The S&A Digest: Porter's Rules for Investing

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

As of 07/01/2013

Porter's investing rules... Who does financial aid really benefit?... No YouTube in Thailand... Well, Baltimore's the best at something... More dividend-grabbing questions...

Inside Strategist pick WCI Communities (WCI) should decide today whether it will accept Carl Icahn's $22-a-share tender offer for the company. The offer is slightly higher than yesterday's closing of $21.45. If the company accepts Icahn's current offer, readers will break even on the recommendation.

Our friend Dan Ferris sends this note about a high-yielding mortgage REIT: "American Home Mortgage (AHM) is yielding 17%, and it's hardly got any subprime. People are swallowing the credit contagion theory whole. This is classic investor-herd behavior, and therefore a classic opportunity-creating event. The CEO, founder, and chairman of AHM bought about $8 million worth of stock in 2005 at $27... and it's $25 today. I bet you he buys more soon."

How much time do you spend thinking about whether the stock market as a whole will rise or fall? Warren Buffett never considers the market. He recently told CNBC: "I have no idea what the market will do next week, next year, zero. I don't think about it. If I thought about it, it wouldn't do any good. The main thing an investor needs is the proper temperament. He doesn't have to have 150 IQ, he doesn't have to be an expert on accounting, but he does have to keep his balance when untoward things happen in the market. The reason investors do poorly is they beat themselves... The people who didn't do well are the people who panicked at the wrong time, came in because stocks were popular, and left when they were unpopular. So you have to have an emotional stability. If you have an emotional stability and you stick with American businesses, you're going to do fine."

CIT group, the country's largest nonbank commercial lender, is investigating allegations that school officials were invested in a loan company recommended to students. Financial aid directors at Columbia University, University of Texas, and University of Southern California all owned and sold shares of Student Loan Xpress, a CIT subsidiary. The New York Times reported that these universities recommended the company to students as a "preferred lender."

New York State Attorney General Andrew Cuomo sent letters to 400 colleges and universities on March 15 urging them to divulge any potential conflicts of interests between them and lenders. Cuomo alleges that the $85 billion per-year student loan business is rife with corruption and gives kickbacks to colleges that recommend it.

A problem we'd all like to have... China ordered banks to put more money aside as reserves for the sixth time in less than a year. The People's Bank of China raised the reserve rate 0.5% to 10.5%. China worries that all of the excess cash in the country may lead to an asset bubble.

"Baltimore is the heroin capital of America, ain't no more dope sold nowhere than right there on Pennsylvania Avenue. It's the largest open-air drug market in the world for heroin," says Shaidon Emanuel Blake, a man on trial for drug-related murders. In a Baltimore Sun interview, Blake claims to have made $180,000 in one night selling heroin on Pennsylvania Avenue. We're all in the wrong business...

After a decade of living in Baltimore, we don't doubt Blake's figures. Last night, as we walked through downtown, we saw two kids operating a five-foot-tall tank of nitrous oxide – laughing gas. They were selling balloons full of the drug to white hippy kids on their way to the Widespread Panic concert. The police blithely ignored them.

Thailand has blocked access to the website YouTube after the site's owner, Google, refused to remove a video mocking King Bhumibol Adulyadej. I have been doing research on some Thai stocks and have found what seem to be incredibly cheap and well-run companies. Right now, Thailand is the second-cheapest market in the world. I know we’ve said it before, but we will be taking a trip to find some great investments for you.

We have received several questions about what to do if you already owned a dividend-grab stock before it announced the special dividend. The answer varies from dividend to dividend and depends on your personal situation. If you own a company before a special dividend is announced, you must decide whether to accept the cash (which may trigger taxes), or sell the stock (which may also trigger taxes) and repurchase it on the ex-dividend date. We recommend you consult with your tax advisors and your broker to figure out what makes sense for your particular circumstances.

We offer only two general bits of advice for this situation.

First, the stock price will probably rally as soon as the dividend is announced – so you've got the kind of problem investors love to have. If you decide to sell your shares to avoid receiving the cash dividend, we'd wait to do so until after the news of the special dividend has been widely reported.

Second, our general preference is to keep things simple. Unless your calculations show a substantial increase in return by trading around the ex-dividend date, it seems simpler to hold, receive the cash, and then re-invest.

On to the mailbag... the never-ending font of venom and ire. Add yours at: feedback@stansberryresearch.com.

"If the record date is before the ex-dividend date, does one have to buy the stock before the record date in order to 'grab' the dividend or is it OK to buy any time before the ex-dividend date?" – Paid-up subscriber Benito Diaz

Goldsmith comment: The record date is before the ex-dividend date when a company pays out a dividend that is more than 25% of its market cap. In this case, the ex-date is set one day after the pay date. Again, the ex-dividend date is the only date that matters when grabbing dividends. If you want the dividend, buy before the ex-date. If you don't, buy on or after the ex-date.

"I played this dividend grab by buying the [January 2009 $30 calls] instead of buying the underlying stock. I paid $6.70 per share for 30 contracts (ie: 3,000 shares). My investment parameter was $20,000. I could have purchased 600 shares at the ex-div price on April 3 for about $33 per share. I now have 3,000 shares 'working for me' vs. 600 by purchasing. Please advise on this strategy. Did I go too far out to the Jan2009s or should I have purchased calls "closer in" (March or April 2008)? What are my upsides and downfalls of using the leap options (or any calls) instead of buying the underlying stocks on these 'grabs?'" – Paid-up subscriber "RRH"

Porter comment: Beats me. We don't recommend or follow options in these situations.

"Tried to purchase DF at 4/2 Marker at 47.33 less 15.00 or 32.33 on 4/3/07 as instructed. Price never dropped by $15 as mentioned my order at 32.33 is outstanding." – Paid-up subscriber Bill

Goldsmith comment: There is no guarantee that the stock will drop by the exact amount of the dividend. It falls around the amount of the dividend on the ex-dividend date. There is no way to know what the stock will open at on the ex-date.

"I am a member of the Extreme Value letter. In the December 2005 report World's Greatest Hedge Fund, Dan Ferris mentions that Mohnish Pabrai has made 31.9% since 1999 for his clients. What is the ticker symbol for his fund?" – Paid-up subscriber B. Berbotto

Goldsmith comment: Mohnish runs a private fund. To contact his fund,

click here.

"In my ignorance, I assumed a stop is a stop. What is the difference between stop losses and trailing stops?" – Paid-up subscriber Richard S. Shaw

Goldsmith comment: Let's say you have a $10 stock. You decide to set a 25% stop loss. That means, if that stock drops below $7.50, you sell. On the other hand, with a trailing stop, you adjust the stop as the price goes up. So, if your $10 stock rose to $12, your trailing stop would rise to $9 ($12 x .75). Trailing stops lock in profits for you.

"In one of your articles, or one of your associate's articles, I don't remember which one, it mentioned that a person should never put a trailing stop with the broker, but keep track and do it yourself. I am not a trader as such, and I don't always check my positions on a daily basis. What is the problem with leaving a trailing stop with the broker?" – Paid-up subscriber DM

Goldsmith comment: Just like in a game of poker, you don't want to show your hand. Market makers aren't your friends. They will gladly lower the price of a stock to pick off your shares and make a few dollars off of your loss.

"Is any of your analysts' research sold/given/rented/traded to institutional traders prior to being offered for sale to your customers? Also, do you share data that you are working on with other divisions of Agora Publishing?"

– Paid-up subscriber Duncan DeBond

Porter Comment: No... absolutely not. And no... absolutely not.

"It was bad enough when Circuit City fired the top 10% of their sales force either in 2005 or 2006, so they could replace them with less expensive salesmen. Somebody forgot to tell them about Prato's Law which says that 15% of any population causes 85% of the result. For example, the top 15% of the US population controls 85% of the wealth. It also says that the top 15% of your sales force produces 85% of your sales. Now they have gone even more crazy and fired the employees making the most money, so they could replace them with cheaper employees. Didn't anyone stop to think about why these employees were paid more then their contemporaries? To all you betting investors out there, I would think a January 2009 put on Circuit City would pay off very handsomely." – Paid-up subscriber Ted Bywater

Porter Comment: Exactly...

Porter's Rules for Investing

A few weeks ago, a good friend of mine asked me if I would be interested in making a relatively large private investment in a start-up business – in this case a high-end restaurant and wine bar. My friend knew about my passion for wine, and he knew this business was likely to succeed (unlike most restaurants) because of the proprietor and the location.

I receive similar offers regularly. And I turn them all down.

Why?

I've developed a set of rules for investing that works for me. Most of my rules aren't strictly logical. But they are based on my actual experiences and the experiences of my partners. (Whenever possible, I try to learn at someone else's expense.)

I wouldn't necessarily recommend adopting my rules wholesale. However, there might be an idea or two worth considering the next time you get a call from a good friend with a great idea.

One more thing... I don't always follow my own rules. But every time I break them, it costs me.

1. Investments must be totally passive. If I have to be hands-on with my investments, then I didn't leverage my ability to research stocks the way I should. Also, time spent on investments takes away from running my own business, which represents a much greater share of my personal interests. That's one reason why I decided not to be a landlord.

2. Investments should be fairly liquid and/or marginable. From time to time, I have large capital demands, mostly relating to my real estate portfolio. So I need to be able to borrow against my equity holdings easily, cheaply, and quickly for short periods. Additionally, holding liquid investments is comfortable for me, since I believe in cutting losses quickly.

3. Never buy what I don't thoroughly understand. This means I should be able to easily explain everything I own or am about to buy without notes. This also prevents me from diversifying beyond what I can personally research and track. (This is probably my most important single rule... the rule that's most applicable to any investor.)

4. Never buy stock without a substantial margin of safety, which I define as a company's ability to buy back all of its own shares.

5. Never buy anything that shouldn't produce at least a 50% annualized return over the life of the investment. (This greatly reduces the number of investments I can chose from... and makes it easier for me to follow Rule 3.)

6. Never invest in debt directly. I'm not set up to foreclose and liquidate (see Rule 1), so when a friend asks me for a loan, I say "no."

7. Never invest with family. (See Rule 6.)

8. Avoid management fees completely. Avoid taxes for as long as possible.

9. Maintain a horde of gold, silver, and cash equal to roughly 10% of net worth – for emergencies. Don't tell anyone where it is.

10. Never buy any equity that doesn't return capital to shareholders – either through buybacks or cash dividends.

Regards,

Porter Stansberry

Baltimore, Maryland

April 5, 2007

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