trading at 13-14 times free cash flow, when its intrinsic value is easily more than 20 times. As long as the business doesn't become permanently impaired (highly unlikely with Amex), there's no reason to sell. Buying is the more rational decision.

Dead money isn't when the stock price doesn't cooperate. It's when the business value declines permanently.

 "Please explain CAGR." – Paid-up subscriber Richard S. Shaw

Ferris comment: CAGR stands for "Compound Annual Growth Rate." It is the average rate at which a sum has compounded over a given period of time. If you start with $10,000 and it grows to $50,000 over five years, that's equal to a compound annual growth rate of approximately 38%. Like all averages, CAGR doesn't tell the whole story. You could have held your $10,000 for four and a half years, and watched it go nowhere, then made $40,000 profit in the last six months, and you'd still have compounded at a 38% CAGR over that time period.

Here's a more detailed definition, which includes a simple CAGR formula: http://www.investopedia.com/terms/c/cagr.asp.

 "I have to say that Dan Ferris has outdone Porter with the April 22 report. I can't lay my finger on any particular part of the report that was so outstanding, but I can only say that in the past I was always disappointed when Porter's name was not in the byline. Now I will be looking forward to watching Dan continue to outshine the old champ!" – Paid-up subscriber Mike Lamb

Ferris comment: Thanks. We should also credit Sean Goldsmith, who contributes much to The Digest every single day. April 22 was no exception.

Regards,

Dan Ferris

Medford, Oregon

May 15, 2008

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