Borrowed money

Borrowed money... Microsoft can buy itself... "It's a damn disaster"... Dow under 10,000...

My wife is scared.

She saw Jim Cramer on TV telling people to sell, and it scared her. I'm away from home and super busy. So I had to find just the right explanation of events, something brief and simple. Here's what I told her...

Right now, the whole stock market (and the bond and futures markets) is like a man who borrowed too much money and gambled it away in Las Vegas. He's got nothing to show for his expenditures, so he has to sell everything he can as quickly as possible. He doesn't really get to choose what he sells. He sells whatever moves. Stocks move. Bonds move. Commodity futures move.

When the debt-payers start selling, everyone else in the market – professional and amateur alike – follows in herd-like fashion. That pushes stocks down.

As long as you're not overloaded with borrowed money, you should be OK. Same with your stock portfolio.

Due to all the selling, you can find some amazing bargains around right now. Consider Microsoft, a stock we've mentioned several times. Microsoft is once again cheap enough to buy itself. It's got $21 billion of cash and produces $18 billion a year of free cash flow. That's enough to cover a down payment and interest on the debt needed to buy itself – and still have enough cash left over each year to funnel $7 billion in dividends up to its new owner.

I've been telling you for some time that Bank of America would cut its dividend. Yesterday, it happened. BofA cut the dividend in half. CEO Ken Lewis said, "We cannot pay out what we have not earned." He also said, "It's a damn disaster... It's not going to be pretty for awhile."

BofA, which Lewis recently said was in the financial position to take over Merrill Lynch, also disclosed a 68% drop in earnings to $1.18 billion – lower than analyst forecasts of $3.22 billion. The bank plans to raise $10 billion through a stock sale. BofA shares fell 6.5% yesterday and more than 9% in after-hours trading.

The Dow Jones Industrial Average dropped nearly 400 points yesterday to put the index below 10,000 for the first time in four years. Attendees of the Value Investing Congress cheered...

Today at the conference, we'll hear from Leon Cooperman, founder of hedge fund Omega Advisors, and other value investors like Aaron Edelheit, David Nierenberg, Mohnish Pabrai, and Jeff Matthews.

Carl Icahn gave the best speech yesterday. He arrived about 20 minutes late because he was stuck in traffic. Unlike the other speakers, Icahn offered no investment ideas. He just gave a 30-minute comedy routine on why corporate boards are such a joke. He shined a light on what everyone already knows: Corporate boards are gatherings of friends prone to groupthink and apathy. Icahn told the crowd he doesn't have to watch Saturday Night Live anymore after watching the many board meetings he's attended.

Icahn said two words shaped his career as an activist: "personally liable." When he told board members they were personally liable for their stupid mistakes, they put down their newspapers and started paying attention.

Bill Ackman, head of hedge fund Pershing Square Capital Management, gave the most interesting stock recommendation. He explained his long position in Wachovia. The same day Citi announced it would take over Wachovia, Ackman took a 180 million-share position. Going just off the press release, which contained no details of the transaction and a spelling error, Ackman and his team ran the numbers on the bank and bought a huge position by day's end. Ackman said the valuations of all of Wachovia's businesses – including the brokerage, banking, and insurance businesses – were worth far more than Citi's $2.2 billion offer.

Ackman also said he took a position in AIG, the first financial firm he's bought in five years. Wachovia was his second.

As far as I'm concerned, Ackman can have Wachovia and AIG. I don't have the resources and people to figure out their impenetrably opaque financials. Even Ackman admitted he had no idea how much cash Wachovia really has. Could be less than $2 billion. Could be $22 billion. He doesn't know.

One of the most insightful comments of the first day of the Value Investing Congress came from activist investor Alexander Roepers. He said his firm doesn't buy banks, brokerages, or insurance companies due to a lack of transparency in the financials.

Toyota Motor lost 4.9% yesterday and relinquished its post as the world's largest automaker by volume to Volkswagen AG. Toyota's sales in the U.S. have plunged this year as Volkswagen's shares have gained 87% on a buyout bid from Porsche SE.

New high: Market Vectors Double Short Euro ETN (DRR).

Drinking? Who said anything about drinking? Send your baseless accusations to: feedback@stansberryresearch.com.

"The biggest frigging day in history and you guys go and get drunk or something!!"

– Paid-up subscriber Sam T.

Ferris comment: I wasn't drinking... at least not until David Eifrig called me around 10 p.m. I was working. I had one beer, came back to my room before midnight, and kept working.

"Arch Coal (ACI) coal prices are expected to remain high and Arch is sitting on some pretty big built in earnings from their mining efforts." – Paid-up subscriber John Fleckenstein

Ferris comment: Thanks for the heads up, John. I've been writing about coal on and off since 2000 and continuously since December 2006. Last week, central Appalachian coal was still high at $133/ton, and northern Appalachian coal was at $143/ton. While coal prices are high, coal stocks have been completely flattened as investors liquidate whatever moves.

"Thank you and your team for your continued excellent coverage of the financial debacle now playing out. I'm pleased to say that I've been in near cash (contracts guaranteed by life insurance companies) since last fall and have earned 5.1% annualized. Not great, but it sure beats the market's performance.

"I'm waiting for an opportunity to buy a sizeable lot of Johnson & Johnson stock [around] $60/share for my 401-K (I also work for J&J), and took Steve's advice in 2007 to buy Annaly Capital Management. It's been a fantastic investment.

"Your investment ideas and commentary should be mandatory reading for anyone in Washington involved with the current debacle, as well as the morons on Wall Street whose overleveraged house of cards has now collapsed. A few of them might actually hear the words as well as the music. Thanks for all you do for us." – Paid-up subscriber Bernie Torbik

Ferris comment: Thanks for the kind words, Bernie. I'm confident we can keep on top of it and figure out what to do. So far, I've come up with three things: Buy gold coins, world-dominating franchises, and riskier stocks that have had the risk flattened out of them by the current liquidation. I'll have one of the latter type in the next issue of Extreme Value, due out Friday after market close.

Regards,

Dan Ferris

New York, New York

October 7, 2008

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