Masters Series: Why You Should Never Buy Stocks (Really)

Why You Should Never Buy Stocks (Really)
By Porter Stansberry, editor, Stansberry's Credit Opportunities

I firmly believe that most individual investors should never buy stocks. That probably seems ironic coming from a guy who has spent his entire adult life researching investments and advising people from around the world on markets. I've recommended hundreds of different stocks. Was I lying then, or am I lying now?

No, I'm not lying. In fact, I'm telling you such a huge secret that it could easily lead you to cancel your subscription and never buy a stock again. I'm telling you this secret for the simple reason that it's what I would like you to do if our roles were reversed.

That's how I do business. And I know that if I serve my subscribers in this way – by that exacting standard – everything else in my business will take care of itself. The folks who appreciate my efforts will stay. The folks who don't weren't going to renew their subscriptions anyway. So... whatever you decide to do with this information, I hope you'll read carefully and think deeply about what I'm about to tell you.

Stocks can be fantastic investments. And I try my best to only recommend the ones that will make you a lot of money. But the hardest part of my job is overcoming unbelievably bad management teams. If more investors really knew what happened in the offices of the CEOs of publicly traded companies, I promise... you'd never buy a stock again.

I've personally seen deal after deal executed – involving billions of dollars – that had zero chance of ever creating any shareholder value. Likewise, I've seen CEOs refuse to make simple, logical, and necessary changes or divestitures that would have, in some cases, saved their companies from bankruptcy.

The fact is, 90% of the time, CEOs do what's in their best interest – damn the torpedoes. That means trying to garner as many assets as possible, in the blind hope that something good eventually happens with one of them. And often enough, what's in their self-interest is diametrically opposed to what their shareholders deserve.

What won't you often see? Management teams giving themselves an honest appraisal. Not even Berkshire Hathaway founder Warren Buffett. He wrote publicly for many years that the test of his skill as a manager was to outperform the S&P 500 on an after-tax basis for any rolling five-year period.

For the first time in his entire career, he didn't achieve this goal. So what did he write in his 2014 letter? Going forward, he promised to beat the S&P 500 every six years.

He didn't say anything about his disastrous investment in ConocoPhillips (COP) at the top of the oil market in 2008 or his $10 billion investment – the largest of his entire career – into lackluster tech giant IBM (IBM). Instead, he made excuses about the size of his portfolio and "moved the goalposts" – something he had spent his career criticizing other CEOs for doing.

Keep in mind, Buffett could spin off any of the assets he doesn't want to manage anymore and quickly regain a growth rate that's more appropriate. But will he ever do so? Not a chance. And that's from the management team at one of America's most respected and beloved companies. What can you do about it? Buffett recommends only buying businesses that, as he says, "could be run by monkeys." After all, he warns investors, "sooner or later, that's what will happen." Too bad nobody realized he was making a prediction about Berkshire.

Is that a cheap shot? I don't know. Probably. But it's amazing how every management team – even Buffett – can devise wondrous excuses for miserable performance. What can you do about it? Well, that's easy: Don't give them any cheap capital. They don't deserve it.

"All right, tough guy," you're probably saying. "If we're not going to put our money into stocks, then what should we do? We can't trade commodities, we'll get killed. We can't hold cash – the Fed is printing the dollar into oblivion. Fixed income? You must be kidding – how can anyone survive on earning less than 6% a year?"

Yes, the answer is fixed income. And you won't be surprised to learn that it's a kind of fixed income that your broker probably won't sell you... at least, not easily. It's a kind of fixed income that offers you incredibly high rates of income – more than 10% – and huge capital gains, too... capital gains that can rival (or even exceed) the largest gains you've ever made in stocks.

But before I get into the details of how to make this work for you, I want to pause for a moment and talk about why this works.

American managers act like capital is free. They make terrible capital-allocation decisions. Far from "allocating to value," they constantly allocate to popularity. As a result, they chronically overpay for super-low-quality assets. The way you can make this work for you is simple: You lend them the money.

Capital isn't free, of course. And if you take a more senior position in the capital structure (bonds versus stocks), you can make sure that you nearly always get paid. The management team doesn't have the option of whether to reward you for your investment or not. It must pay the coupon on your bond, or else the company will go bankrupt, its assets will be sold, and its employees will be out of a job.

I would bet that more than 90% of my subscribers have never purchased an individual corporate bond. That's madness. In fact, if I could, I wouldn't let any of my customers buy stocks until they had invested in corporate bonds. Bonds are far safer than stocks. The average recovery rate on corporate bonds in default is around $0.45 on the dollar, according to financial-services firm Standard and Poor's.

No, you don't want to try to buy a bond of a company headed for bankruptcy. Of course not. Recovery in bankruptcy is always uncertain and there are no guarantees, especially not these days, when the government and the courts are doing crazy things.

But it's an indication that, for most bonds, at the very worst, you're going to get back a good portion of your money. That's especially true if you follow my advice, which is to never pay more than $0.70 on the dollar for corporate bonds. But... I'm getting ahead of myself.

There are really three things you have to know about buying corporate bonds the right way. The right way means:

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That's three times more than you'll make in stocks on average. The reality is, most individual investors make almost nothing (less than 3% annually) in stocks, because they always sell at the worst possible time. I say that based on studies like those done on mutual funds (by research firm Dalbar) and by a big study conducted on actual brokerage account results (by investment manager BlackRock).

Judging by our feedback e-mail and conversations I've had over many years with both investors and brokers, I believe the same facts apply to most (not all) of my subscribers. My advice? At the very least, make bonds the center of your portfolio going forward.

When you own bonds instead of stocks, there are three layers that protect you from making bad decisions. First, you don't have to worry about bonds going to zero (90% of the time). You are legally entitled to your coupon payments and to your share of the company's assets if it can't pay you in full.

Second, if you will learn to buy at the right time (when the bond market is in distress), you will receive very large amounts of income. This makes it hard to lose money overall. Like the "rich man" in the famous Richard Russell essay, having a rich stream of income makes you patient and allows for you to wait until the perfect deal comes along.

And third, bond investments normally take several years to mature. This encourages you to avoid overtrading and, again, to wait until exceptional deals appear.

In tomorrow's essay, I'll show you a real-life example of how to earn 30% a year in bonds...

Regards,

Porter Stansberry