THE S&A DIGEST: 2006 Report Card

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 07/05/2013

The S&A 2006 Report Card

It was a good year for stocks. A very good year.

Measured from December 30, 2005 (the last business day of last year), the S&P 500 is up 14.1%, as of today. That’s a number most professional investors will find hard to beat in any given year. Fortunately, almost all of our letters did much better than this.

But, before I show you our numbers and our "grades," let’s talk about what you should expect to earn as investor in stocks, how we measure our results, and how to make sure that your results match (or exceed) ours.

I tell my analysts that I expect them to produce average annual returns equal to inflation, plus 10%. I don’t believe the government’s inflation numbers – which leave out most of today’s soaring costs, like real estate and health care. I believe the true rate of inflation is probably around 6%, based on the falling trade-weighted value of the dollar. Ergo, I expect recommended portfolios to produce at least 16% per year. That’s also double what you would expect to make in a diversified bond portfolio (pretax).

More importantly, I expect absolute returns. That is, I expect our recommendations to perform this well regardless of what the stock market does. Most money managers prefer to be judged by relative returns. If the stock market goes down, they’ll tell you that even though you’ve lost money, you’ve beaten the market. That kind of success doesn’t interest me.

Making 16% a year in stocks – year after year – is difficult to do, will far outpace the market, and will turn $50,000 into $1,000,000 in about 21 years (before taxes), assuming you add nothing more to the account. If you add $10,000 per year, you’ll get to a million by year 16. And by year 21 you’ll have $2.1 million. I don’t think it’s realistic to believe you can compound a significant amount of capital faster than this, over a long period of time. It might happen... but odds are it won’t.

I’m confident nearly all of the letters I’m publishing now will achieve this minimum result. I say "nearly all" because some of our letters are sector-focused, like the S&A Oil Report and the S&A Gold Report. It’s hard to know where we are in the commodity price cycle. Sector-specific letters are obviously at the mercy of the sector, to a large extent. Additionally, one of our letters, The 12% Letter, is focused on providing current income, not capital appreciation.

Now... a word about methodology. This report card is attempting to show how the stocks recommended in our letters during 2006 have performed, on average. I will also report on the overall success rate of each letter, i.e., what percentage of the recommendations went up. Any open recommendation more than 5% in the red or any recommendation sold at a loss counts against the success rate.

I am using a simple arithmetic mean (aka, a plain-vanilla average), not a geometric mean, because these picks were all made this year and the numbers do not reflect any compounded return. Our results are based on the stock’s closing price immediately prior to our recommendation and the closing price the day after a sell recommendation.

This type of evaluation severely handicaps our performance. Many of our best recommendations don’t perform well immediately. For example, my November 2005 recommendation of Akamai (which is up more than 200%) isn’t included in this year’s report card because it was a 2005 recommendation. Additionally, despite the fact that the average holding period for most of our 2006 newsletter recommendations is around six months, I have not annualized these results. You can easily approximate the annualized result by simply doubling the returns shown here. I don’t like to report these figures because you can’t "eat" annualized results.

(The S&A Short Report is an exception to the simple "double-it" rule for annualized results. Its average holding period is much shorter, typically between two and three weeks... thus its annualized results are much, much larger).

Before you write a nasty note telling me all of the things that are wrong with our evaluation methods, please know that we’re building an online archive where subscribers will be able to see each newsletter’s entire recommendation history. With this data, you can devise any method you’d like to evaluate our work.

Looking at the results, a few things immediately come to mind. There are a lot of A’s. We have upgraded our editorial staff continually over the last four years, and our investment is paying off.

That’s especially true of our biotech-centric, conference-call service, Phase 1. Under a previous editor, we called this product Diligence. It performed well on average, but was plagued with "blow-ups." Rob Fannon is our new editor, and he’s done a fantastic job. He recommended nine early-stage biotech companies and a nanotech company this year. Only one stock has gone down since his recommendation. Achieving a 90% success rate with a biotech-focused product is exceedingly difficult to do. If there were a grade higher than A+, Rob would have earned it.

Some of you may wonder why Matt Badiali’s S&A Gold Report didn’t receive an A+. His portfolio’s numbers would support such a grade. He’s outpacing other A+ portfolios in average return and he has better than an 80% success rate picking highly speculative early-stage resource stocks. I withheld the "+" only because Matt hasn’t seen one of his small-cap gold picks really soar. With these gold stocks, two or three should rise 300%, 400%, or even 1,000% every year. And, while Matt’s picks have done well, he hasn’t hit the big ones... yet.

The results of four of our "core" newsletters – Extreme Value, True Wealth, Inside Strategist, PSIA – were superb. While the average returns were in the double digits for all of these publications, what was more gratifying to me was to see our success rates. Three of these publications pitched a "perfect game" this year.

What about the laggards?

In the case of The 12% Letter, the answer is simple: The Canadian government wrecked us. An income letter, the 12% portfolio was heavily invested in Canadian royalty trusts. The Canadian government is threatening to take away their tax privileges, resulting in a big sell-off of these stocks. We were stopped out of several at a loss. However, the raw numbers don’t tell the whole story.

Our new 12% editor, Tom Dyson, has done a fantastic job of profiting from the crisis. In the middle of November, at the precise bottom of the market for these royalty trusts, Tom recommended three energy-related trusts... and has already seen double-digit gains in all of them. Additionally, Tom’s first recommendation, the Canadian royalty trust company, Westshore Terminals, was picked in early October, just before the crisis. And Westshore has weathered the storm with ease. It’s up 10%.

Watching Tom make the best of the situation was inspiring. He earned his B- with "extra credit" gained from buying back into the royalty trust sector at exactly the right time.

There have been two big disappointments this year – Sjuggerud Confidential and The Big Trend Report.

Jeff Clark is a great trader, but this year he got caught in a "Chinese trap." He was right about the sector... but just a little bit early in his recommendation of China Yuchai. He kept holding on, knowing it would turn around eventually. He was right, but his 50% trailing stop took him out at the bottom in the stock in July. The resulting 47% loss, plus two mis-timed biotech bets, wiped out all of his other gains, resulting in a breakeven year.

Jeff’s results remind me of how important it is to keep your losses small. You can come back from a 15% loss. Even a 25% loss. But to make up for a 50% loss, you need a 100% gain. Those are hard to come by...

One newsletter hasn’t yet earned its "grade." I’ve given Sjuggerud Confidential an incomplete, because its results were heavily weighed down by a single pick that’s deeply in the red – down 46%. Steve has recommended hanging on to the stock because he expects a big announcement early next year to vault the share price to around $30. (Currently the stock is trading for less than $10.) We’ll have to wait until February to see how this all pans out.

It’s a shame to see one big losing position wipe out the spectacular gains Steve made in Confidential. He recommended a small homebuilder on November 1 – at the exact bottom in housing stocks. It’s up more than 20% already. Less than three months ago, he bought a zinc smelter that is now being acquired, for a 46% gain.

But... it’s the average results that count. And that reminds me...

The most frequent complaint I receive from subscribers is that they can’t replicate our results because they don’t buy all of any given letter’s recommendations. Instead they "cherry-pick" and end up picking the losers. Naturally, I ask them why they do this – why not put a little bit of money into each of your favorite editor’s picks? I get lots of different answers to that question (I don’t have enough capital, I’m not organized, my broker won’t let me buy some of the things you recommended, etc.) but underlying each of the variations is a simple, but faulty, bias.

Emotionally, it feels like you’ve got to take a big position to make a lot of money in stocks. Of course, that’s not true. If you’ve spread your capital among a group of 12 or 15 picks that have gone up, on average, 15% in less than a year, you’re making good money in stocks.

In any case, if you want to replicate our results, you’ll have to buy what we recommend, follow trailing stops... and be organized enough to invest on your own.

I hope we’ve made a positive impact on your net worth this year. We’ll be hard at work again, on your behalf, on January 2.

Best,

Porter Stansberry

Cockeysville, Maryland

December 27, 2006

P.S. Yes... I know, the S&A Oil Report was left out of this evaluation. There was a slight glitch in the data we compiled, and, as our offices are closed for the holidays, I can’t get it sorted out. I’ll report on the letter early in the new year.