Tue, Sep 24, 2013|Sean Goldsmith

A first for Dan Ferris...

One employee Porter fired almost immediately...

Firing people is never easy. In today's Digest Premium, Porter shares the story of an employee he fired almost immediately... And he offers an important piece of business advice on the subject of hiring and firing.

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A first for Dan Ferris... Five financial clues... Apple versus Microsoft... New low for J.C. Penney... 'Your options material changed my life'... Doc is 136 for 136...

Dan Ferris is doing something he's never done before...

Before I explain the incredible value Dan is offering our subscribers, why should you care?

Dan is one of the best value-oriented stock analysts we know. He spends his days scouring companies' annual reports and other financial filings. He's constantly reading different trade journals for energy, insurance, software, etc.

He's dedicated the past decade of his life to learning everything there is to know about equity analysis... Specifically, how to spot the best companies in the world – the types of businesses that investing legend Warren Buffett likes to buy – and what prices you should pay for these businesses.

If you're able to recognize great companies and know what price you should pay for them, you will get rich in the stock market over the long term.

After you acquire those two skills, you need to have the patience to sit and let your wealth compound.

Some people believe that because the holding periods for these stocks are so long (in some cases "forever"), only young people who can hold them for a decade or more can buy them. But that's simply not the case.

These are elite businesses... They undoubtedly outperform over the long term. But they often outperform over all time frames.

As Porter explained in the August 26 Digest Premium...

Remember, the trick is to simply hold these stocks forever... You will compound your wealth at amazing rates.

Because we say the timeline for holding capital-efficient stocks is "forever," many people think only young people can buy these stocks... Older investors won't have time to enjoy the miracle of compounding. But that's not true...

The notion that these companies are only better over the long term is wrong. These companies frequently perform better over any period. But they're always better in the long term. So investing in them is the smart thing to do with your capital in any case.

Porter often discusses the merits of investing in "capital efficient" companies.

He has written about the importance of capital efficiency here and here.

Many of Dan's World Dominators – like software icon Microsoft and soft-drink giant Coca-Cola – are capital-efficient. They gush cash flow. They dominate their sectors. And because they generate so much cash, they're able to reward shareholders via dividends and share buybacks.

As we've said several times in the past… when two or more of our top analysts agree on something, you should pay attention.

That's what we're seeing today with World Dominators... Only, in addition to Porter and Dan agreeing, so do some of the best investors in the world – guys like Buffett, Leon Cooperman, and Dan Loeb.

In short, the ability to analyze these companies is one of the greatest skills you can have as an investor.

That's why Dan put together a five-part series explaining the "five financial clues" he looks for in great investments.

And in today's DailyWealth, he shared his first clue...

Simply put, I want a business that gushes with free cash flow.

Free cash flow is all the excess cash profit left over after a business pays all its expenses and taxes and after it reinvests enough cash to maintain and grow the business.

When you buy a stock in your brokerage account, you're buying a piece of a business. It's not a debt interest, and it's not a preferred stock interest.

It's equity.

And equity is a "residual claim" on the earnings of a business. "Residual" just means the equity holder doesn't get paid until everybody else gets paid.

This is really important.

You see, there's nothing left over for equity holders until secured creditors, salary and wage earners, taxes, trade creditors, unsecured creditors, and preferred stock holders all get paid.

Only after all these obligations are met can you, the equity holder, expect your shares to be worth anything.

In fact, excess cash flows are the one thing that give your stock nearly all of its value.

It makes sense, right? This is what makes a business valuable: the ability to generate lots of extra cash. Without excess cash, your shares are worthless.

Dan also sent me a note yesterday discussing the differences between two of the biggest names in technology – Apple and Microsoft – following Apple's blockbuster release of its latest iPhone...

The belief that every announcement is a buy or sell signal is one of the worst habits of investors... and of the financial media.

The only thing the news tells us today is what everybody already knows: Apple has no problem sticking to its knitting, and Microsoft does have a problem doing so.

It's no surprise people lined up outside of Apple stores and that Apple sold out of the iPhone 5S within 48 hours. That always happens when it launches a new iPhone. Apple says it sold a record 9 million of the new iPhones in the first three days. The Apple Insider news and rumors website says the high-end 5S outsold the less-expensive 5C by a wide margin.

Apple CEO Tim Cook has made it clear the company wants to make the very best smartphones, not the cheapest. He's also said he's not interested in the lower-end "junk" market phones. The 5S and 5C launch proves that's the right way to think. Apple trades for about seven times trailing free cash flow (if you back out all the excess cash). That's too cheap for a brand whose products fly off the shelves the way Apple's do.

Microsoft isn't about consumer devices the way Apple is. Over 60% of Microsoft's sales are software to businesses. Microsoft is a business software company. Its "new direction" as a devices and services company is a mistake... just like all the other mistakes its management has made.

As I write this, Microsoft is up a few pennies, but it doesn't matter. Microsoft should focus on what it does best: making great software corporations can't live without. I doubt Surface will ever pose much of a competitive threat to iOS or Android devices.

Both stocks are buys. Both stocks are very cheap. Apple is a buy because it's a well-run company with products the world is fanatical about. Microsoft is still a buy because it's a phenomenal, cash-gushing business and very hard to kill.

A better question is why is Apple cheaper than Microsoft?

The answer is Apple has a bigger cash hoard. And big cash hoards (rightly) scare investors because you never know what they're going to do with them.

One of our favorite short sales – a trade that profits as the share price declines – hit a new low today: plagued retailer J.C. Penney.

In the August issue of Stansberry's Investment Advisory, Porter outlined a "pairs trade" in the retail industry... He shorted J.C. Penney, which he believes is doomed to fail. And he went long shares of retail chain Sears, which he believes is undergoing a secret transformation that will benefit shareholders.

Take a look at how Porter's trade has worked to date...

Porter's subscribers are up nearly 23% in less than six weeks.

We've covered the issues at J.C. Penney ad nauseum (here and here, for example), so we won't go into it today. But Porter outlined the latest drama at the retailer in August...

After showering Ackman's "extremely talented management team" with more than $100 million in compensation, J.C. Penney shareholders now get to fund an ad campaign apologizing for their efforts. Aside from New Coke, there has never been a more colossal failure in the history of marketing.

J.C. Penney lost more than $500 million in the fourth quarter of 2012 alone. For the entire year, the company burned through $1 billion in cash. In May, Goldman Sachs threw J.C. Penney a $2 billion lifeline. This buys J.C. Penney some time with its immediate liquidity needs. But the loan is secured by the company's most valuable asset – its real estate portfolio. We project J.C. Penney will burn through another $1.1 billion of cash flow in 2013... and another $500 million-plus in 2014... if it survives at all.

Meanwhile, thanks to the terms of the new Goldman loan, the company has limited its ability to finance operations by liquidating assets. J.C. Penney offers us an opportunity to short an obsolete business burdened by a high debt load.

This saga played out in the worst possible way. It has been an unmitigated disaster. But ultimately, this drama is just noise. Regardless of Ackman's involvement (or lack thereof) J.C. Penney is doomed. The dying retailer has passed the point of no return... no matter who sits in the corner office or boardroom.

J.C. Penney has already borrowed $3 billion this year. And last Friday, rumors surfaced that the company was looking to borrow even more money. Investment bank Goldman Sachs, which already loaned the company $2.3 billion, is said to be advising the retailer on obtaining the financing.

This quest for new capital comes just one month after the company reported second-quarter results... At the time, CFO Ken Hannah said J.C. Penney probably wouldn't need to raise more capital this year, and he expected the firm to have $1.5 billion of liquidity at year's end.

Clearly, that forecast was off. And the death cycle continues...

J.C. Penney shares sank today as much as 3.7% to hit their lowest level since late 2000.

New 52-week highs (as of 9/23/13): Integrated Device Technology (IDTI), short position in J.C. Penney (JCP), National Fuel Gas (NFG), Sturm, Ruger & Co. (RGR), and Walgreens (WAG).

Lots of praise in the mailbag today... Keep it coming. Send your feedback to feedback@stansberryresearch.com.

"In July I couldn't believe all the praise heaped on James Altucher's books and so didn't purchase until finally a week ago I bit on your offer. I am extremely pleased with his writing. I've read 'I was blind, but can now see' first over the last few evenings. He is open, honest, funny, and has many common sense ideas. His 'daily practice' is something we all should be striving to do. Received the hard cover Choose Yourself today and will be taking it on my next trip for enlightening reading. Thanks." – Paid-up subscriber David

Goldsmith comment: We continue to receive loads of praise for Choose Yourself. If you haven't received your free copy of what Porter calls "one of the most important books" he has read this year, you can get one here.

"Selling puts is a new strategy to me – and where have you been all my life!? I'm on track to increase my account by 25-30% at year's end. It's so easy to do, and I haven't lost a penny on any trades. I've sold off some of my lower performing stocks to free up capital to place larger put-selling trades. I only wish I had known about this strategy years ago. Wow!" – Paid-up subscriber PT

"Your options materials changed my life. I didn't even know what options were until I subscribed to your newsletters. I learned how to use them properly to reduce risk. I also enjoy getting paid to buy and sell my stocks.

Lately I've been selling put options on Dan Ferris picks IBM and AAPL. Instead of leaving my cash in the bank and earning next to nothing, I send it out into the market on Dan's super safe picks to earn my 'interest' the fun way. If I end up with the stock, great, if not, I have another shot at free money. That's some sweet action." – Paid-up subscriber Jeffie H. Pike

Goldsmith comment: If you haven't already, you should read Dr. David Eifrig's piece in today's Growth Stock Wire. Doc recently closed his 136th consecutive winning position... And today, he shares some of the secrets he's used to amass such an incredible track record.

Regards,

Sean Goldsmith
Miami Beach, Florida
September 24, 2013

Editor's note: Today's Digest Premium comes from episode 92 of Stansberry Radio. In addition to speaking with China expert James Gorrie, Porter shared some classic rants – including this bit on firing an employee. While the story is funny, we're sharing this piece for another reason... Porter built an incredibly successful business from his kitchen table. And his business advice should be taken to heart. We hope you enjoy.

I (Porter) remember I fired someone almost immediately after hiring them... It was in the very beginning of my company when I just started. There were only maybe three or four employees. I hired a guy to be the general manager, the role filled by George Rayburn today... And he literally fell asleep at his desk.

And then the next day I said, "Are you well? Is everything OK?"

"Yeah, everything's fine," he said.

"Do you feel good?" I asked.

"Yeah, I feel great," he said.

"Well, you should," I told him. "You got plenty of sleep yesterday. You're fired."

But seriously, if I can share one quick piece of business advice...

Hire slowly. Fire quickly. If you hire slowly, you're only going to pick the best people. Make sure you interview at least three or four candidates for every position, and make sure to not hire anybody whose character you don't find compelling and inspiring.

You don't want to work with people who drag you down. That's important. And then, of course, if you make a mistake, you have to cut them right away. Bad people in your organization are like cancer. They rot everybody else.

Also, if you have to fire somebody, always part as friends. Give them a decent sum of money. Have them walk away saying good things about you and your business. You don't need a trail of angry ex-employees poisoning you in the community.

– Porter Stansberry with Sean Goldsmith

One employee Porter fired almost immediately...

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One employee Porter fired almost immediately...