Fri, Mar 30, 2012|Porter Stansberry

Why Wall Street lies...

Why Wall Street lies... The Superinvestors of Graham-and-Doddsville... The real goal of financial advertising... Speculations that pay... An update on my back...

It's not often that one of Wall Street's leaders speaks openly about the financial sector's biggest secret... In an interview with hedge-fund blog Market Folly, David Einhorn said: "We are looking for situations where we think something is mispriced… We want to find out what the misunderstanding is. Sometimes it's a conspiracy to misinform people. Wall Street has this agenda." (Emphasis is our own.)

Einhorn is the founder of Greenlight Capital, one of the most successful start-up hedge funds of the last generation. He launched Greenlight at about the same time I began Stansberry & Associates Investment Research, and our careers have crossed paths at several points. I know him to be smart and completely honest – a rare combination in the financial sector. I'm not surprised to see him saying things like this. He has always been his own man. But I hope you'll take a minute to consider what he means... and how important this idea should be to your investing.

Think for a minute about how you become aware of most of your investment ideas. Are they pitched to you by brokers? Did your financial advisor urge you to consider them? Did you read about them in a newspaper? Or did you see someone talking about them on CNBC?

I doubt most of our readers know that these channels are all bought and paid for by the folks who are offering the securities. For example, take a big brokerage firm like Merrill Lynch. Did you ever wonder why Bank of America, which underwrites securities, wanted to buy Merrill Lynch? Brokerages like Merrill Lynch are in the business of selling securities. Brokers are their salesmen. They are not there to help you. They are there to help the firm.

What about newspapers? Newspapers exist to sell advertising. Much of the content is planted in papers by public-relations firms. And their goal is to get you to buy stock. Likewise, most of the stuff you see in magazines about companies or executives was written by public-relations firms and placed there in exchange for large advertising purchases.

But what about TV? Surely most of the stuff you see on CNBC or Fox News is really "news" right? Nope. Almost none of it is real. You can buy a guest spot on Squawk Box for about $50,000 per show. Buying an appearance at any other time of the day on CNBC is much cheaper. You know how CNBC runs those terrible infomercials all weekend? Well, its weekday programming is really the same thing. It's just better-produced, and the folks doing the talking are smarter and better dressed. But it's the same business model.

Do this today... Look at where you keep your liquid assets – which banks, brokerage firms, mutual funds, etc. Ask yourself how much money these firms spend on advertising. Then, ask yourself why they spend so much. If they were really offering you something valuable at a fair price, would they have to work so hard to convince you that investing with them is a good idea?

(And before you write in about our "aggressive advertising"... There's no comparison between the billboards and space ads they buy and the kind of detailed marketing we do. For example, we put out our best ideas into our marketing efforts. You'd never see a Wall Street firm do that.)

Now... I don't like to point fingers at Wall Street or the major media companies and complain about the nonsense they endorse. I know it will sound like sour grapes. "Sure, Porter," you're probably thinking. "I guess if they offered you a top job at Goldman, you wouldn't take it... or the anchor chair on CNBC." Actually, I've turned down similar jobs repeatedly. But that's not the point...

Even if you respect my work and don't think I sound like a crazy conspiracy theorist… there's almost no way I can change your mind. The advertising is so powerful... the brands and ideas are so dominant, that when I start trying to teach you about why it's all wrong, I'm going to lose you. There's no way you're going to sell your mutual funds or dump your broker. It's all you know. Nevertheless... here I go again... tilting at windmills...

Virtually nothing you've been taught about investing in school and by your broker and his partners in the media makes any sense. The basis of the modern financial industry is the "capital asset pricing model" (CAPM). It was formulated in the 1950s and 1960s around the idea that risk can be quantified and represented mathematically by volatility.

It's all complete nonsense. But these ideas are the intellectual justification for the entire mutual-fund industry. These principles guide the retirement savings for more than 40% of Americans. What these ideas do is completely excuse the investment industry from doing any actual work. By simply "proving" that risk ALWAYS equals reward, these ideas essentially say there's no way to be a "good" investor, since higher returns will always entail greater risk.

Once you look past the fancy math, the whole thing is based on one simple idea: that risk can be quantified accurately and is equal to volatility (share price changes). Rarely has a bigger bunch of bull ever been published. That these ideas have become embraced as fact – even in our courts – is a testament to the awe-inspiring power of the media.

The guys who invented this nonsense – William Sharpe and Harry Markowitz – even won the Nobel Prize. Risk does not equal volatility. Rational equity investors define risk as permanent impairment of capital. And the risk of permanent impairment of capital is mostly predicated by the price paid to acquire the asset. Thus, the cheaper you're able to acquire a security, the less risk you take. Price volatility might help you get a low price, if you're smart enough to buy when that low price is offered. And believe me, that is the last thing anyone on Wall Street actually wants you to understand.

If you haven't yet, you must read Warren Buffett's famous takedown of the banal stupidity of the capital asset price model – The Superinvestors of Graham-and-Doddsville. (You can read a copy on the website maintained by our friend, value-investing fund manager Whitney Tilson, here.)

Just remember this: Almost all of the things you're sold as an investor rely on the ideas Buffett lampoons. He's the most successful investor who ever walked the Earth… And he says that what Wall Street is selling you doesn't make any sense.

How does the academic community – which is almost wholly supported by grants from Wall Street firms – react? William Sharpe calls Buffett a "three sigma event" (one in 370). Michael Lewis, the former bond salesman turned best-selling author, says Buffett's merely a big winner produced by a random game.

Buffett – by far the most poignant and insightful business writer of the last 100 years – is almost never cited by any academic financial journal. It is as if he never existed. What's that tell you?

Having spent my career in finance, it constantly boggles my mind that more folks don't grasp the plain, uncomplicated truth about investing. As Buffett says…

There seems to be a perverse human characteristic that likes to make easy things difficult... it's likely to continue this way. Ships will sail around the world, but the Flat Earth Society will flourish... and those who read their Graham and Dodd will continue to prosper.

To succeed as an investor, you have to identify companies with a permanent (or nearly permanent) competitive advantage. It helps if they are also capital-efficient. Then, you only purchase shares when you can buy them with a wide margin of safety. Once you've done that... you simply have to be patient... allowing dividends to accrue, compound, and grow. Presto... 20 years or so later, you're earning a remarkable return on your investment – taking on virtually no risk.

To learn exactly how to do this, all you have to do is read The Intelligent Investor, which is the "easy to read" version of Graham and Dodd's opus – Security Analysis. You can pick up a fine used copy of The Intelligent Investor for less than $5. You don't even have to read the whole thing. Just read chapters eight and 20. Focus on understanding the concept of a margin of safety.

And you're done. You can even stop reading this newsletter, but I hope you won't. Because there are lots of other things that Wall Street won't tell you about that Buffett knows will work.

While you're waiting on the price you want to buy "global dominator" stocks like IBM, Coke, and Disney, you can engage in safe arbitrage opportunities. (When a buyout is announced, you buy the company being acquired and sell the stock of the firm acquiring it. You'll find how to do it in the Intelligent Investor.)

You can also sell puts on stocks you'd like to own (like "Doc" Eifrig does in Retirement Trader). And you can buy discounted corporate bonds (if you know how to value them, the way Mike Williams does in our True Income). Buffett has written about all of these things in the past. He says that reasonably diligent individual investors ought to make around 50% a year in these kinds of speculations. Yes, they are that profitable. What? Your broker hasn't told you about these things?

No, he hasn't. Nor will he. If fact, if you start talking about buying discounted bonds (True Income) or selling puts (Retirement Trader) or trading arbitrage opportunities... he'll likely try to talk you out of it. Most brokers won't even give you the identifying CUSIP number for any high-yield bond. That's like the stock ticker symbol for a bond, which you need to make the purchase. So if you don't get the CUSIP from us, your broker will refuse to help you buy the bonds we recommend.

Likewise, you'll have to "apply" to get permission to sell puts. And arbitrage deals? Just try finding any information on them. You won't get that from CNBC, trust me. Why is it so hard to learn how to do these things? Why does Wall Street sponsor academic research that attempts to "disprove" Warren Buffett? Why does your broker refuse to help you buy high-yield bonds or sell puts?

Just think about that for a while today. I'm sure you know the reason why. It's because Wall Street firms make money on all of these things. Yes, that's right. Wall Street firms make most of their money trading bonds – the same ones they won't let you buy. They make a killing selling puts, too. And they don't want you in that market. And they know that if you ever figure out how easy and safe it is to invest for the long term, like Buffett does, you'll never use any of their products again.

Don't be a rube. Start thinking about the media and Wall Street as con men, which is close enough to the truth. Realize nearly everything you see about finance from these sources comes from someone who has a vested interest in you doing the wrong thing at the wrong time. They need you to sell, so they can buy. And they need you to buy, so they can sell. Start doing the opposite of what Wall Street recommends, and you're going to do a lot better with your investing. We'll do our best to help.

In the mailbag... an update on my request from last week. I asked for a favor from our readers: to review an MRI of my lumbar spine and send me recommendations about treating my back injuries. Yes, I received a few sour responses from people who complained about how unprofessional asking for a favor was. Yes, it was unprofessional – but that's the point…

Many subscribers have been reading my work for more than a decade. They've been with me through bull markets and bear markets. They congratulated me on my wedding and the birth of my children. This is a personal journal. It is not written by half a dozen different "professional" analysts, who come and go like the seasons. Very few things are made this way anymore – by one person, doing his best over many years.

I believe the folks who get the most out of my work appreciate the exceptional nature of this product. They know I work hard for them, and they appreciate the trust and the relationship we have – one that's taken a long time to build. When I go through hard times personally, I'm going to write about them. And when it's appropriate, I'm going to ask for your help. As I say frequently, I do my best to give you the information I'd want if our roles were reversed. Once in a while, I'll ask you to do the same for me. And I'm grateful to have this kind of relationship with so many smart, talented and experienced people...

The response I got was overwhelming. I received more than 5,000 knowledgeable responses, including personal replies from dozens of neurologists, spinal surgeons, and radiologists. I also received hundreds of replies from knowledgeable and experienced chiropractors and physical therapists. But the best replies I got were from people who have suffered from similar lumbar injuries. I got thousands of these responses. (I also got several entertaining responses from people trying to sell me magic gizmos for pain – including the "healing stick.")

I was surprised to learn that most of the folks (say 90%) who have suffered from injuries like mine report that after a year or so, they were able to resume leading an almost normal life. These folks broke down roughly 50/50 between those who had and hadn't undergone surgery. Both groups reported a return to health – with the folks who had surgery reporting a much faster recovery than those who didn't. I received thousands of warnings against surgery. But almost everyone who had surgery to repair a disk injury like mine reported it had been a success. Most said they were back on their feet within a week or two.

I also discovered that in every single positive case reported to me, doing regular exercise was the key to remaining pain-free – whether the treatment involved surgery or not. One form of physical therapy received the most support from our readers – Pete Egoscue's Egoscue Method. I haven't started physical therapy yet. But when I do, I will try Pete's method first. Thank you very much for all of the help.

And by the way... if you're having serious back problems, I can't endorse Dr. Lanman strongly enough. Remember… he advised me not to have any further surgery now. There's nothing better than a talented surgeon who prefers not to operate. He's been my constant second opinion through this process. I would have been totally lost without him. He spoke – via cell phone – to my surgeon in Miami before and after my surgery, making sure I was getting the appropriate care. He's been text messaging me daily to check on my recovery. I can't imagine any other doctor providing this level of care while serving as a consultant.

Having the ability to gather thousands of knowledgeable opinions is incredibly valuable. I appreciate all of your contributions, and I want to make this knowledge widely available. I will organize the best (most detailed) responses and put them on a webpage, featuring my MRIs. In the future, anyone with similar back problems can see what experts all across the world said about problems like mine. Please... if you've experienced serious lumbar disk-related injuries, let me know what worked for you. And if you're a professional, please render a short recommendation on the best course of treatment. Send all comments and recommendations here: feedback@stansberryresearch.com.

To refresh everyone's memory, I had an emergency surgery about six weeks ago to remove fragments of a ruptured disk (L3-L4) following a boating accident. These MRIs are "post-op," and they show the other large bulging disks. The question to the assembled audience is: 1) Will I require further surgery to make sure that I don't suffer permanent nerve damage in my leg and 2) Are further surgeries recommended to enable me to resume a normal life without undue risk of another ruptured disk?

Finally... an update on my status... My health continues to improve, day by day. The strength in my right leg is back to about 90% and the nerve pain in that leg has decreased by about 90% since my surgery. I'm waiting the full eight weeks post-op to begin physical therapy, as it takes that long for the annulus (the outer ring of the disk) to heal.

Regards,

Porter Stansberry

Miami Beach, Florida

March 30, 2012