The S&A Digest

Magna a bona fide automaker?... Munger's comments in L.A.... A top pick from the VIC... Update on margin accounts... Ron Paul and the bloggers... Million-dollar condos in Detroit... Who's a bigot now?...

We wrote it. Did you buy it?

Magna International's balance sheet is battle-ready. It has almost no long-term debt and net current assets exceed $2 billion. If the world's major carmakers go bust, Magna International will certainly be around to pick up the pieces. And it will have the cash to make big asset acquisitions. I recommended the stock to Alliance members at our meeting in Aspen as a play on the troubled auto sector. The stock was trading around $74 then. It's up to about $80 now. And it's still very, very cheap, because sentiment in the sector could hardly be worse...

– Porter Stansberry, "The Bankruptcy of GM Part III: How to Profit," The Digest, January 18, 2007

Today, Magna International announced that Russian auto tycoon Oleg Deripaska, Russia's second-richest man, made a $1.5 billion investment in its common stock. The move cements Magna's deal to purchase Chrysler from DaimlerChrysler and will create a new auto giant within Russia's booming economy. Magna's chairman, Frank Stronach, uttered this wisdom about the Russian car market: "Everybody needs cars there. They've got oil." Magna's shares spiked up as much as 15% on the news and are trading up 6.3%, at $83.90, as I write.

We'll have Dan Ferris' final report from the Value Investing Congress (VIC) tomorrow. In the meantime, Goldsmith is on the scene in L.A.: "I just got back from the Wesco (Charlie Munger's holding company) meeting in Pasadena. Munger, Berkshire Hathaway's vice chairman, literally did not mention one thing about Wesco. The meeting should have been dubbed 'Berkshire Part Two.' The highlight was Munger explaining why Buffett has been so successful: 'Warren Buffett got to where he is by sitting on his ass and reading. You'd get fired from corporate America for doing that.' Other good quotes:

"Munger also recommended two books: The Martians of Science, by Istvan Hargittai, and Walter Isaacson's biography of Einstein.

"The last question Charlie fielded was: 'Have you and Warren thought about what is going to happen to the stock after you both die?' Response: 'Well, the Munger family owns $2 billion in Berkshire stock. We've put a little bit of thought into the matter.'"

One good pick from the VIC: SK Telecom (SKM). Ferris says one of the best value managers in the world (Chris Browne of Tweedy, Browne) told him the stock was one of his firm's most recent buys.

PSIA readers should be familiar with SKM – I recommended it in March at $22.50. "Right now, similar CDMA-based wireless telecom providers are trading for around 15 times earnings. SK Telecom could double from here and still be 50% cheaper than its global peers. Simply based on its retained earnings and its buybacks, I expect the stock to increase 15%-20% per year. Sooner or later, the market will re-rate this stock, and it will trade at a higher valuation, maybe 12 times earnings. The stock will more than double when that happens..."

Shares are up about 20%. The stock was so cheap when we bought it, I suggested doing your own "leveraged buyout" via in-the-money, long-dated call options (January '09) on the stock – which I almost never recommend. The options have gone from $4.80 to $7.00.

Fannon strikes again. On Monday, Rob Fannon rushed out his monthly newsletter, The Medical Investor, two days early because he was convinced his new recommendation would beat its earnings forecast on Wednesday. "We have a brief chance to pick up this industry leader on the cheap. The window is rapidly closing, however... On May 9 (before the market opens), [our new recommendation] will report earnings... we think it's best to establish a position in the company ahead of Wednesday's earnings announcement... We should make about 20% as the company trades back up to fair value. Thereafter, this [company] should produce at least double-digit returns for the next 10 years." Rob's latest recommendation is up 7% in only two days. Since February, Rob also has picked winners of 21%, 13%, and 7%... with no losses.

Regarding Ron Paul... says a friend, "Hey Porter. I was at a marketing conference in NY the last 2 days. One website I learned about is www.technorati.com. Not sure if you are familiar with it, but it tracks what people are writing about in their blogs. It tracks over 80 million blogs. The reason I am telling you about it is that 'Ron Paul' is the most searched for term on the site. There has been a pretty big surge in people writing about him, as you can see by clicking here. Thought you might be interested. I know you mentioned him a time or two in the Digest."

From USA Today: "The NASD, a brokerage regulator, recently sent out an 'alert' to investors outlining the risks associated with margin. Through the end of March, the latest data available, the amount of debt taken on by investors to buy stocks totaled $317.7 billion. And while that was a bit below the $321.2 billion record hit in February, it still surpasses the $300 billion in March 2000 at the top of the tech-stock bubble."

A few weeks ago, we mentioned here that James River Coal – the cheapest American coal stock, in terms of price to reserves – looked to have finally made a bottom. Graham Summers covered the situation in a recent Growth Stock Wire. And now... we might have finally gotten it right.

Extreme Value pick Wal-Mart (WMT) announced a 3.5% decline in April sales, its worst performance in 27 years. Shares of Wal-Mart were down less than half a percent in early-morning trading. Subscribers are even on the recommendation.

While Wal-Mart's sales are floundering, S&A Dividend Grabber pick Saks (SKS) announced an 11.7% increase in sales, beating Wall Street expectations. Shares jumped 3% on the news. Subscribers have made more than 30% in less than six months.

Leading the charge in Detroit... People are pumping money into Detroit's depressed real estate market. Investors are developing the downtown area, with luxury condos, a new Westin, and three casinos with hotels on the way. Only a handful of $1 million-plus condos remain available in one of the new developments. Our ultra-contrarian 12% Letter editor Tom Dyson is planning a trip to Detroit to look for real estate deals... Read more about it here.

New highs: Enterprise Product Partners (EPD), Given Imaging (GIVN), Oneok (OKE), Pike Electric (PEC), POSCO (PKX), Saks (SKS), Southern Copper (PCU).

A huge mailbag today. Don't miss the angry, "unbigoted" Mormons and insightful subscriber questions about stop losses and stock buybacks. One more thing... At the request of subscribers seeking more international stock research, we offered to publish an all-international version of Extreme Value if we could get 1,000 subscribers to agree to pay for it ($1,000 a year). So far, we've gotten about 50 pledges. We do cover international opportunities, from time to time, in our letters. But we've found over many, many years that solely writing about foreign stocks is a great way to lose a ton of money in publishing. Send your pledge and your condemnations, criticisms... or even your praise... here: feedback@stansberryresearch.com.

"Would you please ask Dan Ferris to explain his position on the use of trailing stops? Am I correct in believing that a majority of investment letter writers associated with Agora recommend the use of trailing stops? Perhaps I am not your only reader who is confused?" – Paid-up subscriber Richard S. Shaw

Porter comment: Dan Ferris would tell you that diversification and arbitrary stop losses are poor substitutes for investment wisdom. Dan's insight into the true value of his recommended investments affords him the confidence to hold through down periods and see much higher gains over time. (On the other hand... in the one or two times Dan's been wrong about the true value of a business, the losses were large.)

Steve Sjuggerud, who first brought the idea of trailing stops to prominence in the newsletter community, would argue that an ironclad rule against accepting the possibility of large losses (via trailing stops) is worth the potential loss of future gains. Using this philosophy, Steve is able to invest with a high amount of safety, even in positions that are more speculative.

Both Dan and Steve have produced great results for their readers over many years – they simply have different approaches. You must decide which approach works best for you.

"I bought 10,000 pounds worth of stamps. I agree the Stanley Gibbons people are excellent and Geoff is very helpful. Hope to treble my money in 7 years." – Paid-up subscriber Geoffrey M Boyce, Australia

"After reading about some massive insider investing, I did a little more research into [a very recent Inside Strategist recommendation]. I bought in and saw a nice gain of ~8% for the day. Keep up the good work [Graham] Summers!" – Paid-up subscriber Brent Hehl

Porter comment: Although his work is almost unheralded in these pages (through my neglect, I must say), Graham Summers could easily compile the best track record of 2007. He's doing a phenomenal job for his subscribers... as they already know.

"In Wednesday's Digest you say, 'We wish Bill Gates would stop trying to buy other companies and spend more money buying back stock.' I've heard this type of comment often and I am relatively new to investing. Can you please explain how a company buying back stock benefits the average investor?" – Paid-up subscriber Thomas M. Corjay

Porter comment: Good question, Mr. Corjay... one that has at least two answers.

First, the most obvious benefit of a company using its cash flow to buy back shares is to increase the intrinsic value of each remaining share. If a company is worth $100 and has 10 shares outstanding, it's easy to see that each share is worth $10. But... what if the company buys back one share, leaving only nine outstanding? With only nine shares outstanding, each share is worth about $11.11 – assuming nothing else changes at the company. As a shareholder, the value of your stock just went up.

We call such buybacks "synthetic" dividends because, like a dividend, they represent a return of capital to shareholders. In real life, an increase to intrinsic value is even more powerful because, typically, a company's earnings increase too. Using our example above, imagine the value of the company (through increased earnings) rises to $120 and it also buys back two shares of stock. Then you have $120 in intrinsic value divided by only eight shares. Instead of each share being worth $10, now they're worth $15! That's a 50% increase in stock price, powered by only a 20% increase in earnings.

As you can see, buybacks greatly accelerate the capital gains of shareholders, assuming the company continues to do well (as is certainly true in Microsoft's case).

The second reason we like to see certain companies (like Microsoft) buy back stock is because it's simply the best use for their capital. Microsoft's return on equity is more than 35% per year. It has an absurdly good business that's very likely to remain dominant for at least another 10 years. There are almost no other highly liquid investments Microsoft could make that are as good as buying back its own shares. And I don't believe there are any investments it could make that would benefit shareholders as much.

"You said you agree that the US Dollar is doomed. Well then, why invest in the US stocks since that should be cutting your returns by about 10% a year?... I can't find reasons to buy US stocks this year or next. Why are you ignoring these facts? Please don't make claims like 'buying at the right price is good enough', what's your evidence? I mean we are talking about two strong hits on the total return here, I don't think you can offset that with cheapness. And even if you can, the total return on the end (measured in Euros or gold) is going to be too small. Now go ahead and don't publish this and keep making claims without any backing so you can sell some newsletters" – Paid-up subscriber Fernando

Porter comment: Historically, stocks have more than outpaced inflation (the result of a weak currency). Historically, annual returns in stocks have not been closely correlated with economic growth. In fact, returns on stocks tend to be negatively correlated with expected GDP growth in developed markets. I also note that the macroeconomic factors you're talking about have been in place since mid-2001 (at the peak of the dollar). Even if you knock off 10% annually from the average returns of our model portfolios, we've still done very well over this time period. Despite inflation (loss of dollar's purchasing power), I expect we will continue to do well when we buy equity for less than its intrinsic value.

"I'm off to Japan this morning, but just a quick note to thank Rob Fannon for the excellent call on [Fannon's latest recommendation]. I bought some calls on Tuesday May 8, 2007 and sold them 24 hours later for a 92% gain. Good job, Rob! I'll eat some sushi in your honor." – Paid-up subscriber Bob Greene

"I've had trouble asking this question through your so-called 'Customer Service' e-mail so I'm trying this route. When checking into Steve's May 4th recommendation on Macau, my broker indicated the prices that Steve used were in English pounds rather than dollars. I would appreciate a clarification. Thank you." – Paid-up subscriber Wes Pearl

Sjug comment: Your broker is wrong. It trades in London, so I could see why your broker would think that. But it's priced in, and trades in, dollars.

Porter comment: Our customer-service folks are well trained in providing you service on your subscriptions. On the other hand, we've also trained them not to answer any questions about your investments. We're not licensed to deal in personal investment advice.

"You know, I really have enjoyed your commentary in the past. But with each new commentary, it is clearer that you truly are bigoted and enjoying it very much. I've always found it interesting that religious bigotry is somehow tolerated but if you were to imply the same things racially or on a gender basis you would be censored. I guess we can generalize that since many investment gurus are in it for the money and fraudulently promote their successes by manipulating the numbers, that that makes all investment gurus including yourself bad and therefore fair game for ridicule. Certainly you are not painting a very flattering picture of yourself as you try to defame a religion." – Paid-up subscriber Mark Flammer

"OK, Porter, I know all I need to know... It's crystal clear you have an axe to grind. It's evident you want to convey a very distinct impression about Mormons and Mormonism, even if you have to resort to unsupportable accusations to do it. I asked you yesterday to publish your sources for your accusation that law enforcement officials claim that 75% of all financial fraud in the US is committed by Mormons. All you publish in response is the story of a company in Utah that is under investigation. I know I'm wasting my time here. For reasons only you know, you've chosen to use your publishing pulpit to defame an entire religion. If nothing else, you've provided me a fascinating case study. One of my former business colleagues teaches university classes on ethics. He teaches that the essence of honesty is to convey an accurate impression. He's always on the lookout for interesting case studies to use in his classes. He's going to LOVE this one. Well, you won't be getting any more of my tainted Mormon money to support your cause. This constitutes official notice that I am canceling my subscription to True Wealth, effective immediately. I also request that you remove my name from all of your mailing lists, effective immediately. It actually feels very good to do this. Very good indeed." – "A liberated and gratefully unpaid former subscriber" David Tippetts

Porter comment: I cited my source for the 75% statistic in my original reply to your first angry e-mail. But I can repeat it here: Ken Thornberg, who is the director of the Better Business Bureau office in Idaho, was quoted by the Ogden Standard-Examiner: "I would say – and I am not exaggerating – that 75% of the country's major investment schemes are hatched in the Salt Lake City-Provo area."

According to FBI agent Jim Malpede, who was cited by writer Jon Krakauer (a Pulitzer Prize finalist for non-fiction in 1998), no other state has more white-collar crime than Utah. "At any given moment, the FBI is investigating scams totaling $50 million to $100 million perpetrated by con artists based in Utah county," which is overwhelmingly Mormon.

Michael Hines, director of enforcement for Utah's state SEC, says it's common for scammers to ensnare their victims by asking to evaluate the proposed investment through prayer.

Newsweek, which has reported on these problems for nearly 30 years, says, "Utah, the land of the Mormons, has earned itself another name: the Stock-Fraud Capital of the Nation." The Wall Street Journal has reported the same, as have at least half a dozen other major national publications.

Within the broad community of people who label themselves Mormon, there is a surprisingly high frequency of financial fraud. As investors, you should be aware of this fact.

If I were to tell you that Baltimore is the heroin and syphilis capital of the United States (it is), would I be impugning the reputation of everyone in the city? If I warned you to stay away from the black girls working the corners of North Avenue, because there's a much higher than normal chance that they're addicted to heroin and have a venereal disease, would that be good judgment? Or would that be bigotry? What if I were talking about the white prostitutes around Patterson Park?

And... how can any discussion about bigotry and Mormons leave out the fact that Brigham Young instructed his followers to kill "on the spot" anyone caught having an interracial sexual affair, because, as he said, members of the African race are "the seed of Cain." Why don't you mention the Mormon Church banned black people from its priesthood until 1978, because its scriptures taught that black people were the Devil's representatives on Earth? And you call me a bigot?

Having a debate with a Mormon about bigotry is like being in a knife fight against a one-armed man. When you're holding a gun.

"As a member of the LDS church, your recent commentary on Mormon crooks is uh... how should I say, it's an ugly reality that can't be ignored. Plain and simple, there are a disproportionate number of network marketing and other types of business thieves in the state of Utah. However, having lived in the south a couple of years, I noticed that the money thieves just took on a different form... they were the super evangelists. Both groups prey on the poor, and shame on them. Thanks for your good work." – Paid-up subscriber Kelly Sonderegger

Regards,

Porter Stansberry

Baltimore, Maryland

May 10, 2007

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