The triumph of Wal-Mart shareholders...
The triumph of Wal-Mart shareholders... A fallacy you probably believe... The type of opportunities sophisticated investors drool over... A simple investment question...
The markets are treading water this week. The S&P 500 is nearly unchanged from last Wednesday. Gold is hovering above the important breakout level of $1,640 an ounce. Trading volumes are light. Chinese stocks are still in the toilet. The Volatility Index (the "VIX") is still at a docile reading below 17.
Most folks are waiting to see what comes of Fed Chairman Ben Bernanke's speech at the much-publicized central bank meeting in Jackson Hole, Wyoming. The speech is scheduled for Friday. These days, Bernanke is Wall Street's E.F. Hutton. When he speaks, the market listens.
Guessing what Bernanke will say is a lot like guessing whether the market will close higher or lower on any given day. We won't offer a guess... But we will say that with the market up nearly 7% in just the past two months, the overall market has "priced in" a lot of good news from Bernanke. And when we say "good news," we mean more stimulus... more "quantitative easing"... whatever you want to call it. If Bernanke's comments are anything less than something like, "We still plan to flood the system with liquidity," the market will suffer a sharp correction.
With the markets quiet, we continue our fruitless, unpopular attempts to help readers "unlearn" the flim-flam and old wives' tales they've heard – and now believe wholeheartedly – from brokers, college professors, mutual-fund companies, and in-laws.
We know it sounds cynical, but we've found the vast majority of Americans hold utterly wrong beliefs about money and investing. They write in to us every day. They tell us how we are insane for recommending gold... or for buying a stock with the intention of holding it for the rest of our lives.
What we're trying to do is help people "unlearn" these beliefs so they can become much more successful investors and traders. We'd expect the same if our roles were reversed. We expect and appreciate it in other areas of our lives... like we'd appreciate our doctor telling us that eating a bucket of fried chicken wings each day for breakfast isn't a good idea.
And today, we take on a popular misconception... one that leads to frequent reader complaints. We get this complaint all the time. When an investor rids himself of this thinking, he's much more likely to make money in stocks.
This complaint typically pours in when we recommend very cheap, very safe, blue-chip stocks. It pours in when we recommend, say, the world's dominant semiconductor maker – Intel – at eight times annual cash flow and a 3%-plus dividend yield. Buying high-quality equities for low prices and then compounding your money for long periods of time is the "Holy Grail" of investing.
It sounds simple... I know. But many of our readers howl when we recommend these positions. Why?
It all comes down to a basic human fault: We tend to look back at the past and let it dictate our thinking. We expect what has already happened to continue happening, and we make decisions based on this belief. In the investment world, this tendency to drive by looking in the rearview mirror causes folks to miss out on huge opportunities. It also leads them into disasters.
We'll cover disasters in another Digest. This one concerns missing out on huge opportunities in cheap stocks. It concerns the previously mentioned complaint...
You see, when an excellent company – like Hershey, Intel, or Coca-Cola – gets very cheap, chances are good it has lagged the market... or suffered a short-term setback. Or maybe the company has spent years coming off a period of overvaluation... like many excellent businesses did after the 2000 stock market bubble.
When we recommend an elite company that has spent years in this position, hundreds of people write in to tell us we've lost our minds. They tell us we are insane for recommending a stock that "hasn't gone anywhere for years." And then they run away from an absolutely incredible long-term investment opportunity. All because of the human tendency to expect what has happened in the recent past to keep happening in perpetuity.
You may not have this belief. Many of our more sophisticated readers love these recommendations. They realize these are fantastic opportunities. But most readers can't stand them. If you're among the latter group, we ask you to consider a hypothetical situation...
The owner of a successful, sustainable, cash-generating local business wants to sell the business and retire. Everyone in town likes the business. It has served its customers for more than 30 years. You're considering buying the business.
When you do your due diligence, would you devote your time to analyzing the current business and figuring out the right price to pay for it? Or would you devote your research to determining what the business was worth five... seven... or eight years ago?
The answer is obvious.
You'd make sure the books look good... And you'd make sure you don't overpay for the business.
But this isn't the way most people view public stocks. They don't see stocks as pieces of a real business… even though that's what they are. Instead, they view them as lottery tickets and fast gambles.
I believe if you look at buying a stock as buying a piece of a business… you'll agree with me that studying the quality and sustainability of the business and making sure to buy it at a good price is 100 times more important than studying what it changed hands for 10 years ago.
Most stocks reached incredible levels of overvaluation at the peak of the 1998-2000 stock mania. So the share prices of many high-quality businesses spent years "treading water." However, nothing changed about the actual businesses… Coke kept selling soda to hundreds of millions of people. Wal-Mart remained the "King of Retail." Hershey kept selling chocolate. Microsoft remained the planet's dominant software maker.
This is a key idea. When a business relentlessly grows its cash flows, dividend payments, and book value over many years, the share price will always follow. You simply have to buy these stocks at bargain prices... not at 1999 prices. Bargain prices are often available after share prices have spent years "not going anywhere."
And while a great business whose share price has spent years "not going anywhere" scares off the average investor, it's something the sophisticated investor sees as an incredible opportunity. Sophisticated investors drool over these situations.
One of our favorite examples of how these situations work out recently occurred with Wal-Mart. Shares of the King of Retail have skyrocketed from $50 per share last October to around $75 per share in July (a 50% gain in nine months).
We received a lot of complaints about Dan Ferris' recommendation of Wal-Mart. Wal-Mart is a steady, dividend-paying, cash-generating powerhouse. In 2000, shares of Wal-Mart peaked at $70, when it was trading for more than 50 times earnings. Remember, this was during the peak of the 1998-2000 stock mania. Stocks were incredibly expensive back then.
After the bubble deflated, Wal-Mart spent most of the 2000s in a sideways trading range of roughly $40-$50 per share. People complained about Wal-Mart being "dead money." All that mattered to them was where the share price had been over the past decade.
What should've mattered to folks was how much cash the company is capable of earning and distributing in dividends... and how sustainable that cash-generating ability is over the long term.
As Dan frequently pointed out during the 2000s, the value of Wal-Mart's business soared. Earnings per share and dividends paid kept rising. Take a look...
Dan's readers have made great money in Wal-Mart shares. They are collecting a safe and growing dividend. And Wal-Mart isn't an isolated example… Porter's hugely successful Hershey recommendation is a similar example. Microsoft and Intel have soared in the past year.
The story behind all these big winners is the same: An elite business continually grows its cash flows and dividends. But for some reason, the share price treads water. The sophisticated investor sees opportunity where the amateur runs away because the stock "hasn't gone anywhere for years."
Mind you, I'm not trashing the idea of studying past price action. Studying past price action can be useful. I'm simply pointing out that most people arrive at the wrong conclusions when they do look at it.
The sophisticated investor is much more likely to buy an elite business if it is unpopular with the public because its share price has treaded water for years.
The sophisticated investor looks for an elite business with growing cash flows and dividends... And he looks to buy it for a good price. Meanwhile, the amateur mutters something about "dead money," walks away, and moves on to the next gamble.
The next time you see a great business trading for a great price, ask yourself which type of investor you want to be.
Speaking of this, another of Dan's World Dominators just hit a new all-time high. Extreme Value holding Anheuser-Busch InBev, the global brewing giant, closed at $84.01 per share yesterday. Dan's readers are up 76% on the position since May 2010. You don't have to take big risks to make big money in stocks.
Other 52-week highs (as of 8/28/12): Guggenheim BulletShares 2015 High Yield Corporate Bond Fund (BSJF), SPDR International Health Care Fund (IRY), Anheuser-Busch InBev (BUD), Eli Lilly (LLY), and Two Harbors (TWO).
In today's mailbag… a question about trailing stops. We've often cited trailing stops as one of the most important tools to successful investing. If you're not familiar with them… please read this Digest Porter wrote, describing how and why they work. And of course, you can always send your investing questions to feedback@stansberryresearch.com.
"Do you use trailing stops only after a stock doubles in value or every time it closes for higher than what you bought it for? Example: you buy Stock A for $10 (52-week high is $14.50), and it closes for $10.50. Is you stop based off of $10 or $10.50?" – Paid-up subscriber Jay
Hunt comment: You adjust your trailing stop every time the stock closes higher. In your example, the stop is based off $10.50.
Regards,
Brian Hunt
Delray Beach, Florida
August 29, 2012