The S&A Digest

Ian (our resident quant) looks at China and sees very expensive stocks… Ferris and Goldsmith at the Value Congress… The most expensive city in the world… Questions about Argentina… Doubts regarding our motivation to write about GM… Us, bigoted…?

"Don't worry, Porter. We haven't seen any beautiful women at the pool yet," said Goldsmith via Google's "chat" software this morning...

Dan Ferris and Sean Goldsmith are in Los Angeles today, attending the famed Value Investors Congress and the annual meeting of Wesco, Charlie Munger's holding company. I was supposed to be with them… until a look from my pregnant wife changed my travel plans.

"No kidding, Goldsmith. It's 6:30 a.m. in L.A. And you won't see the pool deck all day. You'll be stuck in a stuffy hotel ballroom listening to brainiacs, like Dan Ferris, talk about the intricacies of corporate balance sheets and new accounting regulations. Have a great time…"

Keynote speakers at the Value Congress include Mohnish Pabrai and Wally Weitz. Goldsmith is under orders to report back to us. Check the Digest tomorrow for more on the conference.

James Ottaway, the largest Dow Jones shareholder, opposes News Corp.'s bid for the company. Ottaway feels that The Wall Street Journal would lose status and credibility under Murdoch's control. Even Warren Buffett had something to say. Buffett believes that Murdoch's desire for the newspaper stems from "noneconomic factors." We don't think the deal is going to happen.

London is the most expensive city in the world to buy a high-end house, according to a property study published in the Financial Times. Each square foot will cost you nearly $4,600. New York is in second place, where each square foot brings in $3,200.

PSIA pick Johnson & Johnson (JNJ) today announced that its experimental drug-coated stent failed to perform in a study. The company will also discontinue sales of the CoStar stent in certain countries in Europe, Asia, and Latin America, where it is already approved. News sent shares down 1.3% in pre-market trading. We would add to our position.

The latest takeover target… Alcoa made a $26.9 billion hostile bid for rival Alcan that would create one of the largest aluminum manufacturers in the world. The $73.25-a-share cash-and-stock bid is a 20% premium to Alcan's Friday closing price.

One other portfolio note… We apparently missed a trailing stop on Akamai last week (see the mailbag, below). That happens from time to time with very volatile stocks. If you don't catch every new high, your stops can be off by a $1 or $2. In any case, we will exit the position now ($45) in the PSIA model portfolio. We "made" 171% since our November 2005 recommendation.

If you (like us) have trouble keeping your stops exact, don't worry. It's the principle of cutting losers that matters, not whether you cut them at 22% off the high or 27%. We've noticed that some subscribers… mostly engineers… demand precision with these matters. If you're in that group, you can use one of several software programs to make sure your stops are always correct. One of our subscribers created a website that will track your stops for you – www.tradestops.com.

New highs: Anglo American (AAUK), BHP Billiton (BHP), Career Education (CECO), Disney (DIS), Eni (E), EnCana (ECA), FLIR Systems (FLIR), KHD Humboldt Wedag (KHDH), KLA-Tencor (KLAC), Coca-Cola (KO), Marathon Oil (MRO), Oneok (OKE), Sigma-Aldrich (SIAL), Saks (SKS).

The mailbag has finally returned to normal – lots of folks angry with us. Not enough foreign stock picks. Too many good stock picks. Not watching our stops closely enough. We appreciate all of your criticism. Please, keep it coming: feedback@stansberryresearch.com.

"Grrrrr… Porter, nothing is more frustrating then to hit a stop, sell the stock, and then receive your newsletter and see you have not sold it. You don't even mention it in the portfolio notes section. I even subscribed to TradeStops to track the trailing stops. They also agree that the stock went below the trailing stop. Akamai hit a high of $59.15 on 2/8/07, a 25% trailing stop loss of $44.36 was exceeded on 5/1/06 ($44.08) and 5/2/07 ($43.16). [It] was only $0.01 above at $44.37 on 5/3/07. So... how can I be sure that you really sold? Set my trailing stops a little lower, say, at 27%? Now the stock is up, do I buy back in? I could wait until it goes back down, but then it will be below the stop. What gives?" – Paid-up Alliance subscriber Dave.

Porter comment: Just an oversight, Dave. Nothing intentional. Thanks for reminding us that we'd missed it. One thing to watch, however. We only record closing prices. Often subscribers think we've hit a stop because they're using intraday pricing. In this case, though, you're right. We blew it.

"There are simply too many good recommendations each month [for S&A Private Wealth Alliance (PWA) subscribers]. Like most investors there is a limit to the amount of cash I have available for new investments… If you look across all of the publications in PWA, I'll bet you will see more open positions [than anyone could buy]. My count is 126 open positions. Obviously, I haven't invested in all of them since I have only been a subscriber for about 7 months, but [I] am already tapped out as I picked up some prior positions that were rated as a BUY." Paid-up subscriber Robert Tanner

Porter comment: We plead guilty. The Private Wealth Alliance – an infinity subscription that includes PSIA, S&A Oil Report, True Wealth, Penny Letter, and The 12% Letter – is for readers interested in having access to a lot of good ideas… at a great price. In fact, our charter subscription offer to the Private Wealth Alliance cost less than one year's subscription fee to all the letters – but it never expires. We are going to re-open enrollment to the Private Wealth Alliance later this month.

If you only want to see one good investment idea per month, maybe PWA isn't right for you. I think, for most people, having a constant stream of proven investment ideas coming across their desk is a good thing. Even better is paying for the research once and getting it for the rest of your life.

If you're new to S&A and you want to know my best advice for how to get started using our services, please see my earlier comments.

"I find your description of the Argentina venture very exciting. It seems to be just what I have been looking for. A couple of questions:

Alternatively, do you know of any other property available at reasonable cost near you? Or perhaps a realtor." – Paid-up subscriber David McMillen

Porter comment: As I've written about previously, a group of friends have purchased several big plots of land in Salta, Argentina, with an eye towards developing the best parcels. The most attractive piece of ground lies within a few hundred yards of Cafayate, Argentina – which I've described here.

The idea for this development is to build about 300 homes, all of which would have golf course and/or vineyard exposure. The community would produce grapes to sell to winemakers and use the revenues to offset the community fees. The initial stages of the development are still in progress, though the developers hope to have lots and a welcome center in place by later this year. As I learn more, I'll pass it along.

To answer your other questions: The weather is absurdly good. It's a high mountain desert valley, surrounded by 16,000-foot Andean peaks. There's plenty of water, thanks to the snow on the mountains, which fuel incredible artisan wells, some of which shoot water 25 feet into the air. Temps are the same year round – 85 degrees during the heat of the day and 40 degrees at night. There's no humidity. And I've never seen it rain there.

Yes, I believe they're planning for a gated community. The lot sizes will vary, with the smallest being around one acre. I don't have any pricing information, but in discussions with my friends, I believe they're trying to stay below $500,000 – including the house. Beats me about the community restrictions – it's a master planned community, and I know there will be restrictions. I just don't know what they are in detail.

Certainly other properties are for sale. Every time I go down there, the hotel I stay in is packed with developers from around the world. But I don't think anyone else is doing anything else on our scale, with a golf course and luxury amenities. Cafayate is worth the trip. It's very special place – and it's still dirt-cheap. A world-class steak lunch with wine costs about $10 per plate.

"I am the mother of three daughters, who are all professionals and ages range from 28 to 37. I have made a practice of trying to stay tuned in to whatever 'the latest' is for this age group. In the past, letting their product recommendations guide me in choosing a company that will give me a good investment return has been beneficial to me. Last summer, my oldest daughter said 'Mom, you ought to buy some Crocs... they are really an ugly shoe, but they are SO comfy... you will love them. I did order a pair, and after wearing them, checked out the stock. From what I saw of its history, I thought... 'oh, you are too late,' and did not buy. Then, two weeks ago, I received a mailer from my local department store showing Crocs new line. They are beautiful shoes!! I ordered a pair immediately, and the next morning immediately bought the stock. Now, I was thinking that the new line will reflect on next quarter's earnings, and the gain will come then. However... the earnings announcement today for last quarter was up 15%, and today the stock was up $11.44 or 19.93%." – Paid-up subscriber Linda Lehmann

Porter comment: At 35 times earnings, in a difficult and finicky fad-driven market, there's not a lot room for error in the stock. Is any rubber-shoe maker worth $3 billion?

"I get myself – and clients – almost fully invested and along comes Sjuggerud with a great sounding deal in Macau. And Porter writes about the whopper in Sam Zell's holding company (who sold EOP at a fantastic price). Good ideas at a market top? It's hard NOT to make money now, so I need to be careful to keep the stocks that will do well in an eventual downturn. And now, of course, I get to wait a week to see what Ferris comes up with. Someone said that a train comes by every 10 minutes... it's true. It's darned hard to continually juggle good ideas so that you have the best available (sigh). I passed up CECO because I didn't like the industry. Been a great special situation. Nice work." – Paid-up subscriber Jim Pursley

Porter comment: Again, we stand guilty. We believe it's our job to produce great investment ideas consistently, month after month. It's your job to put them to work in a way that fits your goals and risk tolerance.

"With respect to your continual tirade against GM, what are your motives once you have pronounced that 'GM is dead!'? It's almost as if you ghoulishly continue to dissect the body after the autopsy is complete. Or could there be a financial motive here? I hope not because that would be just so wrong. I don't expect this to be published, like my other two letters, as it must be really striking a nerve. What country is your home because I can't imagine an American taking such joy in attacking a long-standing part of the business community. Very unprofessional and so unnecessary." – Paid-up subscriber Victoria Smith

Porter comment: My motivation is simple. I am deeply offended by the way the management team of General Motors has lied to the public for the last 25 years. Equally inept teams of manager and union bosses have slowly bled one of history's greatest industrial corporations to death. Both groups have been living off the marrow of this company, leaving nothing behind for future generations of Americans. To me, what happened to GM is a crime.

I tell the story of GM's demise as it should be told because I know when the company finally goes bankrupt the mass media will report the story in one of two ways. Fox News will blame the failure on the union. CNN and CBS will blame current senior executives. Neither will get the story right.

Both groups – management and union workers – have stolen something from GM shareholders and from future generations of Americans. Since 1992, union workers have been paid to do nothing – sitting in a so-called "jobs bank." These kinds of ridiculous union demands left GM with dozens of money-losing plants. On the other hand, the company's board of directors continued to pay big dividends to hold the stock price up. Meanwhile, the company was running at a capital loss, with no funds available for the continual investments necessary to compete in the global market. The result is what we have today: The shell of a formerly great corporation getting crushed in its home market by Toyota – a company that 30 years ago barely sold cars in America.

If telling this story honestly and completely is unprofessional… well… that's probably why I write newsletters instead of kowtow to advertisers in a newspaper or a magazine. GM still buys a lot of ad space and TV time. You won't see the true story of GM in any other type of media.

"Broad generalizations are what causes bigotry and hatred. Just because one Mormon is corrupt doesn't warrant a generalization any more than one Catholic who is a mass murdered makes all Catholics mass murders. I am very disappointed with the characterization and will be canceling my subscription" – former subscriber James

Porter comment: We're sorry to see you go. And we're sorry our comments upset you so much. If you visit Europe, we might warn you to "watch out for gypsies." It's not because we're bigoted or because we have anything against gypsies. Quite the contrary… we secretly admire their carefree ways. But we would still warn you because gypsies in Rome have ripped us off and several friends have had items stolen by gypsies in Spain and Germany. We don't think such warnings are bigotry. They're simply common sense. Likewise, if you get a letter in the mail from an investment advisor touting his Mormonism and promising big annual returns, we'd urge caution. It's not bigotry. It's common sense. According to law enforcement officials, 75% of the financial fraud in America originates from Mormons in Utah. That seems like a useful fact to know.

"You have mentioned a number of times in the Digest that Stansberry Research boasts many subscribers from all over the world. In fact, I believe you mentioned it was 130 countries. I am one of those foreign non-U.S. subscribers, and I wondered whether Dan Ferris will ever expand his highly success Extreme Value (EV) model to include a global publication? Perhaps launching the 'Extreme Value Global' publication using the same investment principles as EV but focusing on equity opportunities from all over the world – whether its an undervalued oil major in Russia or a great investment in London." Paid-up subscriber Nayem Kabir

Porter comment: Steve Sjuggerud's very first investment newsletter was titled World Money Analyst. He took over for Mark Tier in 1996. Tier, as some of you know, lives in Hong Kong, and it was natural for him to have an international focus. But we could never find a way to sell the newsletter in the United States.

A consultant explained the problem to us this way. "To an American reader, your newsletter might as well be called 'Death, Death, Death.'" Most Americans, he explained, don't talk about money, hate analysts, and don't know about or care about the rest of the world. The conversation was particularly memorable because it's the only thing a consultant ever told me that turned out to be true. While we do have subscribers in 130 countries, more than 90% of our subscribers reside in North America. So far, we've found that if an editor recommends more than one or two foreign stocks (on foreign exchanges that most American discount brokers can't buy) per year, we can kiss the letter goodbye. Folks will cancel in droves.

While I personally would love to read an international version of Extreme Value, we don't yet have the marketing apparatus to sell the letter globally. And Americans won't buy it.

Regards,

Porter Stansberry

Baltimore, Maryland

China's Overnight Billionare

By Ian Davis

Yang Guoqiang came from humble beginnings.

He was born into a poor family in China's Guangdong province, so poor in fact that he reportedly never wore a pair of shoes until age 17. (A fact he later disputed, saying he had simply never put on a new shirt until age 18.)

The town he came from was known for its rice-growing and fishing, but Yang decided to pursue construction.

At the age of 20, Yang began his career as a cement mixer, though he quickly worked his way up the ranks of his township-owned company. By the time the 1990s rolled around, Yang was a manager.

A wave of privatization was sweeping the country at the time and Yang, along with some fellow investors, decided to buy the construction company that he worked for.

This company went on to become Country Garden, one of China's largest property developers. In 2005, Yang Guoqiang transferred his entire holdings in Country Garden over to his daughter Yang Huiyan.

Two years later, Country Garden went public on the Hong Kong stock exchange. The IPO was 255 times oversubscribed making it the second-most popular IPO in history. Shares in Country Garden rose by 35% on their first day trading, and Yang Huiyan became an overnight billionaire.

Stories like Yang Guoqiang's are typical in emerging economies. When a country moves from a communist to a capitalistic society, like China is doing, privatization and entrepreneurship are accompanied by speculation.

Because of recent speculation, China's stock market is very expensive.

"All over [China], people are rushing to banks to withdraw their money and buy stocks. ‘Now that the stock market is booming, they are sort of catching the fever and think it's an easy way to make money,' said Robert Broadfoot, who runs a political-risk consultancy in Hong Kong." – VOA News (May 5, 2007).

Let's take a look at how this speculation has ramped up China's stock market.

A LOOK AT CHINA'S VALUATIONS

DataStream tracks two China indices, China B-Shares and China-A Shares. The A-Shares trade only in China and are quoted in renminbi, the Chinese currency. These shares are difficult, if not impossible, for foreigners to own. The B-Shares, on the other hand, are sold to foreigners and are often quoted in foreign currencies.

Currently, the China A-Shares and China B-Shares DataStream indices are among the top-5 most expensive indices relative to their historic valuations.

The following chart shows how the local stock-market fever in China has swollen values. In the last year, the price to book value of the China A-Shares has increased threefold, giving it the highest price to book of any DataStream country index.

The rest of the world is speculating in China as well. The following chart shows the P/E ratio of the China B-Shares. Currently, it is 116% above its median level.

CHINA IS ALSO EXPENSIVE RELATIVE TO THE REST OF THE WORLD

China is expensive relative to its own history, but how does it compare to the prices elsewhere on the globe?

We need to ask this question when analyzing developing economies. Maybe the country's high valuations (relative to its history) result from its transition away from being an emerging market, rather than a speculative bubble.

However, relative to the rest of the world, China is also very expensive.

The following table shows DataStream's China indices and their valuations versus broader developed and emerging market indices.

CONCLUSION

Since stock markets can remain expensive for very long periods of time (like the U.S. market in the late 1990s), I don't recommend short selling China. This mania could explode much higher before it corrects.

However, if you are currently invested in China, you should be aware of the downside risk. Were China's valuations to return to historic levels, the Chinese market would fall by around 50%. Were China's valuations to come in line with the current level of the rest of the developed world, they would fall by about 19%.

Good investing

Ian Davis

May 7, 2007

Stansberry & Associates Top 10 Open Recommendations

Stansberry & Associates Hall of Fame

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

As of 06/28/2013