Wed, Apr 29, 2015|Sean Goldsmith

What the market missed about Microsoft...

What the market missed about Microsoft... And why Dan Ferris still sold it... Where Dan sees values today... One of our favorite events of the year...

"The Death of the PC"...

That's the first reason most people will give for avoiding shares of software giant Microsoft.

Yes, Microsoft makes software for PCs. And yes, PC sales are declining as more people adapt to mobile platforms.

But what these naysayers don't realize is that Microsoft is so much more than the company that sells Windows software for home computers. As Dan Ferris wrote in the August 2013 issue of Extreme Value...

The Wall Street Journal and investment bank Goldman Sachs seem to think PC users – individuals and small businesses – are Microsoft's primary customers. And they're betting Microsoft will fail because of the growing popularity of mobile-computing devices among individual consumers. That's not true. Microsoft makes more money selling to big businesses than to all other customer types combined.

In July 2013, shares of Microsoft fell 11% in one trading day following a disappointing earnings announcement. The company missed expectations on earnings and revenue and took a $900 million charge related to its Surface tablet.

But Dan wasn't worried. In the July 22, 2013 Digest, he wrote...

People think Microsoft is about consumer products. That's wrong. It's about selling software to businesses. Microsoft's Server & Tools division – which caters to businesses, not individuals – contains at least five businesses with more than $1 billion in sales. At least two are growing at double-digit rates. Microsoft is using subscription-based business models to make Office and other products "stickier." Microsoft Office consumer sales fell 27% last quarter... and the division sales still rose 7%.

I've seen the stock market make a lot of mistakes, but pushing Microsoft down 11% on Friday based on last week's report is one of the worst.

Microsoft fell from a dividend-adjusted $33.76 per share on July 18 to $29.91 on July 19. And Dan urged his subscribers to take advantage of the market's mistake.

Last month, Dan closed his Microsoft position. Extreme Value subscribers had successfully compounded their wealth by 7.5% a year since 2006, but Dan doesn't expect the large annual returns to continue. Subscribers cashed out for an 87% gain.

One reason Dan sold Microsoft was due to the company's management decisions...

Dan has publicly criticized Microsoft's management for parking billions of cash offshore (a popular move with corporations to avoid U.S. taxes) and making bad acquisitions – like Skype and aQuantive.

He has similar complaints with consumer-products icon Apple, which has most of its nearly $200 billion in cash parked offshore.

Dan sent us the following about Microsoft and rewarding shareholders...

In the March 24 Extreme Value weekly update, I said Microsoft would be closer to $70 a share instead of the current $48ish if it had simply brought all its foreign-earned cash to the U.S., paid all its U.S. corporate taxes, and used the remaining cash to buy back its perennially cheap shares... not wasted $22 billion on bad acquisitions.

I've said more than once that tax efficiency is a giant red herring, which actually destroys shareholder value. The world doesn't seem to care when I say it, but maybe people will listen to billionaire activist investor Nelson Peltz...

Peltz said the following in a proxy presentation his firm filed on DuPont: "Focus on Returns to Shareholders: Grow dividend at 10% compounded annual growth rate (CAGR); assuming all excess free cash flow returned to shareholders. Tax Rate: 33% tax rate (higher than the 22% expected by the Company in 2015) across the business to provide flexibility with free cash flow."

That's similar to what Dan has been saying about Microsoft since November 2012 and about Apple since November 2013...

Investors like Peltz who can do basic math know that DuPont is undervalued. Peltz expects his suggestions to be much better for shareholders than what DuPont is doing right now... And still, Peltz's model of DuPont contains a higher tax rate. Clearly, Peltz doesn't see anything destructive about paying higher taxes.

But sooner or later, people will realize that tax efficiency is often an excuse for cash hoarding, resulting in the erosion of value. These discussions get muddled at times like these, when everybody is buying back shares at cyclical peak valuations.

Last week, we quoted billionaire hedge-fund manager David Einhorn, who noted in his recent letter to investors...

The opportunity set on the long side is quite constrained... Most of the investment theses we have reviewed over the past several months can at best be described as late-cycle opportunities, with valuations that often ignore historical economic sensitivity. The operating (and in some cases activist) execution needed to achieve target results has to be rated at Triple Lindy difficulty level.

Dan has issued similar warnings to his subscribers.

In every Extreme Value weekly update since March 3, Dan and his research analyst Mike Barrett have reminded readers of the following: "In mature bull markets... stocks will become expensive, and we'll have fewer current recommendations."

In the current issue of Extreme Value, Dan wrote...

There's just nothing cheap out there these days... Like many of the world's best investors right now, we aren't finding many new, value-priced ideas that aren't directly exposed to commodity price movements.

But we aren't sitting idly by, twiddling our thumbs. We are conducting deep, thorough analysis on companies that are excellent businesses we'll want to own as soon as they're cheap enough.

He also noted that when the market falls apart, most people will worry... But Dan won't...

We'll be jumping for joy as our favorite stocks come into buying range. Most newsletter readers make the fatal mistake of trying to stay active and milk the market for profits whether it has just fallen 58% (like in early 2009) or risen 200% (like today). Besides keeping a constant eye out for current buys, they should also learn about great businesses and get a good idea of the conditions under which those businesses would make great investments.

That said, there are still a handful of opportunities in the Extreme Value portfolio trading under their maximum buy prices. For instance, Dan has found incredible values in the resource sector, which is approaching a cyclical bottom.

Dan has studied the cyclical pattern of "boom and bust" resource stocks going back 30 years. He thinks we're on the verge of a boom today.

And the companies Dan is recommending will profit from a rebound in all of the blown-out resource sectors, like gold, agriculture, uranium, silver, and energy...

His top investment opportunity today is a "dealmaker." Unlike Microsoft, this company is using its gushing cash flow to make smart acquisitions near the bottom of the resource market. It also just announced its first-ever dividend (which Dan predicted).

This company has access to the types of deals that resource investors dream of... deals you and I would never have access to as individual investors.

The management team is expertly deploying capital. Dan thinks shares could double or triple from today's prices. To get started on a risk-free trial subscription to Extreme Value, click here.

One of our favorite events of the year is coming up next month... and there's still time for you to join us...

Each spring, about 100 of us gather in New York City for a weekend. People come from all over the world – Japan, Panama, Hong Kong, Germany, and elsewhere.

But we're not meeting to discuss business. And this isn't an investment conference...

We join for The Atlas 400's annual meeting.

Regular Digest readers know that The Atlas 400 is made up of people from around the world who are united by their shared interests and passions. Our members want to experience all the best things life has to offer – travel, wine, knowledge, and friendship, to name a few.

The weekend of our annual meeting – our best-attended event – is the highlight of the year for many members... It's an opportunity to spend time with old friends and form new bonds with other members.

If you're familiar with The Atlas 400, you know that our members share some amazing experiences in some of the most exotic places around the world... like black-marlin fishing in Panama, trekking through South America's Patagonia region, and wine tastings at Bordeaux's most exclusive chateaux.

Despite these incredible adventures, our annual meeting is still our most popular...

We all stay at the St. Regis hotel. We share a few fantastic meals – like dinner at the famed 21 Club. And we enjoy the sights and sounds of springtime in the city.

Members of The Atlas 400 understand that "business first" is the wrong way to go about life. Focus on your relationships. Opportunities will inevitably spring from those relationships.

One of our board members discussed this camaraderie in the December 26 Digest...

Atlas members come from all walks of life and professions – surgeons, high technology executives, entrepreneurs, and industries like entertainment, publishing, agriculture, law, and finance.

Everyone brings something interesting to the group. Every conversation provides an opportunity to learn about something that you may not have had any exposure to.

The annual meeting is a chance for our members to mingle and discuss whatever is on their mind. We always invite outside speakers to share knowledge with our group, whether it's a hedge-fund manager discussing his favorite international investment opportunities, a renowned doctor discussing the latest in health care, or a representative from a top lifestyle brand sharing the finest wines or luxury goods.

But year after year, the primary takeaway is that we must make time for what is important.

We've discovered the value of slowing down every once in a while to enjoy time with our best friends and share amazing experiences in venues around the world.

For example, we're headed to British Columbia from August 27 to September 1.

We'll enjoy days filled with kayaking, trekking across glaciers, touring the wilderness, fly-fishing, and much more. Our home for the trip is one of British Columbia's best-kept secrets. It's a lodge located on a remote cove, just a few hundred yards from the Pacific Ocean. But what has us really excited is that the lodge comes with a fleet of helicopters. They'll take us to the best fishing locations... to the top of the most scenic ridgelines... and to the middle of massive glaciers. This trip is going to rival our adventure through Patagonia.

And there's something incredible in store for 2016.

We're still finalizing details and we don't want to give away the surprise. But I can tell you: This trip is going to be the farthest The Atlas 400 has ever traveled. We're headed to the last major landmass on Earth to be settled by humans.

We aren't even giving the secret location away to our members yet... but it promises to be an incredible adventure.

Understand that these trips are only a means to facilitate the true meaning of The Atlas 400: To get people out of their daily routines, out of their comfort zones... and place them in a faraway land with a group of like-minded people.

That's the way to build friendships... to make lasting relationships.

The Atlas 400 isn't for everyone. It's consistently one of the most controversial topics mentioned in the Digest.

Yes, there's a substantial initiation fee to join ($25,000), and our excursions aren't cheap. We know this club isn't for everyone. Most people will never have the opportunity to join The Atlas 400.

But if what I've just discussed resonates with you – and you're at a point in your life when meaning is paramount and you're in a position to enjoy the fruits of your labor – then I urge you to click here to learn more about the opportunity.

There are still a few spots available at our annual meeting. Hopefully, we'll see you there...

New 52-week highs (as of 4/28/15): Blackstone Mortgage Trust (BXMT), Global X China Financials Fund (CHIX), and Scorpio Tankers (STNG).

We received a huge amount of feedback in response to Porter's Friday Digest about the "magic portfolio." If you missed it the first time, be sure to go back and read it. And send your e-mails to feedback@stansberryresearch.com.

"I remember Warren Buffett talking about how he wants his wife set up, following his death. I think his strategy for her is to have a certain percentage in index funds and the remaining percentage in bonds (can't recall the ratio, but I believe it was something like 60% stocks, 40% bonds). He feels that over time, index funds produce acceptable results, and the bonds provide spending money during bear market times.

"I think it would be interesting to see just how much better the magic portfolio would outperform Buffett's 'after he dies' strategy for his wife. My thoughts on the subject are irrelevant, but it has been my personal experience that repositioning portfolios, resizing, etc. takes both skill and luck. The main limiting factor I have so far experienced is timing. It is very hard to consistently get the timing right, as Mr. Market is the best poker player I have ever played against.

"So, the more a person can limit timing mistakes, then the more successful the magic portfolio will be, IMHO. Each of us must be honest about ourselves and our abilities regarding the stock market. That should be the number one factor in deciding what type of portfolio is the ideal one to have." – William Durst

"Mr. Stansberry, your Magic Portfolio article sent to me April 24, 2015 makes good sense to me. It certainly simplifies investing for the long run of 10+ years. One thought that occurred to me was why you might not have developed a mutual fund or ETF based on the principles and stocks you specify. There are many considerations in pursuing such a venture:

"Have a subscription period to limit the amount to be invested? Limit or not limit subscriptions to your subscribers? Administrative costs expected (broker fees, re-investment of dividends, accounting and tax reports, etc.)? Set up like target date funds for new subscriptions every 5 years? Handling sales and fund distributions? Accounting for IRAs, 401ks, 403bs, regular investment accounts? Other administrative expenses, etc.? Such an investment opportunity would certainly be of interest to me." – Paid-up subscriber Roger Clavey

"This Friday's lesson is great. I am a successful investor, but I have not been paying enough attention to Beta values (I will after reading this). For the stocks I want to hold long term, I will look for low betas (as well as profit and dividends), but for the small amount of short term trading, looking for a high Beta might make sense if a person can catch it at a low point (might be considered gambling). I have held ExxonMobil for about thirty years and my net cost of the $87 shares is about $5 (not counting dividends.) Enjoy your newsletter and Doc's Retirement Millionaire newsletter." – Paid-up subscriber D.R.C.

Regards,

Sean Goldsmith

Baltimore, Maryland

April 29, 2015