A Major Change to My Investment Philosophy
A major change to my investment philosophy... Why knowing about a bear market might not help you... Understanding the 'snowball' strategy... Where to learn about 'dark stocks'...
Editorial warning...
This Friday Digest is going to get me in a lot of trouble. And not just with our subscribers. Nothing I've written before will probably make more people here, at my own company, angry. It might make you angry, too.
Of course, backlash isn't new to me or to the Friday Digest...
Mondays have been the biggest day of the week for cancellations at my firm since we started. And according to the comments many subscribers make just before we part "as friends," their cancellations occur directly because of the things I write in these Friday Digests.
What do subscribers hate the most? Anytime I'm critical about one of their "sacred cow" strategies or favorite investments.
And that's exactly what I'm doing today.
So why write these things?
Clearly these Friday Digests have an overall negative financial impact on my company – they trigger thousands and thousands of cancellations! So why publish messages that are likely to be divisive... likely to challenge our readers... or, like today's message, likely to deeply insult so many of my colleagues?
Why do it?
I write these messages on Fridays because you, all of you – my dear subscribers, my brilliant employees, and my loyal partners – have given me the career I've always wanted. I believe I owe you my best efforts, my best ideas, and my complete sincerity.
So... even though I'm certain that many of you will be angered or offended by today's message, I'm compelled to write it. To write it fully. To write it completely.
What's so offensive?
I believe that most of the work we publish probably leads investors in the wrong direction, despite our best intentions. We tend to focus far too much effort on predicting the market's general direction, and we tend to publish far too many strategies that are based on marketing timing or general trends.
I increasingly believe there's a far easier, far simpler, far safer, and far better way to approach your investments. It's an approach that doesn't require any trading. It doesn't require stop losses. It doesn't require software tools. Or monthly newsletters. Or online videos. Or webinars.
It's an approach so easy that it borders on sloth.
I will, of course, explain...
But first, I need to start with some basics. And I want to tell you some things that I don't think I've ever told our subscribers before.
Let me start at the beginning.
I've been writing about investing in daily e-letters like this one since I founded the company in August 1999. That's almost 20 years.
I've written urgent and important messages through two major bear markets and through a dozen major "corrections" – which always feel like bear markets at the time. I've worked closely with leading professionals in just about every kind of investment strategy offered to the public. And I've even invented a few approaches (like "capital efficiency") myself.
But... how many of these things really work? And how many of these services provide investors with useful, actionable, reliable, and efficient advice? And how many of those bear markets and big corrections really mattered?
I have my doubts.
When I began my career in July 1996, the S&P 500 Index seemed to be in one of the mightiest bull markets of all time...
It was on its way toward breaking the 1,000-point barrier for the first time ever. And it would go on to more than double before hitting its year 2000 peak.
What I couldn't have known for certain (but did suspect) was that this tremendously bullish market action was merely a mirage, driven by a massive credit bubble that was completely unsustainable. The first cracks appeared in March 2000. If you were an investor in the 1990s, then I'm sure you remember the "tech wreck" of 2000-2002. And I'm sure, like me, you thought that was the worst bear market you'd ever see in the U.S.
Wrong. The real damage didn't emerge until 2008, 12 years after my career in finance began.
When the S&P 500 bottomed at 666 in March 2009, it was lower than when I started writing about investing in stocks in 1996. Thus, if you'd been investing along with "the market," you'd have wasted more than 12 years of your savings. You would have earned nothing (or even lost money) for the entire period.
Imagine if someone could have told you buying stocks was a mistake from 1995 to 2008...
Yes, in theory, you would have been better off to have never bought a single share until 2009. Sitting in Treasury bonds would have made you far more money, on average, than owning stocks. Even gold vastly outperformed stocks during that period. Dividends wouldn't have protected you from the huge losses that emerged.
That's what a focus on "the market" would have gotten you.
And yet, here we are today... And what is the constant focus on the media (and of many of our research services, too)? We spend so much time trying to guess whether "stocks" are going up or down or whether interest rates will move higher or lower.
We want to know because we believe that knowing will help us make better investments.
But does it?
Ironically, most of the people I was working with back in the '90s knew exactly what was really happening...
At the time, I was working with the smartest and most skeptical people in finance, including the world's leading Austrian economist, Kurt Richebächer. (Kurt was one of the founding members of the Austrian School of Economics, which pioneered understanding the impact of credit inflations.) My two closest and best financial mentors, Bill Bonner and Steve Sjuggerud, both predicted the stock market top in January 2000 succinctly and accurately.
We knew.
We were all acutely aware of how big the Internet bubble had become and what was very likely to happen next. But no one in 2000 ever came close to predicting that the real bottom in stocks wouldn't arrive until March 2009.
Likewise, no one I worked with back in 1996 ever made a consistent or actionable case that, despite the current market action, we were already in a 12-year bear market and that no one should buy stocks until 2009.
We couldn't have known how far stocks would fall or how many years of gains would be wiped out.
Even though I had direct access to the world's very best "big picture" theorists and even though they were completely right, it wasn't enough to provide a complete picture of how the bear market would evolve... or how long it would take to reach a bottom.
That's not to say these people didn't offer very good advice...
We told subscribers what was going to happen as our view emerged. We told them to follow their trailing stop losses. That would have kept them from suffering the worst impacts of the collapse in 2008 and would have given them cash to invest at the bottom. And we urged subscribers to make big investments at the bottoms in 2002 and in early 2009, with the money they should have set aside following their stop losses.
We alerted investors – more urgently, more consistently, and more accurately than anyone else – about the collapse that was coming in 2008 and the rebound that began in 2009. That's why our track record is much better than the market as a whole.
But I'm asking a different question today. I'm asking if any of that stuff above really matters. Does beating the S&P 500 over a 12-year bear market mean you've done a good job for investors?
Yes, we helped a lot of people keep their savings on track. We kept a lot of folks from being wiped out. But what if there was simply a better way to look at investing altogether?
What if, instead of trying to beat the market or protect investors from a bear market, you simply ignored what the market, on average, is doing?
After all, unless you're buying an index fund, should "the market" even matter?
What if, for the rest of your investing life, you never looked at the S&P 500 again?
What if you stopped comparing your returns to the market or anyone else's and simply strived to make consistently good investments for the long term?
Why should you care what happens to other investors? And why should you care what other investors are bidding for your shares, assuming your investments are growing and their dividends are increasing? Why do we depend on price action alone to dictate our investment time horizon?
If your neighbor suddenly offered you half your house's value, would you sell? No. Would you panic? No. So why do you worry so much about the quoted price of your stock investments? Maybe you shouldn't – at least in some investments. And maybe our focus on limiting risk (trailing stop losses) and diversified portfolios is leading at least some of our subscribers in the wrong direction.
Maybe that's you.
Let me reiterate... I'm not saying that our work has no value...
Or that reading our newsletters and using our new Stansberry Terminal (which is truly incredible, by the way) won't help you improve your investing results. You'll certainly learn a ton about finance by reading our products. And our gurus can certainly lead you into a lot of good investments – our track records prove it.
Likewise, I know that for most investors, using trailing stops and limiting risk through small position sizes is critical. Novice investors will get killed if they don't use these strategies. It takes a long time to understand investing well enough to manage your emotions through periods of tremendous uncertainty.
So, please, don't think I'm saying the "Stansberry Way" of investing isn't good or doesn't work. It is good. And it does work.
The point I'm making here is a lot more nuanced. And I'm afraid most of you won't understand it.
So please... read carefully...
I am saying that, in addition to the approach we've been teaching for 20 years, there's a different approach that works, too. It's an approach that ignores the market's average return completely. It's an approach that requires zero CNBC. Zero newsletters. Zero hedge-fund managers. Zero trailing stops.
The approach I'm talking about, in a way, ignores stocks altogether.
It's an approach that focuses on treating your investments in public equities (stocks) the exact same way you treat the investments you make in real estate or a private business. It's an approach that requires you to understand the businesses you buy, the same way an owner would. A business owner isn't likely to sell just because he has a bad quarter or because the industry suffers a few down years. Instead, a business owner will use a downturn to buy up his competitors or to buy equipment on the cheap.
Why wouldn't you invest this way?
As Warren Buffett said during the 2002 Berkshire Hathaway meeting...
You're not looking at things that wiggle up and down on charts, or that people send you little missives on, you know, saying, "Buy this because it's going up next week," or, "It's going to split," or, "The dividend's going to get increased," or whatever, but instead you're buying a business.
This "whole business approach" means that every time you buy a stock, you treat it as though you were going to buy the whole business and control it.
Obviously, that's not what happens – you won't be in control. And that means you have to make sure that you're buying at a good price... so that if the management teams screw everything up, you can sell without taking a big loss. Ideally, though, you never sell.
This approach can be vastly easier than constantly adding to and trimming from your portfolio...
I'm more and more convinced that this approach is, by far, the best way to invest. I agree with Buffett when he says, "Investment is most intelligent when it is most businesslike." And I'm also more and more convinced that trying to guess when the next bear market is coming... or whether there will be a "Melt Up"... is mostly a waste of time.
That stuff is simply too hard to get completely right. Even when you really know what's going to happen, it's virtually impossible to know exactly when.
And the more time you spend trying to figure it out, the more time you're probably wasting.
Let me show you what I'm talking about...
There's a company called Danaher (DHR) based in D.C., just a few miles south of our offices in Baltimore. Way back in 2000, I first became aware of the company because I ran into one of its analysts in Phoenix, Arizona. My colleague David Lashmet and I were visiting a tiny technology company called Microtest. The company had developed some new test and measuring equipment that was critical for installing fiber-optic networks.
You'll recall that back then billions of dollars were being invested in laying fiber-optic cable all around the world. And Microtest was one of the first recommendations we ever made in our micro-cap technology research service, which back then was called Diligence. (Later, a new senior analyst renamed it Phase I. More recently, when David Lashmet returned to our firm after a stint in technology development, he rebranded it Venture Technology.)
After our Phoenix research trip to visit Microtest, we recommended the stock. Then, very shortly afterward, Danaher bought the whole company.
I knew then the Danaher guys were smart. Microtest was a good business. But I sure wish I'd paid even closer attention.
Back in 2000, no one on Wall Street followed Danaher...
It was a holding company whose operating segments didn't fit into a single sector. Danaher bought controlling interests in well-managed, fast-growing, small companies with excellent economics and growth prospects. After it bought them, Danaher would implement systematic improvements to the companies' operations, greatly increasing both sales and margins.
Danaher's founders – Steven and Mitchell Rales – started in the early 1980s. They bought a dozen small manufacturing companies and worked diligently to increase their companies' sales and profit margins. They've been doing the same exact thing ever since, and have created something around $100 billion in market value in the past 35 years.
Here's how that worked out for their investors...
As you can see, if you'd bought Danaher shares when I started writing about stocks in 1996, you would have paid less than $5 per share. Today, the stock trades at $100. That's a 20 times return over 22 years. And that's not counting the value of the company's 2016 spinoff, Fortive (FTV), which is worth almost $30 billion.
Altogether, shareholders of Danaher have enjoyed annual returns of almost 17% annually since 1996. That's among the highest annual returns for the period of any publicly traded company in the U.S. Clearly this approach of buying good, small companies and holding them for the long term (even through recessions and bear markets) works.
While it's true that our True Wealth newsletter has produced similarly spectacular long-term gains, I'm certain that simply owning Danaher and forgetting about the market was much easier way to make great returns as an investor.
Every $100,000 you invested in Danaher back in 1996 is now worth more than $3 million. The total return is more than 3,100%.
This approach to investing isn't without its difficulties...
I'm sure not every acquisition Danaher made turned out well. Likewise, its share price is volatile. There were substantial declines in the share price in both 1999 and 2008.
But Danaher wasn't in a bear market between 1996 and 2008, like the S&P. Investors in Danaher made more than 5 times their money, not including dividends, in the 12 years between 1996 and 2008.
That's because the Danaher formula of buying small companies and greatly improving them works.
It works whether the economy is good or bad. It works whether investors are optimistic or pessimistic. It works whether the president is a Republican or a Democrat.
Today Danaher is still doing well, but as a $70 billion corporation it can't grow as fast as it once did. Another problem for new investors is that the Danaher story and its founders' abilities as business operators are now far better-known than they were 22 years ago. Danaher's stock trades at 18 times its annual earnings, even when you discount interest expenses, taxes, and non-cash expenses like depreciation and amortization (in other words, its EBITDA). That's not an unfair price to pay, but it's not a compelling bargain, either.
And, of course, the point of today's Digest wasn't to recommend shares of Danaher to you...
I simply wanted to point out that there are plenty of investors who do very well by maintaining a "businesslike" method of buying companies. I also wanted to tell you about Danaher because it's definitely a stock you should follow. I would recommend reading the company's annual report. It will help you learn to think more like a great investor.
What Danaher does is pretty simple. Not easy... but simple. Understanding how it manages its company and its investments will help you recognize other good opportunities. I read Buffett's annual letter for the same reason. And Markel's annual letter, too. Markel, if you don't recognize the company's name, is a property and casualty insurance firm that has a long history of making high-quality, long-term investments.
At Stansberry Research, we have just begun our efforts to build analytical teams and research products to support subscribers looking for extremely long-term investments.
We have long published Extreme Value, which doesn't recommend using trailing stops. But Extreme Value, as its name suggests, is focused on finding stocks that are badly mispriced. When they become fully valued, editor Dan Ferris recommends selling.
I'm more and more interested in a different approach...
As I explained recently, the big problem with value investing is that you end up owning a lot of marginal businesses.
What I'm interested in finding today are businesses that are so good I won't ever want to sell them – businesses like Danaher. To make excellent returns using a very-long-term strategy, you need to find these opportunities when they are still very small. You want a huge "runway" for your investment.
Our first product that's designed to find these kinds of long-term opportunities is Stansberry Venture Value.
We launched this publication in February 2017... so I simply can't tell you yet whether or not our approach has worked over the long term. But I'm happy to report that, at least so far, I'm blown away by the quality of the companies that editor Bryan Beach has brought to our readers. Likewise, the financial results have been superb: Venture Value's average return is more than 25% per recommendation... and the annualized return is more than 30%.
Venture Value takes a market-agnostic approach by looking for companies that are involved in three different strategies.
The first is what Bryan calls the "snowball strategy." That's when management teams are pursuing an acquisition strategy just like Danaher's. We like buying and holding companies with a proven track record of successful acquisitions, where there's a huge "runway" of future deals lined up.
For example, Carrols Restaurant Group (TAST) buys troubled Burger King franchises and turns them around...
That's all Carrols' management team – who I'll refer to as our "partners" – do. And they've proven it's a winning strategy. As long as they stick with this strategy and as long as they continue to execute, we don't care what happens to the stock market as a whole, nor are we concerned about what the share price does. We know there's a risk to owning a burger joint. But compared to the other risks we face as investors, it's extremely small. I'd rather own a well-run Burger King franchise than a U.S. government bond, that's for sure.
We first recommended this stock at the 2016 Alliance Conference, and it's required a lot of patience. The shares fell for about the first year we owned it, and have since rebounded about 60% – from as low as $10 to more than $16. We didn't sell. And we urged investors to buy more at prices under $12.
After all, why give up on this simple, lucrative strategy just because some other investors didn't understand it? Sure, raw materials prices will impact quarterly results. But the strategy of buying up Burger King franchises works and there are thousands more to buy. This investment strategy will take a decade to mature – not just a few quarters.
Our 'partners' at Clarus (CLAR) are continuing their strategy of investing in outdoor-equipment manufacturers...
Again, these are proven operators with a great track record. Outdoor equipment is a stable industry that's unlikely to change much during our investment time horizon. As long as Clarus keeps making good deals and improving the results of its acquisitions, we're happy to continue holding the stock, no matter what happens in the stock market.
Yes, we know there's a risk that sales in this industry will decline in a recession. And we know that a recession is inevitable. But that risk is present in every business. We know it's coming. It won't be a surprise. We accept this inevitability gladly in exchange for the likelihood that Clarus will be able to grow through and past it. We're up nearly 60% since April.
And then there's SiteOne Landscape Supply (SITE) and one of our best 'partners,' Doug Black...
SiteOne is a recent spin-off from John Deere. It's led by one of America's greatest young executives, Doug Black. You probably haven't heard of him... yet.
Doug was a high school valedictorian who led his high school football team in both rushing and tackles. He accepted an appointment to West Point and tried out for the football team. He got cut, twice. So he joined an intramural football team and started boxing as a heavyweight. He went undefeated as a boxer.
Finally, his peers recognized what the coaches couldn't: Doug was a man among boys. They convinced the coaches to give him a third tryout. He made the team and started his junior year at tailback. In the first game he ran for a 37-yard touchdown and finished with 124 yards. By the end of the season, he'd led Army to victories over its service academy rivals and beat Michigan State in a bowl game. He also broke Army's rushing record and scored 11 touchdowns.
This is a guy you should want to invest with for the long term. SiteOne dominates the highly fragmented landscape-supply business. It has about 500 stores around the U.S.
Amazon isn't getting into this business: SiteOne sells to 180,000 landscape contractors. It's No. 1 in all six landscape-supply categories. If you have landscape work done, chances are good you're buying shrubs, mulch, lighting, and irrigation solutions from Doug Black.
Since 2014, Doug and his team have already acquired 18 companies, adding 112 stores and $500 million in revenue. How much more is there to acquire? SiteOne currently owns about 10% of this $17 billion market. There's a lot more to buy. And we're sure that landscape isn't the only thing Doug Black can master.
If housing slows, could SiteOne be impacted? Sure, for a few quarters. But if that happens, it will also be cheaper for it to buy more competitors.
As long as Doug Black keeps adding new companies and improving their results, our returns will be outstanding. We'd be crazy to sell this firm just because we thought we might be able to buy it a bit cheaper in a few months. Better to make sure that we're on board for the ride. After all, we're already up almost 100% on this stock in a little more than a year.
(Just to be clear, I use the term "partner" here to describe how we feel about these companies and their executives. As you know, Stansberry Research is a completely independent provider of investment research. We do not invest in these businesses. But if you do, that's how you should think of these firms and their leaders.)
Recommending companies with this 'snowball' acquisition strategy of buying small, high-quality, and fast-growing businesses isn't the only thing we look for...
We also recommend very small, but extremely high-quality property and casualty ("P&C") firms.
These stocks are completely off Wall Street's radar. But we know their results are mostly a factor of underwriting, not whether stocks are going higher or lower.
This approach shouldn't surprise you... We've long touted P&C insurance companies as one of the very best ways to invest for the long term. But what's different about Venture Value's portfolio of P&C insurance is the size and the growth rates. The smaller the firm, the faster it can grow safely.
In Venture Value, we're recommending the best very-small firms.
In short, we're trying to find the next Berkshire Hathaway or the next Markel, long before anyone else has ever heard of them. And that's why you'll never see these firms written about anywhere else. (In fact, these names are so valuable that I won't mention them here. Our Venture Value subscribers depend on us to keep most of our work very close to the vest.)
And finally, there's one other strategy we follow at Venture Value...
I know you won't find this concept anywhere else. It's completely uncorrelated with the stock market as a whole.
We look for "dark stocks."
These are very unusual situations where, for one reason or another, a company's actual results haven't yet been integrated into Wall Street's main databases, like Bloomberg or Reuters. Investment firms rely on these databases to search for value and to populate their quantitative models. Essentially... if your firm's data isn't in Bloomberg, your company might as well not exist.
We know about these situations only because we actively look for them. We pick up the phone. We call executives and accounting firms. Trust me, virtually nobody else does this kind of work anymore. But this kind of research can be far, far more valuable, and far more certain than trying to guess when the next bear market will start.
As an example, shares of Hanger (HNGR) fell from more than $40 to under $5 because of an accounting snafu. This company is the leading maker of prosthetic limbs in the U.S. It's a real, high-margin business. But it might as well be invisible to Wall Street. For years, there were no current financials on Bloomberg. And the stock has been de-listed from the New York Stock Exchange ("NYSE").
Unfortunately, the company got into trouble because of truly horrible accounting. Back in 2014, it had to fire its chief financial officer and its chief accounting officer. There was a huge investigation. The company wasn't able to file financial statements, which is why you couldn't find any on Bloomberg.
So why would we want to buy Hanger shares while the company was "dark"?
When we first recommended Hanger, we already knew that the re-stated numbers for 2012 and 2013 only showed minor impacts to cash flows. The 2014-17 numbers, published after our recommendation, further demonstrated that it was still a healthy business, despite its "darkness."
Over the past several months, Hanger has been gradually "coming into the light"... refiling all its old financial statements. We expect the company to become "fully current" in its filings in September, at which point the company can re-list its shares on the NYSE and will likely begin a roadshow to reintroduce itself to institutional shareholders. We think its shares will likely return to $30 or $40... or maybe even more... once the dust settles.
And demand for prosthetic limbs isn't correlated to the S&P 500 or even to our country's economic growth rate. What we know about this business will matter to investors no matter what else goes on in the markets.
There are lots of these kinds of 'dark' opportunities out there...
These are businesses where Wall Street simply has no idea what's really happening because there's no information being put into the databases that it relies on for its analysis. We can simply do a bit of legwork in these special situations and find three to four opportunities each year that shouldn't exist and wouldn't exist except for an extreme disparity in information. We give our subscribers that edge.
No, these aren't long-term investments like our core Venture Value "snowball" or P&C recommendations. But they are a great way to "juice" returns and stay uncorrelated from the stock market. What's keeping shares of Hanger off the NYSE and out of the portfolios of hundreds of mutual funds, exchange-traded funds, and pension funds isn't a bear market or interest rates. It's simply an accounting problem that will be resolved. It's not rocket science.
I've spent a huge portion of my career studying 'the market' – the overall environment for stocks, bonds, currencies, real estate, and other assets...
Most investors believe this kind of insight is the most valuable to have and will help them avoid bear markets and get into bull markets. Many of the products and tools we've built for you are designed along these lines and can certainly help you follow marketing-timing based strategies.
But... having watched the market for so many years, I know it's virtually impossible to fully understand what is going to happen next and why. Reacting to or trying to predict what the market does is probably an inefficient way to manage your savings.
I've come to believe that the best approach is simply to buy truly great, well-managed companies that are growing and to hold them for as long as they continue to execute. While that might not offer you enough protection from volatility, there are other ways to accomplish that goal – like adding bonds, cash, gold, or commodities to your portfolio.
If you're interested in this kind of very "lazy" long-term investing, I urge you to consider subscribing to Venture Value.
You can learn more about the service... and how to buy these sorts of "dark stocks"... right here.
New 52-week highs (as of 8/23/18): Automatic Data Processing (ADP), Becton Dickinson (BDX), Blackstone Mortgage Trust (BXMT), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), Grubhub (GRUB), Okta (OKTA), Direxion Daily Retail Bull 3X Fund (RETL), Sysco (SYY), and Verisign (VRSN).
Do you subscribe to Venture Value? Have you found yourself watching the market a lot less? Or did this Digest simply make you angry? Let us know at feedback@stansberryresearch.com.
Regards,
Porter Stansberry
Baltimore, Maryland
August 24, 2018