Porter versus Alan Greenspan...

Porter versus Alan Greenspan... Why outside passive investors should always by these stocks first... Why P&C insurance companies are more attractive than life insurance companies...

In today's Friday Digest, I (Porter) review what I consider to be one of the few really big secrets about investing in common stocks as an outside passive investor.

While I've written about this secret before, there's a part of why it works so well that I recently figured out: these companies make investment returns nearly inevitable. I hope you'll read today's Digest carefully. Remember: there is no such thing as teaching. There is only learning.

But, before we get to that... I have a big announcement to make. For longtime readers and fans of my political and economic views (libertarian/free market/hard money), you won't want to miss the upcoming investment conference we're hosting in New Orleans.

I will be on an economics panel opposite Alan Greenspan. That's right... I'll get a crack at the "Maestro," the man who did more to damage the value of our currency and warp our economy than any other living human being. Don't miss the fireworks. Find out more about the conference (which is the grand-daddy of all investment conferences) by clicking here.

In this month's issue of Stansberry's Investment Advisory – due out today after market close – we are recommending a first-class property and casualty (P&C) insurance company. For reasons I'll reiterate below, I'm convinced that well-managed P&C stocks are the perfect investment for outside passive investors.

As I've written before, this is the only sector of the stock market that I will personally teach to my children. Nevertheless, I'm willing to bet that at least 80% of our subscribers won't even bother to read this section of our newsletter. Probably fewer than 10% will actually buy the insurance stock we recommend. Why? Because insurance companies are complicated... and they will not make you rich overnight.

On the other hand, we're also recommending a biotech company this month that could make you very rich overnight. Everyone will read that story, of course. A lot of folks will buy the stock. I certainly hope it goes well. We've done a very thorough job with the research. But it's still very risky. The stock is expensive. The business is unproven. For most investors – at least 80% of our subscribers – I would argue that the insurance company is a better choice between the two. Why?

For most people, putting a substantial amount of capital to work with high-quality, conservative businesses is a far better idea than putting money into lots of smaller, speculative positions.

While an individual speculation might do very well in percentage terms, it's not wise to put major allocations of capital into risky positions. So while you might make a 100% return with a biotech pick, if you're only allocating 2% of your portfolio into the position, you've only created a 2% total portfolio return.

In my view, you're far more likely to make higher total portfolio returns by focusing most of your equity investments (80%) into conservative, well-run, capital-efficient companies that can produce long-term annualized returns of around 15%. This is easier. It's far more tax-efficient. And it's far more likely to work out as you expect.

The other way – constantly trading lots of small, speculative positions – can work, too. But remember... most of the speculations won't pan out. And whether they work out or not, you have to pay a lot of attention to them. You'll end up trading yourself half to death. You'll also generate a lot of taxes and commissions. At the end of the day, unless you're a really world-class speculator, it's unlikely that you're going to beat the long-term returns of top-tier capital-efficient businesses and well-run P&C companies.

Here's the irony... These facts about why the "tortoise" almost always beats the "hare" should be readily apparent to all of my subscribers – especially if they have much experience trying to trade growth stocks. Yet my company earns far more money selling research to traders than we could ever make selling real investment research to patient long-term investors. The fact is, my view of how our audience should allocate its capital is exactly the opposite of how I suspect most of my audience actually allocates its capital. C'est la vie.

That explains why our insurance stock pick won't be read and won't be followed. But here's why it should be...

Insurance companies have two tremendous advantages over all other business endeavors.

First, they get paid to own permanent capital. While investment management companies also are paid to manage capital, they don't own the assets. Hedge funds, for example, are great businesses. Investors pay 2% a year to be in the fund. And the hedge fund gets to keep 20% of the profits. But this capital is very fickle. It can be taken away at any point. Insurance, meanwhile, charges far more than 2%. Policies typically last several years... or even several decades. And 100% of the earnings of the capital underlying the policies belong to the insurance company, not the policyholder.

The second advantage relates to taxes: it's possible for insurance companies to legally reduce and defer taxes on their earnings. No other industry is as tax-advantaged as the insurance sector. Two of the biggest expenses other industries face (the cost of capital and taxes) are almost completely mitigated in insurance. But that's not why well-run P&C insurance companies are ideal for outside passive investors. It's only part of the story...

As outside passive investors in common stocks, we face a real screw job. We take all of the risk (we're the ultimate owners of the business, not the management team), but we typically have very little knowledge of what's really going on inside the business. We have next to no say in how the company's assets are managed. And we typically suffer from terrible dividend and buyback policies and timing. Well-run insurance companies offer us significant advantages to these core problems.

P&C insurance companies can only compete in three ways: underwriting (the ability to earn a return on the policies sold), investments (money made investing the "float" – the premiums paid before claims are paid), and growth in the book of business. Out of these three forms of competition, only one (underwriting) is essentially guaranteed.

Management can't know how its investments will turn out. Nor can it know how much its book of business will grow over time. But it can know – with a surprising amount of certainty – whether it has priced its policies appropriately to earn a profit.

By focusing on only the management teams that have consistently produced an underwriting profit, we can know – even as outside passive investors – a lot about how the company will perform over the long term.

There's no other kind of business that provides this kind of economic certainty to outside investors. These returns are earned almost automatically because of the very nature of the business. Remember, there are no capital costs... the float is invested... the returns are tax-deferred... and thanks to the management team's discipline, every policy sold will produce a profit (on average).

That's why we've consistently focused on P&C companies with excellent underwriting. This month's recommendation is no exception. And there's one more major advantage we have with these stocks...

Modern accounting treats the insurance company's float (the money paid in policies but not yet paid out in claims) as a liability. That's because, eventually, nearly all of this money will be paid out to policyholders. But the ongoing nature of these businesses really means that float tends to grow over time.

The liabilities are never really paid out. They just grow... and earn more investment income for the insurance company. Thus, even though they're technically a liability, they function like assets. That makes the size of each company's float the single most important variable in knowing how to value the company.

The amount of float is very difficult to compute. It's not listed in the company's annual statements. You have to do a lot of digging and know a lot about accounting to figure it out. Most investors simply won't do this hard work. We have two former accountants on our payroll who do this for us across the entire sector. That enables us to know when the highest-quality companies are very cheap compared with the value of their assets and their float. Many other investors simply don't have access to this information and thus can't properly value these stocks.

My conclusion: By understanding the value of float, and by focusing only on those companies able to produce an underwriting profit, we can achieve a level of certainty with our insurance company investments – both in their current value and in their likely future returns – that far exceeds any other investment we could make as outside passive investors.

That's why I firmly believe everyone who is buying stocks should start with well-run P&C companies. Essentially, if you don't buy P&C stocks, you're ignoring the one area of the market that treats outside passive (common stock) investors the best.

You may be wondering why we don't also focus on life insurance stocks. The answer is simple: Everyone dies. All of these policies eventually pay out. And that means it's much more difficult for life insurance policies to develop a pricing advantage for their policies. Life insurance is a much-lower-margin business.

New 52-week highs (as of 7/31/14): none

A quiet day in today's mailbag... One subscriber shares his S&A success story. Let us know how we've helped (or hurt) your portfolio at feedback@stansberryresearch.com.

"I disagree with complaints about not getting stock picks. When I became a subscriber my portfolio, a 401K, was all mutual funds. After reading the daily e-mails and monthly mailed articles I, with worry about doing the right thing, put the entire 401K into an IRA made up of stocks.

"Based on your recommendations, I selected 12; 9 world dominating dividend paying companies and 3 high risk companies. Thanks to all of you and all of the advice, 8 of 9 WDDG and 1 of 3 high risk have grown enough that they have covered the losses of 1 of 9 WDDG and 2 high risk.

"Overall it is up 46% since purchase. This favorably compares to the mutual fund (I still contribute to the 401K at work) which during the same time is up 16%. And all I did, admittedly at the time with fear and trepidation, was follow 'Stansberry' advice." – Paid-up subscriber Mark MacKinney

Regards,

Porter Stansberry

Baltimore, Maryland

August 1, 2014

This simple strategy can lead to huge gains in the market...

Yesterday, DailyWealth Trader editor Amber Lee Mason revealed which areas of the market she's monitoring.

In today's Digest Premium, she explains the strategy of "bad to less bad" trading and shows how you can use it to make huge returns in the market...

To subscribe to Digest Premium and receive a free hardback copy of Jim Rogers' latest book, click here.

This simple strategy can lead to huge gains in the market...

Editor's note: Yesterday, DailyWealth Trader editor Amber Lee Mason revealed which areas of the market she's monitoring. In today's Digest Premium, she explains the strategy of "bad to less bad" trading and shows how you can use it to make huge returns in the market...

My colleague Steve Sjuggerud coined the term "bad to less bad."

The idea is that you look for a company or sector that has been beaten down and everybody hates. Usually it has spent years in a bear market and things can't get any worse. And when things can't get any worse, they can only get better. You make the big gains when things get a little "less bad." So if there's a glimmer of good news, or if just a little bit of normalcy returns to the market, an asset that has been beaten down below its intrinsic value can rapidly increase in price.

Alcoa (AA) is a textbook example of the "bad to less bad" strategy... and DailyWealth Trader subscribers are up nearly 100%.

By October 2013, aluminum had been in a bear market for two or three years. Prices were hitting new lows. Folks were really gloomy on the global economy. Everyone expected a contraction to begin shortly. Alcoa was trading near four-year lows.

A key part of this trade was that the share price had stopped falling. It had gotten totally beaten up from 2001 to mid-2013. Then it was just bouncing along at $8 a share when we bought in October.

Things were very bad. But we didn't want to catch a falling knife. Alcoa had stopped falling before we entered the position. Maybe it was a fluke of timing, but the day after our recommendation, shares jumped around 8%... and they haven't looked back.

We've had a 10% stop loss on Alcoa (AA) since December. It hasn't corrected much, which is shocking for a commodity producer like Alcoa. Commodity producers tend to be more volatile, but it has been a "stair step" higher over the last eight months.

Newsletter readers receive a lot of different advice once a stock has doubled. One of the main recommendations is to sell half of your investment. This allows you to bank your original capital. Then you're playing with "house money." The thinking goes that it doesn't really matter what happens, because you can't lose money on the trade.

Selling on a double works well if you're buying options or super-volatile stocks – like biotech companies or junior resource firms. You want to use that kind of strategy with super-volatile assets because 30%... 40%... even 50% of your gains can vanish overnight.

Alcoa isn't in that situation. It's not that volatile. In DailyWealth Trader, we recommend keeping a tight stop on it. We don't want to give up a lot of our gains if Alcoa starts to fall from here. At the same time, we want to keep our full position invested... So if favorable market conditions in aluminum and aluminum producers continue, we get the full benefit of the rally.

A few months before we recommended Alcoa, we recommended U.S. Steel (X). That trade also did very well. U.S. Steel went up from August to the end of the year. It had a very sharp rally and then it digested those gains. We got stopped out of the trade. But U.S. Steel was in the same sort of "bad to less bad" situation as Alcoa.

Folks were gloomy about the global economy. They didn't think people would be manufacturing or building as much. So they thought there wasn't as much need for steel. Nobody thought a steel producer could rise from there. Things were looking bad for U.S. Steel. Shortly after we recommended it, folks got a little less gloomy about economic growth and it began to turn around. We made 36% on the trade before stopping out. That's just another example of the power of "bad to less bad" trading.

– Amber Lee Mason

This simple strategy can lead to huge gains in the market...

Yesterday, DailyWealth Trader editor Amber Lee Mason revealed which areas of the market she's monitoring.

In today's Digest Premium, she explains the strategy of "bad to less bad" trading and shows how you can use it to make huge returns in the market...

To continue reading, scroll down or click here.