The best way to protect your assets...
The best way to protect your assets... A classic example of capital efficiency... An update on Porter's favorite business...
If you've been with us for long, you know Porter believes we're about to see a massive wave of credit defaults due to huge amounts of unpayable debt in the student-loan, subprime-auto, and high-yield bond markets.
He's calling it "the greatest legal transfer of wealth in history." And that's why he and the Stansberry's Investment Advisory team have been taking profits on some positions, cautiously adding short positions to hedge their portfolio, and raising cash so they have plenty of "dry powder" when a correction hits.
Yet many readers have been surprised to learn he's still holding several stocks... and even recommending new positions in a handful of others. But this is for good reason. As he explained in last Friday's Digest...
I still think we're heading into a bear market. If that's true, you might wonder why I don't sell all of the stocks in my model portfolio. You might wonder why I don't short dozens of stocks. The answer is: Because the timing on all these things is impossible to pinpoint and, because – and this is harder to understand – many of the stocks in our portfolio will perform well despite a bear market.
So... what stocks should you hold?
Longtime readers know Porter thinks "capital efficient" businesses should be at the top of your list. These are companies that are able to return a large amount of their profits to shareholders without requiring much capital to maintain their businesses.
Chocolate-maker Hershey is a classic example... Porter originally recommended shares in December 2007, just before the worst financial crisis in a generation and one of the worst times to buy stocks in history.
Yet despite the enormous crash in the broad market, Stansberry's Investment Advisory subscribers were never stopped out. They're now up more than 160% and are still holding shares, collecting dividends, and compounding their money in one of the world's greatest businesses.
On Monday, we covered a more recent example in fast-food giant McDonald's (MCD). Porter recommended shares to all Digest readers last April... calling it virtually risk-free and practically pleading with folks to buy shares.
Both of these companies are above "buy range" today. But if you missed those opportunities, you're not out of luck. There's another capital-efficient business you can buy right now...
We've covered the case for consumer-electronics giant Apple (AAPL) several times recently. The company is a "World Dominator," it's a favorite of some of the world's greatest investors, and it's dirt-cheap today.
But many folks may not realize it's also incredibly capital-efficient, too. As Porter and his team explained in the May issue of Stansberry's Investment Advisory...
The surprising fact is that Apple is a fantastic cash machine. It generated $50 billion of free cash flow last year, representing more than 27% of its revenue. Think about that. For every $100 of revenue Apple generated, $27 were left over for shareholders after paying all the bills, including the cost of the merchandise, research and development expenses, marketing expenses, back office expenses, taxes, and capital expenditures. That's the essence of what we call "capital efficient" – businesses that generate loads of cash without having to reinvest huge sums. That leaves plenty of free cash flow – in Apple's case, $27 for every $100 of revenue – to pay out as dividends or buy back stock.
Until recently, Apple held onto its cash rather than returning it to shareholders. It had amassed $82 billion of cash and marketable securities by the end of its 2011 fiscal year. It hadn't repurchased a single share or paid a dividend up to that point.
But since then, Apple has paid $29.7 billion in dividends and repurchased $79.9 billion worth of stock. The number of shares outstanding has been reduced by 10% since that time. And Apple now has a massive $193 billion in cash.
And the news is only getting better...
Apple reported fourth-quarter and full-year earnings after market close yesterday.
The company generated $70 billion of free cash flow last year on revenues of $233 billion. This means free cash flow jumped to more than 30% of revenues. In other words, the company actually increased its capital efficiency this year, despite growing revenue by nearly 30% as well.
Even better, the company continues to prove the naysayers wrong...
The iPhone led the company's growth again this quarter, showing that concerns about sales of the company's new iPhone 6s were overblown.
It also nearly doubled its sales in China, despite fears of an economic slowdown there. As CEO Tim Cook told analysts during a conference call last night...
Frankly, if I were to shut off my Web and shut off the TV and just look at how many customers are coming into our stores... I wouldn’t know there were any economic issues at all in China.
Like we noted last week... Great deals like Apple don't come around often. And when they do, they don't usually last long. If you still haven't taken advantage of the opportunity in Apple, you may not have the chance much longer.
Outside of his capital-efficient recommendations, Porter may be best-known for recommending insurance stocks. After all, he has called them "the only investments I hope my kids ever make."
Insurance companies aren't just capital efficient... they're far better. As Porter has explained, insurance is the only business in the world that enjoys a positive cost of capital...
In every other business, companies must pay for capital. They borrow through loans. They raise equity (and must pay dividends). They pay depositors. Everywhere else you look, in every other sector, in every other type of business, the cost of capital is one of the primary business considerations. Often, it's the dominant consideration. But a well-run insurance company will routinely not only get all the capital it needs for free, it will actually be paid to accept it.
I want to make sure you understand this point. All of the people who make their living providing financial services – banks, brokers, hedge-fund managers, etc. – all of them pay for the capital they use to earn a living. Banks borrow from depositors, investors who buy CDs, and other banks. They have to pay interest for that capital. Likewise, virtually every actor in the financial-services food chain must pay for the right to use capital. Everyone, that is, except insurance companies.
But several astute subscribers have written in with a concern about these businesses in particular...
If we expect a credit crisis, won't that be bad news for insurance companies – even the best property & casualty ("P&C") companies like the ones Porter and his team have recommended – that keep a large portion of their capital in the fixed-income markets? If the problems are as serious as we fear, won't even these companies be exposed to huge potential losses?
Porter and his team addressed this question in last week's Stansberry Data Insurance Value Monitor. As they wrote...
First of all, remember that we're not warning that all corporate and sovereign debt is risky. The vast majority is safe. The specific instruments we've been warning about are emerging-market bonds, noninvestment-grade (or "junk" bonds), and securities backed by student loan debt and subprime auto loans.
Second of all, we don't really care about the current "price" of a bond. Insurers generally carry bonds on their balance sheets at current prices, but market prices don't matter because a large majority of these bonds will be paid in full. Remember, fluctuations in a bond's market price – even large swings – are largely irrelevant to the bondholder. As long as a bond's issuer doesn't file for bankruptcy, the bondholder will be repaid the full face value of the bond at maturity... while collecting interest along the way.
Unlike equity investments, where the price of a security matters, the only risk to a bondholder's principal is bankruptcy. So if the issuers' businesses are able to pay back the bond principal at maturity, market prices in the interim don't matter.
If you follow the list of companies hitting new 52-week highs at the end of each day's Digest, you may have noticed two of the Stansberry's Investment Advisory team's top insurance recommendations – Chubb (CB) and Travelers (TRV) – have appeared again this week. These two companies in particular hold nearly half of their investible assets (47% and 46%, respectively) in ultra-conservative municipal debt.
That isn't unusual for the high-quality insurance companies Porter and his team have recommended. Muni bonds make up more than one-third of these companies' total investments. And if you've been following our work for long, you know we believe muni bonds are one of the safest places to put your money.
Of course, as we've discussed, we believe there will be significant problems in other areas of the credit market, particularly in high-yield bonds and subprime lending. But this will be a huge opportunity... folks who buy the right distressed bonds at the right prices could make a fortune with little to no risk. That's why we're launching our new advisory – Stansberry's Credit Opportunities – next month.
New 52-week highs (as of 10/27/15): National Beverage (FIZZ) and Travelers (TRV).
A TradeStops question in the mailbag today. What's on your mind? Let us know at feedback@stansberryresearch.com.
"Porter, I signed up for TradeStops based on your article. Great tools, happy I signed up. However, there is no tool for adjusting position sizes according to volatility. There is a Trailing Stop that accounts for volatility and as such determines the %TS to use, but no volatility based position sizing. Being brand new to TradeStops, have I simply not found the tool yet?" – Paid-up subscriber Mario
Richard Smith comment: Hi Mario, thanks for writing in. In the research section of TradeStops, there is a position-sizing tool. You can enter a stock ticker, an amount of money you're willing to risk, and select the volatility metric (VQ%) as the basis for your risk. (That's the default setting.)
If, for example, you decide to risk $1,000 on a stock that has a 25% VQ, then your position size will be $4,000. If that position falls 25%, you will be down $1,000 – the amount risked.
Hopefully that clears things up. And stay tuned, because next month we're launching our new portfolio-rebalancing tool, which will show you exactly how many shares you should hold in each company in your portfolio, based on the volatility of the stock and the size of your portfolio.
Regards,
Justin Brill
Baltimore, Maryland
October 28, 2015
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