Holiday tomorrow... Latest Stansberry Radio show... Aaron asks about WDDGs... What is equity?... Businesses that generate extra cash flow... Porter's insurance call... Steve's secret for buying Berkshire at a steep discount...
We're taking tomorrow off in observance of Independence Day. With the holiday squarely in the middle of the week… the market should be sleepy for a few days. As Jeff Clark wrote in a note to his S&A Short Report readers this morning:
|
Wednesday is Independence Day. And when a major summer holiday occurs in the middle of the week, there's no reason to stick around. All the big fish on Wall Street are swimming upstream to the Hamptons. The guppies have been left behind with strict orders not to let anything happen. |
|
Europe could implode, but there won't be anyone around to react to it until next Monday. |
So eat some barbecue, drink some American beer (though those are getting harder to find), and relax. The markets will be waiting for you on Monday...
We'll be back to our regular publishing schedule on Thursday.
I (Dan Ferris) filled in for Porter yesterday on the Stansberry Radio podcast show, which you can listen to here.
Host Aaron Brabham asked me about World Dominating Dividend Growers (WDDGs), which set me off for about 10 minutes at the beginning of the program.
I talked about how stocks like Coca-Cola, Wal-Mart, Microsoft, and Intel make more money than they know what to do with.
This is a critical point… one that could keep you out of a lot of losing stocks and keep you in winning ones. Here's why…
I want you to stop right now and ask yourself what a stock is...
It's a piece of a business. A stock is equity in a business.
Well, OK... what is equity?
Equity is a residual claim on the assets and earnings of a business. The word "residual" is really important. It means equity holders – shareholders – get whatever is left over only after everybody else gets paid.
Only after all the expenses of the business are paid – all the executive salaries and bonuses, all the utility bills, employee wages and benefits, interest, taxes... everything – does the equity holder get anything. So... what you really want when you own equity is a company that has a lot of cash left over after it's paid everybody else.
Take Microsoft, for example. After paying all the bills and reinvesting in the business during the first nine months of fiscal 2012 (ended June 30, 2012), Microsoft generated more than $22.2 billion in free cash flow. THAT's what I mean by having lots of cash left over after paying everybody else.
Public companies have to report how many times over their earnings cover their interest and other fixed charges, like leases. Last year, Microsoft covered its fixed charges 81 times over. THAT's what I mean by having lots of cash left over after paying everybody else.
Microsoft has nearly $60 billion in cash and investments on its balance sheet. THAT's what I mean by having lots of cash left over after paying everybody else.
If you want to know how to get a quick read on whether a company generates more cash than it needs, just go to its cash flow statement. Subtract "additions to property and equipment" from "operating cash flow." (Sometimes that first number will simply be called "capital expenditures.") The resulting number is called "free cash flow." In many cases, free cash flow won't even be a positive number. In most other cases, it'll be pretty small.
I used Microsoft as an example, but free cash flow is a big number with all WDDG stocks. If they don't generate gobs of free cash flow, they're not allowed on the list.
If you're holding equity in a business that doesn't generate lots of free cash flow, you have some explaining to do. At least be honest enough to admit you're not investing. You're speculating. Equity without free cash flow is little more than a bet that the assets will be worth more in a liquidation than what you paid. Maybe it's a bet the business will one day generate a cash profit. Either way, it's more a statement of hope than one of understanding.
A lot of people buy equities without having any clue of what it means to be an equity owner. Now that you know what it means... what are you going to do about it? Are you going to make darn sure the businesses you invest in are generating lots of free cash flow after they've paid everybody else?
Well, we've got a whole list of companies that generate more free cash flow and do it more consistently than any other companies in the world – our WDDGs. These companies are the world champion generators of extra cash flow. And they use that extra cash flow to pay out higher and higher cash dividends to shareholders every year.
Most of these companies buy back lots of stock every year, too. That makes the remaining shares more valuable. It cuts a growing pie into larger slices. They shower shareholders with gobs of cash every year. Few companies do that consistently, year after year, for decades on end.
Investors say they're worried about safety today. There's no way anyone can tell me Microsoft isn't safe. Its cash and investments generate extra cash that more than pays the interest on its debt. It doesn't get much safer than that. And Microsoft is just one of 11 WDDG stocks we've covered...
The 12% Letter is the one and only place where you can get our full list of WDDGs. Right now, two are selling for less than their maximum buy prices. Both are the No. 1 companies in their industry. They've dominated their industries for decades and show no signs that'll change anytime soon. They sell simple products used every day by tens of millions of people all over the world. And they pay out their extra cash flows in higher and higher dividends every year, year after year, for decades on end.
The 12% Letter is really inexpensive, just $39 a year. That's less than $0.11 a day. And remember… you can get your money back any time within the first four months if you decide it's not for you. We do that because we want you to be happy with our work. It's the only way we do business around here. To get The 12% Letter without sitting through a long promotional video, click here.
Insurance companies including Allstate, Stansberry's Investment Advisory pick W.R. Berkley, and World Dominator Berkshire Hathaway (though Berkshire owns many companies, insurance is its backbone) are hitting 52-week highs this week. We're not surprised... We turned bullish on the stock market and financial companies earlier this year. And insurance is probably the best business in the world...
Insurance companies collect premiums to insure people against losses... But most times, those losses don't happen. Meanwhile, the company is able to invest that money, called float, into higher-yielding assets.
Legendary investor Warren Buffett, founder of Berkshire Hathaway, explained the magic of insurance in his latest annual letter…
|
Insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers' compensation accidents, payments can stretch over decades. This collect-now, pay-later model leaves us holding large sums – money we call "float" – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire's benefit... If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit occurs, we enjoy the use of free money – and, better yet, get paid for holding it. |
Every financial institution has to pay interest to borrow money. (Think of a bank that pays for your deposits.) But not insurance... Its float is free, as long as it breaks even selling insurance. And if an insurance company underwrites insurance profitably, meaning it collects more in premiums than it pays out in claims, it's actually getting paid to take and invest money. Again from Buffett…
|
We have now operated at an underwriting profit for nine consecutive years, our gain for the period having totaled $17 billion. I believe it likely that we will continue to underwrite profitably in most – though certainly not all – future years. If we accomplish that, our float will be better than cost-free. We will profit just as we would if some party deposited $70.6 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit. |
In addition to a great business model, we also like insurance companies. They are great hedges against inflation. As Porter explained to subscribers in the March issue of his Investment Advisory…
|
[W]e want to own insurance stocks because we believe inflation will increase the size of policies sold, increase the return on float, and enable these companies to profit from the time arbitrage of inflation. (The dollars paid today in premiums will be worth substantially more than those same dollars paid back later.) Also, the nature of the float means that these companies are hugely leveraged to the financial markets – their investment portfolios are typically large relative to the equity of the firms. If I'm right about a big bull market this year, these stocks will soar. |
Porter recommended W.R. Berkley (WRB) in that issue. Like Berkshire Hathaway, WRB is an expert underwriter. It makes money from underwriting insurance...
|
[WRB's] 10-year average combined ratio (a standard term in the industry that refers to underwriting profit) is 94%. Anything less than 100 means it collected more in premium than it paid out in claims. Over the last five years (beginning in 2007), W.R. Berkley's combined ratios have been 88.1%, 93.1%, 94.2%, 94.5%, and 98.3%. I can't stress this enough... nothing is more important to the value of an insurance company than underwriting discipline. It is the key to the entire model. With it, vast wealth will accrue. Without it, all is quickly lost. The thing I admire most about W.R. Berkley is its proven underwriting discipline. |
His Stansberry's Investment Advisory subscribers are up 10% on WRB in a little more than three months.
In his latest True Wealth, Steve Sjuggerud showed subscribers a way to invest in one of the world's best businesses at a huge discount. (It's a holding company like Berkshire Hathaway... though it has performed better than Berkshire from 1998-2011.) Like Berkshire, this company's backbone is insurance. But it uses that money to buy other businesses. And the company's on the prowl.
In a recent interview with Barron's magazine, this company's chief investment officer said…
|
In my 50 years on Wall Street, it is rare that I've been so attracted to some of the best and finest companies. I feel like a kid in a candy store... The best companies in the world are now some of the cheapest stocks. |
So this company is currently looking to deploy its insurance float to create value for shareholders. And if you buy today, you can get it for roughly 30% less than its liquidation value.
Its insurance arm is so undervalued, you're actually paying 50% of liquidation value.
Best of all, the managers of this company treat shareholders well. (The controlling family has owned shares for generations)... In the 40 years this company has existed, it's brought the share count down from 1.3 billion shares to 400 million today... And it's still buying.
To learn more about True Wealth and access Steve's latest pick (without watching a long video), click here...
New 52-week highs (as of 7/2/12): Berkshire Hathaway (BRK), iShares Nasdaq Biotechnology Fund (IBB), iShares Dow Jones U.S. Home Construction Fund (ITB), ProShares Ultra Health Care Fund (RXL), W.R. Berkley (WRB), Utilities Select Sector SPDR Fund (XLU), Constellation Brands (STZ), Coca-Cola (KO), Pepsico (PEP), Abbott Laboratories (ABT), Johnson & Johnson (JNJ), Eli Lilly (LLY), Monsanto (MON), Alico (ALCO), Dominion Resources (D), Integrys Energy Group (TEG), Hershey (HSY), BLADEX (BLX), CVS Caremark (CVS), and Altria Group (MO).
One of the easiest ways to get rich in stocks is to buy great companies and not sell... as we explain to the gentleman below. Send your questions to feedback@stansberryresearch.com.
"The McClellan Oscillator and Jeff Clarke say to sell. If I own stocks paying good dividends including WDDGs purchased below S&A's recommended ceiling should I sell and repurchase at a lower price? Or should I hold them?" – Paid-up subscriber Ron Rogers
Ferris comment: They're two different questions. One is a question about the direction of the overall market, which I have no view on. The other is a question about WDDG stocks... about which I can say a lot.
As we remind Digest readers regularly… we cannot offer individual advice. It's against the law. And even if it weren't, we know nothing about your individual circumstances.
In general, I think subscribers are wise to enter any position – including one in a WDDG stock – slowly, buying a little at a time over a longer period of time. That tends to lower their costs and raise yields. And the higher yield also allows investors to buy more shares if they're reinvesting the WDDG dividends.
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and New York, New York
July 3, 2012