The S&A Digest: Madden's cash

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

As of 06/25/2013

Madden's cash... Nokia booming... Buy shovels... How to make 40% in a CD... Stansberry Focus?... Did Sjug break his rules?

In a recent 13D filing with the SEC, the Clinton Group, a $1 billion money manager, suggested ways the Steve Madden Shoe company might optimize its cash. Whether Steve Madden will follow the advice, we can't say. But we liked the letter because it shows why buying cash-laden stocks is often a great bet:

"The Company has substantial, unrestricted cash balance, which we estimate will grow to be at least $90 million by year end, representing approximately 22% of the current market capitalization. Clearly, this is an inefficient capital structure given the Company's free cash flow generation, ongoing strong earnings, and limited capital expenditure requirements. We believe that $72 million of this cash, combined with a modest senior debt financing of $110 million, could be used to purchase 40% of the outstanding shares of the Company, resulting in pro forma leverage of 1.5x net debt to 2007E EBITDA. The Company could execute such a buyback at a range above $21.00 per share or a 13.5% premium to current market prices. The extraordinary accretion from this transaction produces implied stock prices well north of current levels and a premium to our proposed tender price of greater than 20%."

Nokia released shockingly good numbers. Revenue was up 28% thanks to the company's focus on selling cell phones in emerging markets. Lots of people in lots of places have never owned a phone before. Net profit rose 85%. Worldwide, Nokia's market share remains the biggest at 29%. Samsung and Ericsson also reportedly gained market share in the quarter... which leaves us thinking that Motorola hasn't hit a bottom yet. We're looking forward to the Motorola conference call. Icahn should be very entertaining.

Buy the "shovel sellers"... Private-equity firm Carlyle Group and James Packer, Australia's richest man, are passing on mining companies and investing instead in mining services firms. Ron Cameron, who oversees the $22.5 billion Ord Minnett fund, put it best: "Mining services companies get paid on the volume of dirt moved, whereas the miners get paid on the value of the dirt itself." With the price of gold closing in on $800 an ounce, Carlyle and Packer are betting mines are going to be throwing around lots of dirt.

Both bought stakes in major mining services companies, which trade at a 33% discount to miners, in the past month. Carlyle bought Coates Hire, Australia's largest rental equipment company, for $1.5 billion, and Packer bought a 50% stake in mining services and construction company Arccon Pty Ltd.

A question for you, dear reader. Actually, two questions...

In February 2006, we began to rank each recommendation in my newsletter, PSIA, based on its potential risk. We assign each recommendation a number from 1 to 10 – with 1 being the safest and 10 being the riskiest. As we've told our readers numerous times, it has been our experience that contrary to financial theory, we actually make more money on our least risky investments. Thus, we've always urged our readers to buy the 1-, 2-, and 3-ranked investments before the others. In general, anything ranked "5" or higher is a "hold."

We now have more than 20 months of data to judge whether or not it's working. If you bought the stocks I had ranked "1," your average return, so far, is 48%. If you bought the stocks ranked "2" or "3," your average return is 17%. If you bought the stocks ranked "3" or "4," your average return is 14%. (Keep in mind, these are not annualized figures, and the average holding period for the portfolio is only about nine months.) As an indicator of future returns, my ranking system seems to work, with the lowest-risk opportunities producing the highest average return – just as we expected.

Our questions? First, if you can accept that we tend to make our best investments in the least risky situations, why would you put money into anything but our "sure things?" And, second, would you pay to receive a "focused" list of recommendations from across all of our newsletters, if each of recommendations qualified as a 1-ranked investment?

We're considering publishing such a newsletter. Stansberry Focus, we might call it. But we wonder... would a total recommended list of only 8-10 stocks and perhaps only two new recommendations each year be enough information for you?

A 40% gain in a CD? This shouldn't be possible... Years ago, our friend Chris Weber developed a brilliant form of income investing, the "Max Yield" strategy. It first appeared in Weber's book, Getting Rich Outside the Dollar.

The strategy begins with Chris' fictional character, "Max Yield." At the beginning of each calendar year, Max buys a one-year Treasury note in the world's highest-yielding safe currency. Past currencies include the Icelandic krona, the New Zealand dollar, and the British pound. The interest payments in these notes are usually more than 10%. If the highest-yielding safe currency remains the same on January 1 of the next year, Max simply rolls the proceeds over into a new note. In the past 30 years, Max has made gains as high as 26% through currency gains and interest. Since 1975, Max has turned each $20,000 invested into $425,000, a far better return than stocks. Max's gain this year? 40% – in a CD. Chris' subscribers can read the report, The "Max Yield" Strategy: How to Make a $425,000 Profit on the Decline of the U.S. Dollar, on his website. Even if you don't invest a dime in Max Yield, you'll know much more about how currencies work after reading the report. You can learn more about Chris's letter here.

China stocks fell 3.5%, the most in five weeks, on speculation that Shanghai "A" shares will correct after the government allows arbitrage trading between Hong Kong and the inflated mainland China shares. Steve explains the arbitrage opportunity in DailyWealth.

More earnings...

Medical Investor pick Novartis (NVS) tripled its earnings through the sale of Gerber and its Medical Nutrition unit, but poor drug sales mean it will cut 1,260 U.S. jobs. The company earned $6.87 billion for the quarter. Shares gained close to 1% in morning trading.

PSIA pick eBay (EBAY) took a $935.6 million hit this quarter after writing off losses for its Skype division. Without the Skype charges, earnings would have been $564 million, 24% above analyst estimates. The company grew revenues 30% to $1.89 billion. Shares dropped nearly 6% this morning. Investors appear spooked by eBay's decision to discount its listing fees during the critical Christmas season. Our view? eBay is probably making a mistake, but the market is overreacting. And... hopefully... management's constant bungling will soon result in a major management overhaul. Someone call Icahn. Tell him there's this thing called eBay...

New highs: Coca-Cola (KO), Pogo Producing (PPP), PetroChina (PTR), Provident Energy Trust (PVX), Sangamo (SGMO), ExxonMobil (XOM).

In the mailbag... what's an SIV and where to get Harry Browne's book for cheap. Plus, did Sjug break his own rules? Send us your best: feedback@stansberryresearch.com.

"Could you provide an explanation of what these Structured Investment Vehicles (SIV) are? I am particularly interested in why many are 'off balance sheet' entities. Also, it seems to me this consortium of banks establishing a fund to buy $75 billion-$100 billion (I keep reading different numbers) of instruments to avoid 'distressed sale prices' is an attempt to risk capital buying securities at above current market prices with the hope the market will change in the future. With mortgage delinquencies expected to grow, not shrink, it seems like a poor use of capital reminiscent of 'throwing good money after bad' based on a 'greater fool' theory of pricing, to use several cliches at once. Could you comment on this seemingly strange event? What am I missing?"

– Paid-up subscriber Allen Jones

Porter comment: Structured investment vehicles (SIVs) are a kind of "virtual bank." Almost exclusively located in the Mayfair district of London, these asset managers issue short-term commercial paper and medium-term notes to investors, then use the money to buy higher-yielding, often longer-term, investments – subprime CDOs, for example. Because the assets in the SIV belong to investors, banks don't have to track them on their balance sheets. A few dozen SIVs exist, and investment banks own many of those.

Thanks to their deep-pocketed backers, their fancy Savile Row suits, and their supposed expertise in this market, SIVs were able to tap the short-term commercial lending market. In short, these funds raised a sliver of equity, borrowed cheaply in the commercial paper market, and then bought a huge amount of high-yielding mortgage bonds. Now, they're in trouble because the commercial paper market doesn't trust them anymore and won't allow them to roll over about $350 billion in obligations. Especially at risk is Citigroup, which owns large stakes in several SIVs and holds lots of troubled mortgages. If these SIVs can't get financing, they might have to "dump" all of their mortgage assets on the market.

We saw the same thing happen in August to many publicly traded mortgage finance companies, such as Countrywide and Thornburg. Those companies were forced to take huge losses as they sold mortgages. However, the big boys would very much like to avoid this unpleasantness by organizing a bailout. Let's hope the U.S. Treasury doesn't get involved. I'd love the opportunity to buy Citigroup at less than $10 per share...

"About 15 years ago, I ran across Harry Browne's How I Found Freedom in an Unfree World. It was in a box full of old family books. My father must have bought Harry's book when it was published in the '70s. I have to agree with Doug Casey's recommendation – my only regret is that I didn't read it sooner. It is out of print – but apparently the message regarding freedom from oppressive entities is a hot topic these days – the cheapest used paperback edition goes for $35 on Amazon." – Paid-up subscriber Ed

"I have mixed feelings about the theses in Harry Browne's book, but it is certainly thought provoking. Your readers may want to know that it is available for download from the author's web site for about $10. He also has an investment book there which offers a lot of common sense about a balanced safe investment portfolio, also with some debatable points." – Paid-up subscriber "Thomas"

"I have been troubled by your recent recommendation to buy the homebuilders. It's not the recommendation itself, though I did not opt to follow it, but rather the fact that it is a blatant violation of trading rules you claim to impose upon yourselves. Specifically, I refer to your April 2007 issue of True Wealth in which you wrote:

"'...the big sector bet we put on... appears to be wrong... So when could we re-enter the trade if we wanted to?... First, there's "the six-month cooling off period" rule: We have to wait six months before we're allowed to consider re-entering a trade that went against us. And second, there's the "new highs" rule: If the stock hits a new high, its recent problems are now water under the bridge, and you can consider re-entering the trade.'

"While you did meet the 'six-months rule,' albeit barely, homebuilders are certainly nowhere near a 'new high.' Granted, your previous pick was a specific play on DR Horton, while your current recommendation is [a homebuilder ETF]. However, it is clear from your writing that the play on DR Horton was a sector bet. So while swapping DHI for [the ETF] may pass the wash sale rules, I do not believe it justifies violation of a self-imposed trading rule, at least not without some type of public explanation to your subscribers. Don't get me wrong here. I do not have a problem with you taking another stab at the sector. You made a good call to sell DHI, protected precious capital, and now believe it may be time to re-enter. That's all fine and good. If my memory serves me correctly, George Soros lost money on his big currency bet of the '80s four times before it finally worked. When it did work, it made him a fortune. My problem, rather, is twofold. First, your stated purpose of the self-imposed rules is 'to keep your egos and emotions in check.' What does it say about your ability to keep your egos and emotions in check when you are clearly willing to violate rules put in place to do just that? And second, and probably more troubling, is that you didn't bother to explain why you were violating this rule when you made the second recommendation in October. I consider this an insult to your readers. It was as if you expected us not to remember what you wrote in April and not to question this recommendation. I love the ideas I get from True Wealth, but I could not let this pass without comment. I was, really, quite upset when I read the October issue and saw no reference to these rules that were laid out in April." – Paid-up subscriber Timothy J. Edwards, CFA, CPA

Sjuggerud comment: We followed our rules... Either 1) a new high, or if that doesn't happen, 2) wait six months. Doesn't have to be both. We've used these rules for 11 years. We waited six months. I debated about mentioning it in the issue for the reasons Tim brought up. But I decided against it, as we followed our rules.

Regards,

Porter Stansberry

Baltimore, Maryland

October 18, 2007

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