The S&A Digest: Penny Stocks You Should Buy

A dirty secret of our business... Penny stocks you should buy... An $11 dividend... No global warming at opening day... More silver at Durango... Icahn buys more Motorola... Buffett buys Burlington... What does 'buy below' mean?

We went to opening day yesterday at Camden Yards. With a high of 47 degrees and seats in the shade, we wondered: Where's global warming when you need it?

To grab or not to grab... that is the question: iPCS (IPCS), a Sprint Nextel subsidiary, announced its intention to pay an $11 dividend. The company will borrow $475 million to pay off old debt and use the remainder – in addition to existing cash – to pay the dividend. The debt and dividend payment are still subject to board approval. Goldsmith and I will, of course, cover the situation fully in our new publication, The S&A Dividend Grabber.

Carl Icahn raised his stake in Extreme Value pick Motorola (MOT) to 2.9% from 2.7%. The activist is seeking a seat on the No. 2 phone producer's board. Icahn is pushing for the company to use its $11.3 billion to buy back shares. Assuming an $11.3 billion buyback, the company would be paying a synthetic 25% dividend to shareholders.

Silver Standard Resources (SSRI) announced today that its wholly owned Pitarrilla silver project in Durango, Mexico, has 350.4 million measured and indicated ounces of silver, 50% more than it previously believed. Readers have made 100% since S&A Gold Report editor Matt Badiali recommended the company in June. Sources close to the company and familiar with this project tell us it will be the richest silver mine ever developed.

British Bank HSBC's annual report is so big this year Royal Mail, the UK postal service, promulgated a new rule limiting the number of copies their postmen may carry – to prevent back injuries. The 454-page, 4.76-pound report covers the details of the company's $11 billion in subprime write-offs. (I dare any subscriber to read the whole thing.) All you really need to know is that HSBC paid $14 billion to buy Household International... and then lost $11 billion. Whoops. There goes about one whole year's worth of profits.

Some folks like reading Warren Buffett's annual letter for his folksy humor and business sense... but most folks read it to see what the world's greatest living investor is buying. This year was a disappointment: He wouldn't say. He listed all his company's investments, save two... "because we continue to buy them. I could, of course, tell you their names. But then I would have to kill you."

The veil was lifted on April 6. Berkshire Hathaway announced it bought 39,027,430 shares of railroad operator Burlington Northern Santa Fe (NYSE: BNI), more than a 10% stake. Berkshire's position has a market value of close to $3.2 billion. Shares of Burlington gained 6.5% on the news. According to CNBC, the other undisclosed investment is also a railroad company.

New highs: Alexander & Baldwin (ALEX), Allegheny Technologies (ATI), Banco Latinoamericano de Exportaciones (BLX), Gabelli Dividend & Income Trust (GDV), Coca-Cola (KO), McDonald's (MCD), Nokia (NOK), OMI Corp (OMM), Silver Standard Resources (SSRI).

We're back from our one-day hiatus. I hope you didn't miss us too much. As always, send your comments to feedback@stansberryresearch.com.

"I recently purchased Dividend Grabber and think it is a very easy procedure to use. Just buy the stock on the ex-date and hold for a few months. I just saw that you had a sale on a more complicated option-trading newsletter and I am not sure that if I subscribed to it whether I can execute trades like that. I just don't know about options and if there are differences between brokerages that do options trading. I just want to know with my lack of knowledge that I can get up to speed and make money quickly – and will you help me get to that point?" – Paid-up subscriber Ben Nesbitt

Porter comment: Yes. Jeff Clark wrote a primer for his subscribers explaining the terminology and his strategies. Because we offer a money-back guarantee on all of our products, you can sign up, read the primer, take a few trades, and see if our S&A Short Report is something that works for you.

"You say that you personally cannot buy the stocks that you recommend in your letters. Not even your retirement trust funds? Is that a universal rule, or the law, or just an ethical choice? The cynic in me has always thought you guys bought first and recommended next." – Paid-up subscriber R. Rush

Porter comment: It's an ethical decision and a business-management decision. First, let me make this point: We've got skin in the game. Every time we blow a recommendation, we get demands for refunds. And the only way to keep readers (and stay in business) is by making the right call far more often than not. Some subscribers have asked, "If you don't buy your own picks, how do I know you care about your work?" We've got something much more valuable on the line than just a few thousand dollars. If we're wrong, we'll lose our jobs. Folks won't continue to pay for our stock research if our track record isn't great.

We don't allow our editors to buy the stocks they write about (me included) because we want our analysts to have only one customer – you. Imagine, for example, that one of our writers is extremely bullish about a stock. If he owns the shares, maybe he's "talking his book," or exaggerating the potential simply in an effort to move the shares higher. Or, imagine the opposite. Let's say Sjuggerud learns something really important about a stock's upcoming quarterly report. If he's personally invested, he could be subject to insider trading rules if he says anything about it. I want my writers to say exactly what they think about the stocks they cover. And I don't want my readers to have any reason to doubt their sincerity.

We do allow our employees to buy stocks recommended in our publications – as long as they didn't do the writing. I buy Steve Sjuggerud's recommendations from time to time, for example. And Jeff Clark's. And Dan Ferris'. The rule on these purchases is simple: Always allow our subscribers the opportunity to buy on the recommendation first. So we must wait 24 hours or 72 hours to buy, depending on whether it was an e-mail recommendation or a print recommendation. In fact, though, I almost always wait several weeks or months to buy in order to avoid any appearance of wrongdoing.

"In your April 5 Digest you had a small paragraph about AHM [American Home Mortgage] from Dan Ferris. Anything else you'd like to add after what's happened so far? Do you think it's still worthy of consideration as an investment?" – Anonymous

Porter comment: I've got two things to say. First, Dan's timing was pretty lousy. I'm glad that wasn't in his newsletter. And, second, Dan's not wrong very often. I wonder if, in the long term, he'll be right here too.

"I am in the first few months of my Alliance membership, and I'm still a little confused by the S&A 16 that you publish every quarter. I had expected that the latest one, last week, would be an update of the one from January including, basically, which of the 16 to continue holding and which to replace, and with what... Instead, I see an entirely new set of 16 holdings. If, indeed, there are 16 different recommendations each quarter, then we are looking at 64 recommendations per year, which is not much simpler to follow than the total universe of recommendations in the Alliance suite." – Paid-up subscriber Jarl McDonald

Porter comment: We think it's very valuable to know, at the start of each quarter, exactly which stocks (in each major investment category) we think are most attractive. This should enable you to "fine tune" your own portfolio each quarter. If we simply kept one, semi-static list, you'd have to wait 12 months to learn what we think is best. Let me repeat what I told all of the Alliance members about the S&A 16 this January...

The S&A 16 is a diversified portfolio of stocks (16 in all), chosen from among our coverage universe, which we believe will provide you with a market-beating rate of return over the next 12 months. These stocks have been selected by Porter Stansberry and managing editor Brian Hunt, using a variety of criteria. In short, we're looking for the safest stocks that offer you the best chance of doing well in the short term (one year). Additionally, this portfolio is how we would put the information you've paid for to work for ourselves, if our roles were reversed...

There's one more thing you should understand: Each S&A 16 should be viewed as a separate and distinct portfolio... Although there is typically a substantial amount of overlap from quarter to quarter, we don't consider ourselves to be active portfolio managers. We start from scratch each quarter and build a new list.

Why? Because we're demonstrating the value of our research with a real, diversified portfolio. Building a new portfolio each quarter allows us to have a diversified benchmark to measure against the world's investment managers and index funds...

We hope you'll compare your own portfolio to ours and make any adjustments you and your advisors deem appropriate for your risk tolerance and your goals.

"I am a new subscriber to your S&A Dividend Grabber service. Your concept is very interesting and, based on your recent recommendations, appears to be financially rewarding. However, I do not quite agree with your recommended procedure regarding when to buy these stocks, which is on the ex-dividend date. My tentative conclusion from this is that it is better to purchase a 'dividend grabber' stock at the end of the day prior to the ex-dividend day and then to collect the dividend. Am I missing something?" – Paid-up subscriber John Weil

Porter comment: Yes. We've run all the numbers... and buying for the capital gain instead of the dividend payment seems to create a significantly larger total return. We were surprised to discover this ourselves... Log onto the S&A Dividend Grabber website and read How to Grab a Dividend for a detailed analysis.

"What do you mean when you say, 'Do not enter your stops into the market'? How do you keep that private? I do all my trades online myself."

– Paid-up subscriber D. Parker

Porter comment: Decide what your trailing stops are by following your portfolio or by using something like www.tradestops.com. Don't tell your broker when you plan to sell, just keep a "mental stop" in your head.

"As a new subscriber, looking at the Extreme Value portfolio, most of the picks are a few months or years old and the 'buy up to' prices are dated from when they were originally recommended. Only about less than 10% of the picks can be purchased today for under the recommended price. Does it mean that the majority of this portfolio is not recommended for new subscribers today?" – Paid-up subscriber Rafal

Porter comment: Yes... that's right. And it's a wonderful problem to have, to follow a stock picker whose results are so good that you've got to wait for new recommendations to be made.

Penny Stocks You Should Buy

Before you commit to reading these thoughts, it's only fair to give you a warning.

What lies below – if you believe it – will probably disappoint you and may even insult you. On the other hand... it might also make you rich. You see, I plan on discussing a dirty secret of our business, the financial publishing business.

We know a lot about our audience – you. We know what kind of marketing works. We know what kind of products will sell. We know from years and years of testing and rigorous statistical analysis of the results. (If we didn't know these things, we'd quickly go out of business.)

After 11 years in the business (eight of them as a publisher), the one thing I know for certain is that more people want to buy information and advice that's bad for them than want to buy information that will actually help them make money.

While this may not be true of you personally, I know with 100% deadeye certainty it is true of the newsletter-buying community. The emotions that lead you to be interested in newsletters (fear and greed) are the same emotions that will destroy your chances to succeed as an investor.

Case in point: Last year, at an expensive investment conference with thousands of attendees, we gave a presentation about our Extreme Value newsletter and its amazing track record. (Roughly 26% annualized gains, less than five total losing positions over five years.) We explained our methodology. We showed why what we do in Extreme Value is inherently safe and profitable. Then we offered to sell the letter at half price. (Note: We extended the same offer to all of our subscribers at the same time). Less than 5% of the attendees took us up on our offer. (Less than 1% of our subscribers took us up on the offer.) Instead, the conference attendees were drawn like flies to the penny-stock mining companies when, at just $2 per share, they're almost guaranteed to lose all of their money.

From these and hundreds of other marketing experiments, we know newsletters that promise information about super-risky options trading, or super-risky penny stocks, or fly-by-night gold mines in Africa will sell far better than something like True Wealth – where Steve Sjuggerud delivers big gains without taking on hardly any risk. And we know that something like Red Hot Penny Shares (yes, that's a real title, but not one of ours) will sell far better than The 12% Letter. (What could be more boring than earning 12% a year, mostly from dividends?)

And yet, on the other hand, we know for certain, that investors who follow True Wealth, Extreme Value, The 12% Letter, etc. will prosper, while folks who salivate for Penny Tout (another outside service) will most likely come to ruin.

Given these facts, some savvy publishers have simply abandoned any responsibility for the quality of the advice they publish. I've spoken to these very smart and sincere people personally about the poor quality of their products. They say: "We can't know, in advance, whether or not any investment advice will work. And we don't warrant results. We let the readers tell us what kind of publications are 'good' and what kind of publications are 'bad.'"

Such moral theories lead to products like a certain options newsletter that recommends buying naked put and call options but offers no advice whatsoever on when to sell them. The track record that's marketed to potential new subscribers shows what could be made, hypothetically, if you sold each recommendation at the very highest possible price. No one, of course, could actually do this. However, based on the product's sales (it is one of the very best-selling letters in our whole industry) and the relatively low demand for refunds, its publisher can rightly make an argument that it is a "good" product.

I haven't yet reached the point where I'm willing to publish letters that I believe are bad for people even though they might sell well. (Given the overhead we've been adding recently, I might get there soon.) What then, you should ask, are you doing publishing a penny-stock service, The S&A Penny Letter?

A good and fair question.

We know a few things about investing in stocks with a low price. For example, we know that stocks that have suffered a five-year period of underperformance relative to the market can be excellent investments. These stocks, almost by definition, have a low nominal price – typically less than $10 per share.

The seminal study on this fact is the DeBondt and Thaler article, "Does the Stock Market Overreact?" It was published in the July 1985 Journal of Finance. Famous value-investing firm Tweedy Browne has summarized the article on its website: "DeBondt and Thaler selected on December 31, 1932, and on each December 31 thereafter through 1977... the 35 worst performing and 35 best performing stocks over the preceding five years [on the New York Stock Exchange]. For the worst performing stocks the average price decline was 45%. The investment results of the worst performing and best performing stocks were compared to a market index, the equal weighted investment results of all stocks listed on the New York Stock Exchange. The worst performing stocks over the preceding five-year period produced average cumulative returns of 18% in excess of the market index 17 months after portfolio formation, a compound annual return in excess of the market index of 12.2%. The best performing stocks over the preceding five years produced average cumulative returns of about 6% less than the market index after 17 months, a compounded annual negative return of 4.3% versus the market index."

Thus, we know that among well-financed companies whose shares have badly lagged the market for a long time there are very likely great investments.

We also know stocks with a low nominal share price (under $10) also typically have a very small total market capitalization. These stocks, too, have been proven to frequently outperform the market. Different studies show varying amounts of outperformance, but the amounts are often substantial. One of the most rigorous studies, by Marc Reinganum, showed small-cap stocks have average compound gains of 12.1% per year versus less than 9% per year for the largest-cap stocks.

With our S&A Penny Letter, we have our best single stock analyst (Dan Ferris) working within a very sound intellectual framework to produce a newsletter that's both exciting to read (hey, it's about penny stocks!) and very profitable to follow. Our Penny Letter won't be like any you've ever read before. Its pages won't read like a gambler's guide to the ponies, but like a primer on how to be a safe and successful investor.

This approach serves both our marketing and our moral needs. We hope you like it. But judging from the early feedback we've been getting, we fear that we haven't gone far enough to assuage our readers' greediest desires. Many of you, we fear, are looking for ponies instead of stocks. To wit:

"I purchased the Penny Letter because a penny stock is the only place I have made any real money. I made $30,000 in less than a week. So with Dan's help I hope to do it again... In my opinion the first three stocks I purchased were not true penny stocks, but the best underrated stocks I would not have been able to find BY MYSELF." – Paid-up subscriber John Bull

Best,

Porter Stansberry

April 10, 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 07/01/2013