A Change of Character for the Market

A change of character for the market... Buybacks are booming, but investors don't care... The details behind an epic hedge-fund collapse... How the insurance business bested a Wall Street legend...

Regular Digest readers know U.S. 'stock buybacks' are booming...

S&P 500 companies repurchased a record $189 billion of their own shares in the first quarter of the year. And they're on pace to buy back as much as $800 billion for the full year, which would trounce the previous annual record of $589 billion set in 2007.

As we've discussed, buybacks are a "double-edged sword." Under the right circumstances – when shares are trading at discount to the value of the business, and the company has the cash to fund them – they can add tremendous value.

But that generally isn't the case today. Many companies are buying back shares at or near historically high valuations... And they're compounding this mistake by borrowing heavily to do so.

In short, these companies are destroying long-term shareholder value in exchange for a short-term boost in share price.

It appears the market may now be waking up to this reality...

You see, while buybacks have been a big driver of higher stock prices over the past several years, something has changed of late. Most companies are no longer being rewarded for buying back shares. In fact, many are now being penalized. As the Wall Street Journal reported over the weekend...

57% of the more than 350 companies in the S&P 500 that bought back shares so far this year are trailing the index's 3.2% increase. That is the highest percentage of companies to fall short of the benchmark's gain since the onset of the financial crisis in 2008, according to a Wall Street Journal analysis of share buyback and performance data from FactSet...

"There has been less of a reward for companies engaging in new buybacks over the last 18 months," said Kate Moore, chief equity strategist and a managing director at asset-management firm BlackRock. "It's fair for investors to ask whether companies are buying at the right point."

The S&P 500 Buyback Index, which tracks the share performance of the 100 biggest stock repurchasers, has gained just 1.3% this year, well underperforming the S&P 500.

Speaking of poor returns...

The Journal also profiled the recent troubles of billionaire hedge-fund manager David Einhorn.

If you're not familiar, Einhorn is something of a Wall Street legend. He famously earned investors in his Greenlight Capital hedge fund a remarkable 29% per year over its first 10 years. That's among the greatest 10-year track records of any investor in history... And he did it all before the age of 40.

But Einhorn's performance over the past few years has been anything but great, and even his early investors are now jumping ship. From the report last Wednesday...

For years, David Einhorn's investors did not seem to mind his unusual ways – the aloofness toward clients, midday naps, unpopular stock picks, late nights on the town. Until the billionaire hedge fund manager fell into a slump.

After more than a decade of winning on Wall Street, Mr. Einhorn's Greenlight Capital has shrunk to about $5.5 billion in assets under management, his investors estimate, from a reported $12 billion in 2014, and his investments are struggling...

The value of an investment in Mr. Einhorn's main fund was down 11.3% at the end of 2017 from 2014's end. The S&P 500 grew 38.3%, including dividends, in the same period. The average stock-focused hedge fund gained 18.3% in the period, according to HFR, a firm that tracks hedge funds.

According to the report, Einhorn's poor performance may be due more to hubris than anything else. He has suffered big losses on a number of concentrated long positions in "value" stocks, such as the 75% decline in shares of solar and wind firm SunEdison in 2015. And he has stubbornly continued to hold significant short positions in "bubble" stocks – including Amazon (AMZN) and Netflix (NFLX), among others – that have soared over the past few years.

Of course, Einhorn hasn't only suffered losses in his Greenlight Capital hedge fund...

His publicly traded insurance company – Greenlight Capital Reinsurance ("Greenlight Re") – has performed terribly as well. Shares have lost nearly 60% over the past five years. The reason is simple...

You see, Greenlight Re invests its "float" – the premium that insurers get to hold before they have to pay out claims – into many of the same positions as Greenlight Capital. So it has suffered from similarly poor investment returns of late.

But these problems have been compounded by poor underwriting returns as well.

Longtime readers know we believe property and casualty insurance is among the best businesses in the world...

In fact, Porter has gone so far as to call these companies "the only investments I hope my kids ever make." But there is one big caveat: Not all "P&C" companies are created equal. As he explained in the February 23 Digest...

Just as we were building our research in the space, two famous billionaire investors did the same thing. David Einhorn (Greenlight Capital) and Daniel Loeb (Third Point) are two of the best-known and most respected hedge-fund managers in the world. At virtually the same time we started our coverage of the insurance sector, they launched their own new insurance companies.

Dozens of articles have featured these new insurance companies, and a lot of newsletter writers (even a few we know well) have recommended these insurance stocks. The story was irresistible: Hedge-fund geniuses are applying Buffett's proven formula to make massive wealth in insurance. Who wouldn't want to own these stocks?

Well, us.

As Porter explained, he and his team knew something the market didn't...

When we launched our P&C Insurance Monitor in 2012, there were 40 large U.S.-based P&C and reinsurers (give or take). In the six years since, Third Point and Greenlight have ranked 38th and 40th, respectively, in terms of share-price appreciation. That is, these super-popular stocks are the worst and third worst-performing stocks in the P&C universe.

Greenlight is one of just two companies on our Monitor to have its shares lose value from 2012 to today. We've continuously told people (including several peers in the newsletter world) to avoid these stocks. Our contrarian view was fully based on the clear evidence presented to us through our proprietary research.

That's pretty impressive. We were not only able to predict which stocks would do the best... But our monitor told us to avoid the ones that did the worst, even when they're the most popular and had the best reputation.

Why has Greenlight done so poorly?

Again, the reason is simple. It's difficult to start a new P&C insurer from scratch, as Einhorn did with Greenlight. More from that Digest...

You'll notice that [successful insurance investors like] Shelby Davis, Ben Graham, and Warren Buffett did not break into P&C insurance by starting an insurance company from scratch.

Shelby Davis bought a handful of good underwriters, including GEICO. Graham bought half of GEICO. And Buffett started by buying National Indemnity.

It's a lot harder than it looks to start a new insurance company. Relationships with insurance brokers are a key advantage, as is understanding which operators are likely to have the smallest claims. We don't recommend insurance stocks until they can prove themselves. Remember that the next time a Wall Street tycoon announces a new venture in insurance.

Porter and his team continue to recommend that subscribers stay far away from Greenlight Re today...

But in the July issue of Stansberry's Investment Advisory – published last Friday – they announced that one of their favorite insurers is finally cheap enough to buy for the first time in years. From the issue...

We don't automatically recommend every company in our top 10. To make it into our portfolio, companies need to be trading for a great price.

We have studied every major Buffett insurance acquisition, noting that his most successful transactions come when he can buy the target for a 50%-60% discount to the total of float plus book value (what we call "float + book"). The problem is financial statements and data aggregators, like Yahoo Finance and Bloomberg, don't even publish float.

We broke through this challenge by building the only model we know of – certainly the only one available to the public – which aggregates the float calculation for every publicly traded P&C insurer...

Like Buffett, we do the extra work necessary to calculate the "discount to float + book value" valuation metric... Today, [this company] trades at a discount of nearly 70%... It is, essentially, as cheap as it has ever been.

Of our top-10 insurers, [this company] is by far the cheapest.

If you're not already a Stansberry's Investment Advisory subscriber, you can get instant access to this recommendation – and all of Porter and his team's detailed analysis on the P&C insurance sector – with a 100% risk-free subscription. Click here to sign up now.

New 52-week highs (as of 7/9/18): CBRE Group (CBRE), WisdomTree U.S. SmallCap Dividend Fund (DES), Facebook (FB), Fidelity Medical Equipment Fund (FSMEX), and Lindsay (LNN).

A busy day in the mailbag: Readers respond to Porter's latest Friday Digest... more feedback on our distressed-bond service, Stansberry's Credit Opportunities... and a note from a frustrated subscriber. As always, send your notes to feedback@stansberryresearch.com.

"Hi Porter, you said in your Friday Digest that you are pretty sure nobody listened three years ago when you gave us your Porter's 10 for 10 recommendations. I just want to let you know that I listened and acted on what you said. I still have most of these stocks. The ones I still have are now the cornerstones of my portfolio. They still show great gains, because we bought them for so cheap. Please keep up the great work. Some of us really trust you and we are with you as commodities explode like gold did a few years ago. Thank you." – Paid-up Stansberry Alliance member Riley C.

"Porter: Contrary to your assertion that '...nobody took (your) advice' re: gold in mid-2015, I did take your advice. Result: more than $100K in profits when I liquidated the positions in August 2016. Thanks for helping make my retirement profitable." – Paid-up Stansberry Alliance member R.J.L.

"Hi Porter, that's a great lineup of new [commodities] research material. I am excited, as I like pet rocks too!" – Paid-up Stansberry Alliance member Lee K.

"Looking forward to the new commodities products.

"Bought this two years ago with the profits from Porter's 10-for-10" – Paid-up subscriber Chuck N.

"I wanted to respond to [Thursday's] Digest about buying bonds. I am a current Alliance member and prior to having access to this service I never considered buying a bond. Recently I bought the last two bond recommendations and by holding these bonds to maturity, I will have a 27% gain on one bond and 64% on the 2nd bond over a two year period.

"That's a pretty nice yearly gain without being exposed to the ups and downs of the stock market. I can definitely see buying additional bonds in the future to minimize my exposure to the stock market without sacrificing returns, especially if we start experiencing a market selloff. Really enjoying my subscription to Stansberry's Credit Opportunities. Thanks for providing a strong investment alternative to stocks and appreciate all your hard work." – Paid-up Stansberry Alliance member Kevin L.

"Dear Porter, before I subscribed to Stansberry Research, the definition of 'bond' meant to join, fasten, fix, attach or secure; it also meant a promise, pledge or oath; and then sometimes it referred to my favorite British secret agent. I'm being facetious of course.

"I was once afraid to invest in or buy bonds. But once I understood the simplicity of bonds and how they work, I haven't looked back. Once you taught me and I learned the 'binary' nature of bonds, it all made sense. Thanks to Stansberry's Credit Opportunities, I love investing and buying bonds at discount. Receiving the interest twice a year and waiting for the bonds to mature for capital gains couldn't be easier. Of course, I make them a part of my diversified portfolio of stocks, real estate, global investments and commodities. Thanks again for helping me learn." – Paid-up Stansberry Flex member Nick P.

"Dear Porter and Team: I couldn't agree more with your conclusion and recommendations regarding distressed corporate bonds. I have purchased, or tried to purchase, almost every recommendation and they have exceeded my expectations... Thank you for your outstanding services." – Paid-up Stansberry Alliance member Don G.

"Good afternoon, in response to your request about experiences with Stansberry's Credit Opportunities, I'll offer the following feedback. I became an Alliance member in June of last year and was immediately attracted to SCO. The writing by the analysts is outstanding... stronger when compared to other competing publications.

"Every month I receive a very thorough analysis of the company bond being recommended and by the end of the report I'll know why the analyst feels positive about purchasing the bond, a thorough outline of the risk, the CUSIP number, and, the buy up to price. I have read that some readers have had issues with placing their order and in my case it did take a few minutes to figure out how the order placement works. After that however it is as easy as placing an order for stocks. One thing that I will say is that my fills haven't been automatic, such as the way you see with stocks. I place limit orders and have seen that it may take a couple of days to get the price I want. This isn't a problem but thought I should point it out.

"I currently own 4 of the recommended corporate bonds. They are all performing well plus I like the fact that I don't have to pay attention to them every minute of the day because bond prices move very slowly. I love seeing the interest payments every 6 months and feel very confident that the bond will payoff at the maturity date, which is the obvious risk with bond investments. I trust Mike and the team and their record has been great so far..." – Paid-up subscriber Bill F.

"I've been wanting to provide some thank-you feedback for some time. So often I read the disparaging comments to Porter from idiot readers that it makes me want to write in daily. I realize though that some minds cannot be changed. A little about myself. I grew up in lower middle class. Through years of night and weekend study, my wife and I, (high school sweethearts celebrating our 40th wedding anniversary this year), both earned many degrees and certifications. No one helped us and we never complained... well, ok maybe we complained a few times. I had a successful career at a very prominent blue chip company and am now enjoying semi retirement. Meanwhile, I employ a diverse investment strategy that includes technical price pattern analysis. I believe it's important to always be learning.

"I subscribe to a few Stansberry services and am enjoying the level of analysis that is provided. If I could give any of your readers just one piece of advice, it would be this – subscribe to Stansberry's Credit Opportunities and buy every single recommendation they provide!

"I am at an age where it is important now to move towards providing income in our portfolio, (vs depending on long term growth). So I originally subscribed to this service thinking it would be a way to learn about the bond market. Not only has it been filling this need but the returns have been tremendous! I made back my lifetime subscription fee in my first six months... and this was even with my being cautious. Put simply – SCO KICKS ASS!

"Please keep up the good work. I intend to one day buy this service for each of my kids when I think they are ready. In my previous work I am familiar with how the best ideas were often found by accident. Your Golden Triangle find is nothing short of brilliant!" – Paid-up subscriber Rob W.

"I have 3 of your bonds, Revlon, Community Choice, and Monitronics. I'm down on each only slightly, 1.3%. Hanging in there so far. If the credit market falters, as you propose, where will these leave me? It seems you scare members away from investing in bonds because of all your chatter about imminent crashes especially to the credit market. You can't have it both ways. Is what you're recommending immune to what you are predicting? Not likely. And therein lies the rub." – Paid-up subscriber John F.

Mike DiBiase comment: John, we get this question a lot... And it's a good one. The good news is, we can have it both ways.

You're right... If the bond market collapses, the market prices of the bonds in the Stansberry's Credit Opportunities portfolio will also likely fall... maybe even a lot.

Here's what's important to remember about the bonds we own: As long we believe they are safe, their current market prices don't matter at all. By safe, I mean we believe we'll collect all of our interest and get paid the full par value of our bonds at maturity. Remember, we only recommend and continue to hold bonds that we believe are safe.

When you buy a bond, you lock in the return you're going to earn on that investment through its maturity. That return doesn't change as long as you hold it through maturity. Current market prices don't affect it at all.

When the bond market collapses, it's true that your existing portfolio of bonds might look a bit ugly. But as long as you continue to collect your interest payments and get paid all of your principal, you can rest easy. Your returns will look great at maturity.

Remember, if you buy safe bonds, the only thing that matters is the price you pay. And the lower your purchase price, the higher your returns. That's why I said we're "licking our chops" waiting for the bond market to collapse. We want the market to roll over. When it does, we'll see lots of safe bonds trading at bargain prices and offering huge returns... in other words, far better opportunities than what exist today.

"I am very interested in buying my first bond through Stansberry's Credit Opportunities, but Porter said if we don't have 50K to work with, we shouldn't participate in this. I have about 5K to work with, so I didn't sign up for this service. Still I get promos showing how much I'm missing by NOT doing this. Frustrating." – Paid-up subscriber Gail H.

Porter comment: Gail – I just want to wish you well... and patience.

Investing requires capital. There are no shortcuts. But if you continue saving and learning, I know you can get there. (We have lots of low-cost and free materials that will teach you how to become successful in the markets.)

I hope our subscribers who have started small and seen their savings and their returns grow over time will chime in and encourage you.

Regards,

Justin Brill Baltimore, Maryland July 10, 2018