Porter Stansberry: 7 ‘value traps’ to avoid… and one to short

From Porter Stansberry in Stansberry Digest:

What’s your biggest fear as an investor?

Most people think of failure as losing money. But losing time and opportunity are, in my view, just as serious. Today, I’m going to show you a surefire way to avoid losing all three when you make an equity investment.

The advice boils down to a simple checklist, so if you’re in hurry, you can scroll down. But I hope you won’t. Knowing why these strategies work is just as important. If you don’t know why they work, you won’t trust them. Plus, you’ll find these same dynamics can play out in many areas of your life. I hope you’ll file this Digest away for future reference. I even give you permission to share today’s Digest with anyone you think these ideas might help.

Berkshire Hathaway Vice Chairman Charlie Munger famously says, “Tell me where I’m going to die so that I never go there.” Most people get the joke, but they miss the point. You can’t avoid dying. But you sure as heck can avoid making obvious mistakes. The crazy part is… even the smartest folks in the world make obvious mistakes all the time. Even Munger and legendary investor Warren Buffett!

Warren Buffett has now lost $2.6 billion on IBM.

Worse, since making his original $10 billion investment back in 2010, near the low in stocks, he has missed out on the third-biggest bull market in history. He missed five years of a big bull market with a big chunk of his portfolio, and as a result, for the first time in his career, he underperformed the S&P 500 for more than five years running.

And here’s the kicker: Buffett told investors back in 1996 that IBM, along with General Motors and Sears, were former giants whose shares were no longer safe to own.

Buffett wrote that these businesses, “which had enjoyed long periods of seeming invincibility,” were not in industries where leaders enjoyed easy supremacy. Their lines of business did not “exhibit characteristics that endow leaders with virtually insurmountable advantages.” Instead, these large companies were “imposters” whose shares were “riding high but vulnerable to competitive shocks.”

Over the next 15 years, Buffett was proven right. GM has already gone bankrupt since he wrote these words. Sears is a shell of its former self and, without huge amounts of financial engineering, would have also filed for bankruptcy long ago. And IBM has been suffering from the same kind of competitive shocks Buffett correctly identified all the way back in 1996.

But did he avoid the stock? Nope. He invested $10 billion in the business in 2010 and then bought $3 billion more, an amount of capital that’s 10.5 times more than he invested in Coca-Cola. His IBM position is equal to 23% of all the capital he has invested in Berkshire’s current “Big 15” equity positions. Talk about driving to your own funeral!

In my experience, the biggest and most dangerous mistake otherwise excellent investors make is putting way too much capital in what are called “value traps.” These businesses, like IBM, look so cheap that they just prove irresistible, especially for wise and knowledgeable investors who wouldn’t normally make such an obvious mistake. Buffett’s investment in IBM sure looks like a classic case of this kind of error. It’s a mistake you should never, ever make because it’s completely avoidable.

Let me show you how to block out this problem forever…

I last wrote about how to avoid value traps in the October 10, 2014 Digest. Using the approach, I’ll show you again today how we found 11 stocks that were obvious value traps. (You’ll see the companies listed below, with their return since we published the list.) On average, these 11 stocks declined almost 20% annually since we told you to avoid them. Almost all of these firms used to be major companies – like McClatchy, Ruby Tuesday, Career Education, Monster Worldwide, and RealNetworks. And lots of big-name investors have lost millions and millions of dollars on these names.

In fact, a little secret… I originally built this list because a famous hedge-fund manager (who lives in Dallas) was trying to get me to recommend one of these stocks in my newsletter. I couldn’t believe it. To prove to him how foolish he was being, I asked my team to build this model. I thought when he saw the other companies that were like the one he was buying, he would realize the mistake he was making. But he didn’t. He couldn’t admit he had made a dumb mistake.

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How did I know these companies were going to suffer? How did we pick 11 stocks, most of which have gone way, way down despite the bull market in stocks? (Only three of these stocks went up at all, and only JC Penney has done well… lately, at least.)

Our approach is centered on finding stocks that seem to be in a terminal decline. We look for companies whose shares are obviously out of favor (they’re cheap, trading around book value or less) where revenues haven’t grown for years, and where goodwill is being written off. The last part, about goodwill, is very important. It’s the “secret” in the sauce.

Don’t let the jargon bother you. Goodwill is simply a fancy word for corporate assets that are hard to value because they’re intangible. It could be something as simple as a customer list that leads to lots of sales. Obviously, the list is worth more than the paper it’s printed on… but how much more? That’s where the accountants start arguing.

Don’t get bogged down in the details. Just understand this: When companies start writing off goodwill, it usually means that something important in their business is broken. Maybe their brands aren’t attractive to consumers anymore. Or maybe their patents are expiring. It could be any number of reasons… But in combination with a long-term decline in sales… it’s almost always a tough business problem to solve.

I asked my team of analysts to do a new scan across the markets, looking for stocks that fit this model – out-of-favor shares, declining revenues, and goodwill write-offs.

They found more than 50 examples, but most of the names were small-cap stocks, whose shares can be hard to sell short, and/or were involved in the oil and gas industry. Oil and gas has obviously been through a huge boom-and-bust cycle, so I’m not as confident in those results. When I tossed out the small caps and the oil and gas names, it left us with only eight companies in our current “terminal decline” portfolio…

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Notice that three of the eight companies are in publishing, an industry that is being completely transformed by new kinds of media. News Corp. is a huge, global leader in old-line publishing. It’s highly leveraged. And it has long been a favorite of major institutional investors. Seems like a classic value trap to me…

I hope knowledge of these “terminal decline” stocks will help you in three ways.

There’s the obvious: This approach will keep you 100% away from value traps if you will simply remember to use it.

There’s the inverse: This approach tells you a lot about what you do want to own. You want companies that can grow revenue easily and consistently. You want companies whose goodwill increases through time, as more and more consumers come to love their brands and products. (Again, this is where the accountants will start arguing… they’ll remind you that goodwill is never adjusted higher. But that’s just the accounting convention, it’s not reality. In reality, companies like Disney, Apple, and Coca-Cola have increased the value of their intangible assets steadily, and by huge amounts. That value shows up as premium over book value, but only because the accountants won’t revalue goodwill higher.)

And finally… This approach can give you yet another tool in your fight against the bear market that I believe is developing. It’s not hard to imagine that using News Corp. as a major short position could provide your portfolio with some significant benefits as a “hedge” against lower equity prices.

Speaking of protecting yourself from the bear market… As you may know, over the last seven weeks, we’ve been producing an educational series, published every Friday.

We called it the “Bear Market Survival Program.” The series covered all of our core strategies for protecting your portfolio and even profiting from a bear market – everything from using gold as a hedge to exactly how to short stocks successfully. We even showed you which stocks you shouldn’t sell during a bear market, no matter how bad it gets.

This education was dirt-cheap – just $29 for each week’s module.

We got a lot of positive feedback about this educational series. We knew our readers counted on us for education, but we didn’t realize how many subscribers look to us primarily as an educational resource. We’ve heard from hundreds of subscribers who don’t even use our work for actual investing (yet), but instead simply want to learn how to invest successfully in anticipation of beginning their own investing down the road. This is an exciting new opportunity for us, and we want to expand on our educational materials.

So we’re going to launch another educational series. Like the Bear Market Survival Program, it’s going to teach strategies that are well-suited for difficult market periods. But this time, we’re going to focus on trading. There are lots of different ways to trade the market for safe, short-term profits and income – profits that can help you continue to generate gains even while stocks in general are falling. So we’re calling our next seven-part series the “Bear Market Trading Program.”

What’s the safest way to trade for significant short-term capital gains, regardless of what the market is doing as a whole? It’s not using options. It’s not currency trading (that’s for sure!). It’s doing “plain vanilla” merger arbitrage.

Believe it or not, you can learn to do this in about 15 minutes. It’s not hard. It takes about 10 minutes a week to implement. And you can earn up to 50% a year doing it – even during a bear market. I’m not talking about insider trading. I’m talking about doing completely legal transactions that are super low-risk. We can show you exactly where to find the deals that are safe to trade, how to make the trades, and how to calculate exactly how much you’re going to earn on each deal. This is my No. 1 way to trade safely for profits during a bear market.

We will also teach you how to use the “dividend kicker” for quick (usually less than 90-day), double-digit gains. I don’t even want to describe how this strategy works because telling you anything about it will give away too much of this incredibly simple, lucrative strategy we developed nearly 10 years ago to generate super-safe profits. It even works during bear markets. You won’t believe how easy this is…

And we’ll show you another incredible trick to completely mastering bear markets with trading. It’s a way to completely, 100% guarantee that the general market will not influence the value of your position. The strategy doesn’t cost anything. You don’t have to buy a put option or anything like that.

Again, this strategy is so simple that once we tell you exactly how to do it, you’ll wonder why you never thought of it before. It’s a way to immediately and permanently “insulate” every long position in your portfolio against any and all market volatility. This is the absolute best way to increase your total returns and to make sure that bear markets never, ever disrupt your long-term investment goals again.

Not all of the Bear Market Trading Program ideas will be simple, though. Some of the things we can teach you are fairly technical. For example, we’ll show you a strategy called “flash bids” that can allow you to make 20% or 30% almost instantly.

Yes, these profits are rare. But they don’t cost you anything to set up, and every now and then they will automatically trigger. It’s like someone simply handing you money just because they’re stupid. Yes, this is real. Yes, this is legal (incredibly). We’ll show you exactly how to do it and how to handle your broker complaining about you ripping off their other clients.

These reports will come once a week for seven weeks. They’ll teach you strategies and techniques that have been pioneered and proven by the world’s best investors. These are the strategies that hedge funds charge their clients billions of dollars a year to implement. As you’ll see, they aren’t as hard as some may seem… But they can genuinely transform your investing and take you to a level you didn’t think you would ever reach.

Wouldn’t you love to be able to say with total confidence, and without a trace of arrogance, that you simply don’t care anymore what the market does? That you know – come hell or high water – that your portfolio is going to make 15% to 30% this year (or maybe more, if you hit another flash bid)?

That’s what we’re offering. We’re going to charge a bit more for this information than we did last time. It’s worth a lot more. The Bear Market Trading Program will cost $49 per week. We’ll bill you once a week, on Fridays. There are no refunds (after all, you can’t return the education we’re providing), but you can cancel at any time.

And there’s one loophole… We want to make sure that the subscribers who joined us for our first educational series and who completed the program are rewarded for their loyalty to our business.

For these folks – and only these folks – if they choose to continue their education with us, they will continue to only pay the original $29-per-week rate. They’re going to get the advanced Bear Market Trading Program series for the same price they’ve been paying. They won’t pay the $49 per week we’ll begin charging next Friday. Over the course of seven weeks, that’s a savings of 40%. (Of course, Stansberry Alliance members receive this for free.)

Sure, the information I gave you today about News Corp. is valuable. And yes, you can put it to good use. But that’s what we’re willing to give away for free. There’s a lot more we can teach you. Let us.

Regards,

Porter Stansberry

Crux note: You can learn more about the “Bear Market Trading Program” that starts this Friday, March 11 right here.

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