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Weekend Edition

Porter Stansberry: The most important investment secret ever
Saturday, February 18, 2012

 Interest rates are already near zero. And they'll stay there through at least 2014, according to Federal Reserve Chairman Ben Bernanke. He also said the Fed would consider more quantitative easing should the economy not improve from here.
 
Even Bernanke admits the folly of his ways, though he's in denial of the current situation... "[O]n current, reasonable expectations about policy... the U.S. federal deficit will be unsustainable within 15 or 20 years at the most," Bernanke told the Senate Budget Committee. He urged Congress to clarify the U.S. fiscal plan as soon as possible.
 
 You've heard our thoughts on inflation and bonds over the years. In short, we think inflation is coming... And we're long-term bearish on the dollar. Recently, many of the world's greatest financial minds also commented on the situation. Now, legendary investor Warren Buffett and Bill Gross (manager of the world's largest bond fund for money-management firm PIMCO) have weighed in on current fiscal policy and its effect on investors...
 
 In his most recent annual letter to Berkshire Hathaway shareholders, Buffett called bonds "among the most dangerous of assets." He wrote...
 
Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal.
 
His point: If the payments of interest and principal are created out of thin air, they're not as valuable. "High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments. And indeed, rates in the early 1980s did that job nicely," Buffett wrote. "Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label."
 
 To echo Buffett's point, why would you lend someone money at current rates? (Buying a bond is simply lending an entity money.) One incentive for lending money at low rates is potential capital gains (meaning interest rates fall and bond prices rise). But yields are already near zero. They can only fall a small amount, if any. If you have no chance of capital gains, your principal and interest will be repaid in devalued currency. This leads us to Bill Gross' comments...
 
 In an op-ed for the Financial Times, Gross discussed the danger of "zero-bound" interest rates...
 
What incentive does a U.S. bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed? What incentive does Pimco or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is 2 per cent of par and the downside substantially more?
 
Low rates are supposed to coax money into longer-dated and riskier assets. But Gross argues they may actually be doing the opposite – keeping funds in savings rather than bonds. Interest rates are near zero in both long- and short-term debt, and bonds offer little chance for capital appreciation. That creates a "liquidity trap," Gross says, because the bond market represents "too much risk and too little return."
 
  With so much risk in today's market, what should you buy? Our colleague Steve Sjuggerud says you should get into U.S. housing. As opposed to Gross' duality of "too much risk and too little return," Steve says buying a house today is "the greatest opportunity you will have in the next 10 years in investing – as far as risk versus reward." This week in DailyWealth, he wrote...
 
My friend, the time has come. It is time for you to buy a house, preferably a primary residence.
 
No excuses. No delays. Just figure out how to make it work.
 
Already have a house? Go get another, and rent out the one you're in.
 
The point is, banks are finally willing to get rid of stuff. And investors (like my friend) are willing to step up. Buyers and sellers are finally seeing eye-to-eye. This is it. This is your moment. The opportunity for the really great deal is just about to end.
 
You see, your downside risk is extremely low, as houses are selling way below their replacement cost and you're essentially getting the earth itself "for free."
 
With homes dramatically below replacement cost AND with mortgage rates at record lows (below 4% for a 30-year mortgage), houses in the U.S. are more affordable than they've ever been.
 
Throughout Steve's career, he's shown subscribers how to make big returns without taking big risks. Now... Steve has compiled a set of reports on "outside the market" investments that can give you incredible gains... but come with virtually no risk of going down. Click here for the details.
 
 For those who do want to invest in the market, earlier this week in our sister publication DailyWealth, Porter Stansberry describes "the only sure way to get rich in stocks." He explains the investment strategy Warren Buffett used to become the world's richest investor. And it's not simply buying "cheap" stocks...
 
We've described many times how our government's crushing debt load will inevitably result in a currency crisis and a period of blistering inflation. To profit during the inflation crisis on the horizon, you must understand the difference between traditional value investing (buying a dollar for 50 cents) and how Buffett made his fortune...
 
In short, the secret to Buffett's approach is buying companies that produce huge returns on tangible assets without large annual capital expenditures. He calls this attribute "economic goodwill." I call it "capital efficiency."
 
 Porter's written about capital efficiency many times over the years. He wrote a great essay on the topic last October. And the latest issue of Stansberry's Investment Advisory is dedicated to the topic... In the issue, he calls it "the best way to get rich."
 
  Porter uses Hershey – which he believes will be "one of the greatest investments" of his career – as an example of a capital-efficient business...
 
Over the last two years, [Hershey's] share price is up 60%, versus the S&P's 20% return. Hershey recently hit my first price target of $60. More important to me, it continues to increase its dividends. What did I see that the market (and some of our subscribers) missed?
 
Since 2005, Hershey had repurchased more than $1 billion worth of its own stock – more than 10% of the company, in addition to paying large ($200 million-plus) cash dividends. It has paid 325 quarterly dividends in a row – 81 years. It has increased its dividend payout every year since 1974.
 
On a combined basis (dividends and buyback), the company pays out a remarkably large amount of the cash it produces. For example... in 2008, the company produced a little more than $500 million in cash from operations. It spent nearly $300 million on dividends and share buybacks. (It also repaid $128 million in debt.)
 
Hershey can afford to return so much capital to its shareholders because it requires little capital to grow. Over the last 15 years, the company's annual capital spending has remained essentially unchanged. In 1997, the firm invested $172 million in property and equipment.
 
By the end of 2010, its annual capital budget had only increased to $179 million – essentially unchanged. Meanwhile, cash profits had reached nearly $1 billion – growth of nearly 200%. This is the beauty of a capital-efficient business: While sales and profits grow, capital investments don't.
 
And that leads to the real secret – the most important investment secret you will ever be told. Some companies, like Hershey, can increase the percentage of their earnings they pay out as they grow. Let me make sure you understand this... The size of the payout Hershey makes to investors doesn't merely increase on a nominal basis along with sales... It increases as a percentage of the company's gross profits.
 
  In short, capital-efficient companies earn large returns on tangible assets without large capital expenditures. And they can increase their returns without big increases to capital spending. As a result, they can pay the excess returns out to shareholders via stock buybacks and dividends. The secret to these excess returns is a strong brand... People are willing to pay more for products they love (think Coca-Cola).
 
  The dividends you receive from these businesses could soon increase... Standard & Poor's analysts expect S&P 500 companies to pay more than $260 billion in dividends this year, surpassing the record $247.9 billion paid out in 2008. Even at record-high nominal payouts, the payout ratio (the percentage of earnings paid out as dividends) of S&P 500 companies is currently at a record-low 27%, according to Wells Fargo analysts. Historically, payout ratios have averaged 53%. So earnings growth has outpaced dividend increases... And that means your favorite dividend-paying stocks could soon be paying out a lot more...
 
  To start building a portfolio of solid, dividend-paying stocks, we recommend you read The 12% Letter, written by Dan Ferris. Dan's newest issue came out this past Thursday. I spoke to him earlier this week, and here's what he had to say...
 
I've been doing research and picking stocks professionally for almost 15 years. I've seen a lot of investments go right, and a few go wrong. The thing I want most in any company I buy is a competitive advantage... one that's going to last for years... The company we're buying this month has a huge position in cost-advantaged land that no other company can duplicate.
 
To learn more about The 12% Letter and gain immediate access to his issue, click here.
 
Regards,
 
S&A Research




This Week's Winners
S&P 500 Symbol Change
Sears Holdings SHLD +13.4%
Devon Energy DVN +13.3%
Dean Foods DF +13.2%

Countries Symbol Change
Hong Kong EWH +3.1%
India IIF +2.2%
Japan EWJ +2.2%

Sectors Symbol Change
Biotech PBE +1.9%
Health Care IYH +1.4%
Semiconductors PSI +1.3%

S&P 500 Symbol Change
FOSSIL INC FOSL +16.8%
Devon Energy DVN +13.3%
Dean Foods DF +13.2%
Countries Symbol Change
Hong Kong EWH +3.1%
India IIF +2.2%
Japan EWJ +2.2%

Sectors Symbol Change
Biotech PBE +1.9%
Health Care IYH +1.4%
Semiconductors PSI +1.3%

Commodities Change
Cotton +4.3%
Soybeans +2.5%
Live Cattle +2.5%

Date Range:2/9/2012 to 2/16/2012
This Week's Losers
S&P 500 Symbol Change
First Solar FSLR -19.0%
J.M. Smucker SJM -9.6%
Cliffs Natural Resources CLF -9.6%

Countries Symbol Change
Chile CH -6.9%
Spain EWP -4.6%
Austria EWO -3.4%

Sectors Symbol Change
Clean Energy PBW -5.3%
Basic Materials IYM -1.4%
Airlines FAA -1.2%

S&P 500 Symbol Change
First Solar FSLR -19.0%
J.M. Smucker SJM -9.6%
Cliffs Natural Resources CLF -9.6%
Countries Symbol Change
Chile CH -6.9%
Spain EWP -4.6%
Austria EWO -3.4%

Sectors Symbol Change
Clean Energy PBW -5.3%
Basic Materials IYM -1.4%
Airlines FAA -1.2%

Commodities Change
Coffee -8.3%
Nickel -7.5%
Zinc -7.5%

Date Range:2/9/2012 to 2/16/2012
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