Founder and CEO, TradeStops
Porter and Buck welcome Richard Smith, inventor of TradeStops, the revolutionary software designed to help investors maximize their gains while minimizing risk. Richard tells Porter about his recent analysis of famous investors like Warren Buffett, David Einhorn, and Seth Klarman…and how you can beat them at the investing game. Richard reveals the one thing you can do today to dramatically improve your investment results, without changing any of the stocks you own.
Porter breaks down highlights from Berkshire Hathaway's annual letter to shareholders, and talks about what the world's greatest investor may have left out of his yearly report. Has the investment philosophy changed at Berkshire? Is Buffett breaking his fundamental rules for investing?
Listeners write in with a valuation question about Apple and how to handle stops, position sizing, and asset allocation when it comes to corporate bonds.
Announcer: Broadcasting from Baltimore, Maryland and New York City, you're listening to the Stansberry Investor Hour.
Tune in each Thursday on iTunes for the latest episode of the Stansberry Investor Hour. Sign up for the free show archive at InvestorHour.com. Here are the hosts of your show, Buck Sexton and Porter Stansberry.
Buck Sexton: Hey, everybody. Welcome back to another episode of the Stansberry Investor Hour. I'm nationally syndicated radio host Buck Sexton. And with me, as always, our fearless leader, Mr. Porter Stansberry. Hey, Porter.
Porter Stansberry: Hi, everybody. I don't know how I got that title. I think Buck just has to say something around my name. That's okay. I'll be the fearless leader.
Buck Sexton: So, today on the show we're going to welcome Richard Smith, who's the founder of TradeSmith and the creator of the TradeStops software that many listeners are using right now to help manage risk in their portfolios. If you don't know about TradeStops, it's the top investor tool that helps you let your winning investments run while cutting your losing positions as fast as possible. The TradeStops motto is simple: Make more, risk less. Now, Richard's story is unique because he didn't just create TradeStops and then meet the people at Stansberry Research because they had heard Richard was helping so many investors. Before TradeStops, Richard was a reader of Steve Sjuggerud's –
Porter Stansberry: Sjug!
Buck Sexton: – True Wealth, and eventually became a Stansberry Alliance member. He paid a one-time fee many years ago to have access to a lifetime bundle of Stansberry Research. That Alliance membership started a journey for Richard, and an eventual business partnership between TradeStops and Stansberry Research.
Most recently, Richard completed a study that showed using TradeStops can actually beat the billionaires. Richard and his team have been researching a group of a dozen billionaires for about a year. If famous investors like Warren Buffett, David Einhorn, and Seth Klarman had used the principles behind TradeStops, they would have almost doubled their gains, 47%, to be exact. But that's not the most important part. They would've also increased their gains by 47% with less risk.
Richard is going to tell you today about how TradeStops did this in his exclusive interview with Porter on the Stansberry Investor Hour. And when you listen to Richard and want to try TradeStops for yourself, it's easy to take the first step. For a special trial offer, just for Stansberry Investor Hour listeners, go to TradeStopsOffer.com. That is TradeStopsOffer.com.
And, with that, Porter, rock the mic.
Porter Stansberry: Well, listen, I want to talk with everybody about a couple of big things from the financial world. Berkshire Hathaway's letter came out. I want to give you some insights into that. And I want to talk about the continuing crisis at General Electric, which I know is a topic that's near and dear to Buck's heart.
Buck Sexton: It's my favorite stock.
Porter Stansberry: But let me just say about Richard before he gets here: Stansberry Research has not partnered with very many people. Richard is one of the very few. He's the only person we've partnered with in the software world. And we've done everything we can to get people to try Richard's approach. And I think everybody is missing one central fact. It's very simple, but it's hard to believe, so most people – they don't really believe it. Even when you present them with the proof, they're just like, "It doesn't make sense. I can't figure it out." It's a really important concept, Buck, and I want you to understand it because you're young enough – it could make a huge difference to you.
Here's the coolest thing about Richard's software. He can take your portfolio, no matter what you like to invest in, no matter how many positions you have or how few, and just by changing your allocations, he can improve your performance. In other words, you can still buy when you want. You can still sell when you want. You can still own the stocks that you like. But if you follow Richard's technology, if you'll use Richard's technology, you'll end up investing more of your capital in the better of the companies that you buy and less of your capital in the ones that don't work out as well.
And that is really cool. Just changing the allocations can greatly improve your results. And so when he talks about "beat the billionaires," what he's doing is he's putting the holdings of well-known investors into this software system and he is changing their allocations, and his returns will beat theirs. How cool is that?
Buck Sexton: Sounds good to me.
Porter Stansberry: I think it's a really cool approach. So I hope you guys will stick around and hope that you will listen to what Richard says. And if he gives you a trial offer, I hope that you will at least try it. Because I'm confident it will improve your investing results. If that's important to you, then you need this software.
Okay. Let's talk about Berkshire Hathaway. Now, if you go to the mainstream media, the – what do people call it? The "main lame media?"
Buck Sexton: The "lamestream media."
Porter Stansberry: The lamestream media. Yeah. The lamestream media. You're going to see a bunch of blah-blah-blah about how great Buffett is. Basically they're just slurping him. I'm not quite sure why they do it, but they all love him. Maybe because he's liberal like they are or because he acts like he's a grandfather or something. But Berkshire has a huge problem that I know that nobody else sees.
So, first of all, yeah: Berkshire had a really good year. Book value grew by 23%. About half of that gain was related to changes in the tax code, though. So it was really operating. And I have to say: He has the world's best insurance business by a wide margin. So, listen, I don't want you to think I'm dumping on Warren Buffett. I'm really not. I'm saying that he has made huge mistakes as an investor, and for some reason he gets a complete free pass in the media about these mistakes. And nobody else seems to notice them.
So, for example, he has quietly dumped all of his IBM shares. And he took a loss doing so. And he owned that from 2009/2010 until this year. So that's an almost decade-long investment where he made no money. And no one said a peep. And, by the way, it was a major investment. I think total capital invested in IBM was $20 billion, which makes it one of his three all-time largest investments. He got his ass handed to him and nobody says a word about it. The difference to Berkshire Hathaway shareholders is really important. Let me give you some insight.
Buffett made all – not all of his money, but he made a vast majority of the wealth at Berkshire by making investments in public companies. So, at the bottom of the market in 1973, '74, which was a terrible bear market – people forget about that bear market, but the market fell by about 50% and it didn't recover for about a decade. It was a bad bear market. In the bottom of that bear market, Berkshire invested I think it was $10 million to buy a large stake in the Washington Post newspaper. And that powered his returns for the next decade. At the same time, he bought a half interest in GEICO, and that powered his returns for the next decade. So, coming out of the '73/'74 bear market, he made two unbelievably world-class investments where he would go on to make 10 times his money, 20 times his money. I don't even know how much money he made on GEICO. It's an enormous fortune.
So, when a bear market happens, Buffett strikes and makes a killing. 1987 comes along. The crash. Remember the crash, Buck? Were you alive in '87?
Buck Sexton: I was alive and I remember the crash. My dad was a stockbroker at the time.
Porter Stansberry: Oh! You do remember the crash. No Christmas that year. Anyway, coming out of that crash, Buffett spent $10 billion – which was about 25% of the entire book value of Berkshire – on Coca-Cola. And if you look at a chart of Coke stock in the '90s, it just goes straight up. Huge, huge win for Berkshire. Okay? Big-time win.
Now, there have been two big bad bear markets since the '87 crash. There was the tech crash in 2001 and there was the mortgage crisis in 2008. And my question to you is: what did Berkshire do with its enormous cash loads in those crises? And the answer is: Not a damn thing. There is no GEICO. There is no Coca-Cola. There is no Washington Post. There is no buying Amex at the bottom. There are no great picks out of those crises. He didn't put Berkshire's money into the right public companies. And nobody's called him out on it.
And instead he's done things that he said that he would never do. Classic example. He got killed in ConocoPhillips. He bought it at the very top in 2005/2006, and he said publicly that he believed in peak oil. And he got his ass handed to him. I mean, he lost a ton of money. He lost several billion dollars on that investment. And then of course there was the IBM debacle.
So the nature of the way that Berkshire makes money has really changed. And a couple of things have happened that are very unusual. So, Buffett said that he would never buy tech stock, and then he plowed $20 billion into IBM and got his ass handed to him. He said he would never buy airlines. But if you look at his top 15 holdings today, you'll find Delta and Southwest. Both airlines. But the bigger thing that changed was that Buffett said he would begin paying a dividend when, in any five-year rolling period, the growth in Berkshire Hathaway's book value did not keep pace with the S&P 500. And that happened about two years ago because of the poor investments in IBM and ConocoPhillips and others. Tesco, a grocery store chain in England: Low-margin grocery store chain. Buffett bought it, got his ass handed to him.
So, for years Buffett never ever once underperformed the S&P 500. It's happened regularly, about 40% of the time, since 2000. Why? Because he changed his investment style. He went against the things he already had proven worked. And I don't know why he changed his style so much but he did. And the biggest mistake that he has made – and this is in this year's letter but no one has talked about it. The biggest mistake that he made is he started buying whole businesses that consume massive amounts of capital.
So if you look at the private companies he has purchased, about half of the earnings – it's $20 billion in earnings this year from his wholly-owned companies. These are companies like his railroad company, BNSF, Burlington Northern Santa Fe. That business consumes an enormous amount of capital, and if you read what Buffett says in it, he says, "The depreciation costs of this railroad – so what we're allowed to write off our taxes in terms of the decline in the value of those assets – never keeps up with the capital requirements of that business." So, Buck, on $20 billion of earnings in his wholly-owned businesses, he had to turn around and invest $11.5 billion in new capital to keep those businesses running. That is extremely inefficient. Extremely inefficient. And the earnings of those companies only grew by a billion dollars on 20. So about 5%.
So think about how much capital Berkshire has put into those businesses to own them, how much he spent on Burlington Northern, how much he spent on MidAmerica Energy. Those are giant capital-consuming, regulated businesses that never will have much growth and require tons and tons of capital. And that's what's changed about Berkshire. Berkshire used to own companies like the newspapers, like Coca-Cola, where those companies produce capital for him, and he was able to extract a large percentage of his investment and cash every year from that business and more and more every year. The businesses he owns now consume Berkshire's cash. And that is why the company's not compounding its wealth the way that it used to, and that is why it's not able to keep up with the S&P 500.
But the biggest thing that's changed is Buffett himself. He used to be a fair arbiter of his own track record, and that has now changed. If you read his letters over the last three or four years, he makes constant excuses about why he's changed the nature of his own performance metrics. He used to rail against CEOs who would "move the goalpost" after they had committed their performance. But he did exactly the same thing. He always promised he'd start paying a dividend if he couldn't beat the S&P 500 in any five-year rolling period, and then when it happened and the S&P 500 beat him, what did he do? He changed the goalposts.
Now, I don't know why the media isn't more critical of what's going on at Berkshire. But just like I told people 20 years ago they should look a lot more carefully at what's going on at GE, the same thing right now is happening at Berkshire. And I'm not suggesting that Buffett is cheating on his accounting at all. I'm saying that the nature of Berkshire has changed in a very fundamental way. Berkshire used to be an insurance company that used its massive float, the money that it holds in policy payments before it pays out claims – right now that money is $116 billion. Buffett used to use that money to invest in very capital-efficient companies that could pay enormous and growing dividends to Berkshire's shareholders. And then Buffett would reinvest that money for them in a very good way.
And since 2000, his investment returns blow smoke. And he's hiding that from his investors. He's hiding the fact that he's not going to regularly beat the S&P 500 anymore. And he's hiding the fact that, as a result, he's now sitting on something like $100 billion in cash. So he's not investing the float wisely. And I don't know why. But that railroad investment is going to be a disaster for Berkshire Hathaway.
All right. Is that enough?
Buck Sexton: I know why the media's not on him more.
Porter Stansberry: Why?
Buck Sexton: Because he is their favorite go-to talking point for the: "My secretary pays less than me in taxes – we need to raise taxes." He's bought himself political insurance, Porter.
Porter Stansberry: I don't know. He's very clever. He manipulates the media better than anyone I've ever seen. And he also routinely acts like a complete asshole to the people who work for him. If you go back and you study the Lubrizol transaction, there was an executive who was running MidAmerica Energy at the time who brought Buffett that acquisition on a silver platter. And it turned out that he owned shares in it. And Buffett crucified the guy publicly and set the SEC on him. And the guy didn't do anything wrong. He was cleared eventually by the SEC. And he's like, "What the hell? I told Buffett it was a great stock to buy. That's why I was buying it. What's the problem?"
And I just – I don't like the way that he gets a complete free pass from the media and no one is ever critical of him in any way, shape, or form. And his performance over the last about 20 years has not been anything to brag about. And instead of him, in my opinion, being honest about it, he's changing the goalpost and he's making excuses. And he just does so in a very clever way that nobody else is smart enough to see through.
But why didn't – in 2009, you could've bought McDonald's, Tiffany. You could've bought the world's greatest businesses: eBay, Amazon, Starbucks. You coulda bought all these businesses for monies that he was sitting on. And instead of making those investments, he leant a bunch of money to people like GE and Bank of America and Goldman. Lent them money. And, yes, in some cases he got a little bit of stock. And, yeah, he was making 10% yields on those investments. But if he had bought the right businesses, imagine where Berkshire'd be today. He now owns something like $28 billion worth of Apple, which is great. But why didn't he buy that back in 2009? That's when you shoulda bought it.
And he himself went in the New York Times in October of 2008 and said, "Now's the time to be buying American companies." And he was right but he didn't do it. And I cannot figure out why. And he's never told anybody.
And, of course, I've asked for interviews a dozen times. And we know a lot of the same people. And he reads my e-mails. I know he does because I see his replies to my friends. But he won't answer any of those questions.
Buck Sexton: You know it's shady because he's the only guy in the movie Too Big to Fail, which gets very preachy, and a lot of grandstanding in it – he's the only guy who's a finance guy who doesn't look like greedy scum.
Porter Stansberry: Yeah. I know.
Buck Sexton: Buffett is literally – he's like the Santa Claus that saved America's financial system in that movie. He's like [in old-man voice], "Okay, I'll just write a check and make sure that people's 401(k)s don't disappear." That's kind of how he's presented. It's true.
Porter Stansberry: I can't figure it out. I can tell you: he is going to be right if there is a follow-on massive crisis, if the problems of 2008/2009 have actually gotten bigger – and I believe in many cases they have – and there is a huge bear market, even worse the one we saw in '09 and '08. He'll be right. Because he's sitting on cash. But he's not telling people that's why he's not buying stocks. He's saying, "Oh, America's fine. Meanwhile, I got $100 billion in cash." The way you're behaving, you think the world's greatest crisis is about to unfold. So what I'm saying is: His rhetoric does not match his portfolio at all. And he's not explaining to his shareholders what he is doing.
The reason why you'd own stuff like a railroad and Bank of America and Wells Fargo is because you think the end of the world is here. Those things are going to survive whatever crisis comes. But they're not going to make you very much money if there isn't a crisis. You see what I'm saying? I can't figure out what he's doing. And I don't object to it. If that's what he thinks is right, that's fine. But explain that to people. And he won't. I don't know. It's very odd.
Buck Sexton: Can we move on to the happy talk about how GE has finally figured out what's gone wrong and they're going to turn it all around? Or Jeffrey Immelt and and Welch are now engaged in a legacy battle that's even blowing over into my neck of the woods in the political and news analysis world where people are like, "Maybe this Immelt guy did some bad stuff, and maybe somebody should ask that Welch guy to explain why he's a management expert if he's destroyed one of the great American companies."
Porter Stansberry: I say very clearly: there's no doubt in my mind that Welch would go to jail if there was a real investigation into GE's accounting. And I don't know about Immelt, but I imagine that Immelt kept doing a lot of the same things that Welch had taught him to do. But, look, I'm not saying I have evidence of any particular wrongdoing. I just know that you don't beat your earnings estimates by one penny every quarter for, whatever, 37 quarters in a row, which is what – not Immelt, but the older guy – Welch did. I don't know why my brain's on delay today. I apologize.
Buck Sexton: Isn't that cooking the books?
Porter Stansberry: Here's my favorite part about the GE story. And I have to admit: I didn't see this until yesterday. Yes, of course: he's the guy who – and, by the way, in his own book, which is called Straight From the Gut, which is kind of funny if you think about him the way that I do: It's just a bunch of his puke everywhere, which is really what that book was in my mind. He says very clearly that – he talks about, directly and openly, how he would manipulate the earnings numbers for GE. Plainly and simply in the text of that book. Of course, no one from the SEC called. And here's the classic thing about all this: "How did GE get away with this?" you might say. Well, they owned CNBC at the time. So who's going to investigate them? Nobody.
And when you had a guy in the media – AKA: Me – who was saying, "Hey, there's all kinds of red flags here," what did CNBC do? Banned me. Not allowed to appear on their broadcasts. The other thing that –
Buck Sexton: You got put in CNBC jail? I didn't even know they had that. They have that at other places.
Porter Stansberry: Oh yeah. I'm in CNBC jail. Still am. And they don't even like it when anybody brings up my name. I can show you – Tice –
Country Club Guy: David Tice.
Porter Stansberry: David Tice. Thanks, Country Club Guy. David Tice was complimenting our work on CNBC one day and the announcer jumped down his throat and Tice wouldn't have it. He's like, "No, man, you've got that all wrong. Stansberry Research does the best work out there." It's pretty funny.
But, anyway, here's the best part about GE. I want to get to this. And I want to make sure that everyone hears me and knows that this isn't a mistake or a rumor. Okay? This is a fact. As I like to say, Google it. Mary Schapiro has been on the board of General Electric for the last, I don't know, three or four years. Anybody know who Mary Schapiro is? That name ring a bell?
Hm. Former chairwoman of which government agency?
Country Club Guy: FDIC?
Porter Stansberry: The SEC [laughs]. So you're telling me one of the five largest corporate accounting frauds in history happened in the company on whose board sits the former head of the SEC. And I ask you, ladies and gentlemen, do you think that the SEC is really here to protect investors, or is it here to protect the bigwigs at major corporations and banks? And the answer should be obvious. Who's been sued by the SEC? Porter Stansberry. Does he manage any money? No. Has he ever managed any money? No. Has he ever been a part of any public company? No. What's he do for a living? He sells subscription information. Is that what the SEC regulates? No. [Laughs].
But what else does Porter do? Porter writes really nasty and annoying-but-true things about major corporations. Hm. Who's the SEC sue? Porter Stansberry. Who does the SEC not sue? Jeffrey Immelt [laughs]. Who commits massive securities fraud? Jeffrey Immelt. Huh. I wonder how all that really works.
Buck Sexton: Can I give you – I actually put this one together and have been raising as much hell about it as I can. It's a similar thing here, Porter. You know Bridgewater, right?
Porter Stansberry: Yes, I do.
Buck Sexton: One of the biggest hedge funds in the world, right?
Porter Stansberry: The largest hedge fund in the world.
Buck Sexton: The largest? Okay. You probably golf with the CEO. I don't know anything about them other than they're really big. But what does matter to me is the federal government – we recently had the dossiers, the Democrat memo, the Republican memo, all that stuff. And I was wondering: why would James Comey – don't worry. This'll tie into what you said a second ago.
Why would James Comey be on a seven-figure salary at Bridgewater Associates? He just left the Department of Justice. He has no white collar, criminal defense background. This is not what he does. And he was there in an advisory role. He wasn't even there as chief counsel or anything. Like: this is so weird. They're going to pay him a seven-figure salary to just kind of hang out? By the way, Comey's a lanky weirdo with way too high a self-regard. So I figured there's got to be something else going on here.
Who was the Southern District of New York U.S. Attorney when Bridgewater is paying Comey a seven-figure salary? Oh, that's right, it's Preet Bharara. Who did Preet Bharara work for at DOJ? James Comey. Who is James Comey's protégé at DOJ and helped him get the Southern District? Oh, that's right: Preet Bharara. James Comey. Now it all makes a lot of sense.
When you're a fund like that, do you think it's a good idea to have a dude in-house whose close, personal, and professional friends with the one person who might have the ability to really mess up your business if he decides to?
Porter Stansberry: And Preet was going after every hedge fund. But he never went after Bridgewater.
Country Club Guy: It sounds like an episode of Billions.
Buck Sexton: That's right.
Porter Stansberry: It does sound like an episode of Billions, Country Club Guy. Good call. Anyways, ladies and gentlemen, I don't really care whether you believe me or not. Because there's so much evidence of this that's rampant in our government and our society. I just want you to know: The people that you think are looking out for your best interests are not. They never have and they never will. They're looking out for their best interests. It's that simple. And so you have to regard the securities markets as being a nest of snakes. Because that's what it is. And the guy who's supposed to be guarding the place and keeping the snakes out – he's the guy who's feeding them. So you have to be careful.
And a guy that will help you be careful – see this link? See this bridge? – is my friend, Richard Smith. Why don't we bring Richard in now and talk about how to manage risk in these uncertain times and these corrupt markets.
Buck Sexton: Dr. Richard Smith, everybody, is with us now. He is the CEO and founder of TradeSmith LLC. He's the math PhD and inventor that has now helped tens of thousands of investors manage the ups and downs of the market confidently and stress-free with the TradeStops unique investment tools. After Richard earned his PhD in math and system science, he learned the hard way that it takes more than intelligence to win in the game of investing. After scoring huge gains in the stock market in the late '90s, Richard lost it all in the dot-com bubble and was left wondering: What the heck just happened? This school-of-hard-knocks learning experience put Richard on a path of researching and developing algorithms and services that give individual investors the tools they need to remain in their personal investing comfort zones and succeed.
TradeStops' motto is simple when it comes to investing in stocks: make more, risk less. Please welcome to the Stansberry Investor Hour, Dr. Richard Smith.
Richard Smith: A pleasure to be here. Thanks for having me.
Porter Stansberry: Richard, where are you? You were in Baltimore yesterday, weren't you?
Richard Smith: [Laughs]. That was actually last week, Porter. I'm back in Florida today.
Porter Stansberry: I can't keep up with you, Richard.
Richard Smith: Down here in sunny Tampa. It's I think 85 today.
Porter Stansberry: Well, we got better weather than you today, buddy. It's perfect here and 65, which is what the big guy likes.
Richard Smith: Nice. Yup. That's the sweet spot.
Porter Stansberry: Well, listen, Richard, we had you up here to talk about what you can do for investors and helping them manage risk in their portfolios. Can you just give us a little bit of an overview of where you are now in TradeStops? You know, a long time ago you started out sort of as an alerts company that would help people manage trailing stops. But TradeStops does a lot more now. And in particular, as you know, I'm really interested in the way that you can rebalance people's portfolio for risk and help them make better overall returns.
Richard Smith: Absolutely. We did start out as an alert services company. And trailing stop alerts – which I literally learned about from you and Steve Sjuggerud, right?
Porter Stansberry: Yes you did. And I think you wished that you had followed them during the tech crash.
Richard Smith: I absolutely do. That's how I knew they worked, because I actually back-tested my own portfolio and saw: holy smokes, I woulda made a lot more money if had used these, and I woulda had a lot less stress, right? [Laughs].
Porter Stansberry: You would've had a lot less stress.
Richard Smith: All the second-guessing about when to sell, right?
Porter Stansberry: Yup.
Richard Smith: You know, it's incredible. But then later on I started to – the next question I asked was: "Well, should we use a 25% trailing stop on everything?" And I did some work to come up with an algorithm. Initially I called it the Smart Trailing Stop, and it used volatility to identify an optimal trailing stop on different stocks depending on how volatile the stock was. So Walmart and Johnson & Johnson, maybe 10% to 12%. Tesla, 30%. Apple, Microsoft, 17%. Etcetera. And that was very powerful to identify that. But once I had done that work and came up with that algorithm, I quickly realized that that number was very helpful to investors, whether they used it for a trailing stop or not.
Just seeing the number – and I know, Porter, you know this: Just looking at that number was so helpful to – you know and I know: a lot of people who are investing, they're successful in life but they're not financial professionals.
Porter Stansberry: Lots of our customers.
Richard Smith: Lots of our customers, right? And no knock against us, you know? I was one of them, right? I had to learn. But I had to spend a lot of time doing it. And your readers, my subscribers – they're successful people in life, have acquired enough capital to get into the markets, but they're not spending their whole lives studying finance and financial algorithms, etcetera. So they needed a simpler system, a way to kind of understand the risk that they're taking in the markets. And I found that that number, just looking at it – like 30% on Tesla. Here's one for you Northern Dynasty Minerals: 75% [laughs].
Porter Stansberry: Yeah. You can't really effectively use stops on junior mining stocks. There're some companies that're so volatile that the stop would be so wide it's almost pointless.
Richard Smith: Absolutely. And looking at that number, seeing – for a novice investor to read about Northern Dynasty, it's an exciting story, right? But then see 75% volatility, basically you go, "Oh, okay. This isn't the same thing as investing in Walmart or Johnson & Johnson," right?
Porter Stansberry: No, it's not at all. And tell people – if I can jump ahead. Sorry to cut you off.
Richard Smith: Yeah.
Porter Stansberry: This is the part that I can't believe about your technology. When you study these people's portfolios, you can improve their performance without changing anything about the stocks they own.
Richard Smith: Isn't that incredible?
Porter Stansberry: It's incredible.
Richard Smith: Yeah. It blows my mind. And I see it over and over again. And not just with individual investors. I see it with newsletters, and most recently I see it with famous investors, billionaires. But, yeah: Take the exact same stocks – people are not picking bad stocks. It's the way that the stocks are being managed, the way the portfolio's being managed. Knowing when to buy, when to sell, and how much to invest is a game changer. And people need simple ways to do that without having to spend their lives watching computer screens. And I think that's what I've done.
So, going back to your earlier question about risk rebalancing for – basically I started with trailing stops, but what I really would like to be known for – maybe even on my tombstone [laughs] – is volatility-based position sizing. Allocating how much to invest, deciding how much to invest based on how volatile the stock is so that you're putting more money into your less-volatile stocks, and I like to say just amount of money into your speculative, swing-for-the-fences stocks like Northern Dynasty, for example, right? Northern Dynasty may still turn out to be a winner, right? But that's an all-or-nothing bet. You need to put a little money into that that you're willing to forget about for 10 years and see if it turns into a 20-bagger.
Porter Stansberry: So, Richard, tell me about working with these billionaire portfolios. Could you really improve their performance just by changing their allocations?
Richard Smith: You know, it's allocation – so, taking Warren Buffett as an example, my studies so far in his portfolio, is that the allocation that I've been using, that risk-rebalancer algorithm – so, again, it puts more money into the lower-volatility stocks and less money into the higher-volatility stocks. And it takes equal risk on each of those stocks. In the hedge-fund world they call it "risk parity," right? I like to try to use simpler language. I just call it "equal risk." Based on volatility. So, yes, using that simple algorithm on Buffett's publicly-traded investments does produce a higher long-term return.
Porter Stansberry: That's incredible. You're not changing when he buys, when he sells. You're just changing the position size.
Richard Smith: Yes. But there are – one of my favorites is David Einhorn, okay? And with David Einhorn, what I found is the most impactful thing is actually changing when to buy [laughs].
Porter Stansberry: Oh yeah? What did you discover?
Richard Smith: I discovered that David Einhorn gets into everything about a year too early.
Porter Stansberry: That's good to know.
Richard Smith: He's a great stock-picker, and he's picking ideas that are more volatile than most of the billionaires. So I have this red-light, yellow-light, green-light system that I developed, also based on the volatility quotient, as I call it, or the "VQ." And so monitoring David Einhorn's investment ideas and then waiting until they get a green light in my system and then using the risk rebalancer produces 19% annualized gains over the past 18 years.
Porter Stansberry: Sounds like Steve Sjuggerud.
Richard Smith: [Laughs]. Absolutely, man. Yeah. It's exciting stuff. I think it's a great way for individual investors to enjoy the satisfaction and the success of being in the markets. And I see TradeStops as basically an expert system at this point, the best practices. This is how the pros do it. And it's simple enough that individual investors can manage their own portfolio, be in the stocks that they find interesting, exciting meaningful, and do it in a way that they're really managing their risk and having better ideas about when to buy, when to sell, and how much to invest. And how the pieces of the portfolio fit together.
Porter Stansberry: We have to get Buck set up with an account on TradeStops so he can start investing the right way and learn some good –
Richard Smith: Absolutely.
Porter Stansberry: Some good, sound best practices.
Richard Smith: I would love to set Buck up. I'll give you a personal tour, Buck [laughs].
Buck Sexton: I'm excited. I'm in.
Porter Stansberry: Richard, what I wanted you to do now, if you don't mind, is: instead of just talking about TradeStops – although I know these strategies are all part of what TradeStops help people do. For novice investors – let's say you're talking about a guy who's got $50,000 saved and he's terrified of losing it – Buck's putting up his hand – but he wants to start seeing that capital earn some money. Give me your complete playbook. What's the first thing to do? What's the second thing to do? What's the third thing to do? What do you do first?
Richard Smith: The first thing to do is to make sure that you have a good source of investment ideas. So I would say you buy True Wealth and Stansberry's Investment Advisory and Retirement Millionaire. Those are inexpensive newsletters, right?
Porter Stansberry: You get a $100 newsletter. You get mine, which is Stansberry's Investment Advisory, you get Sjuggerud's, which is True Wealth, and you get Eifrig's, which is Retirement Millionaire. And I'd say you spend six months at least just reading them and learning about what the editors are looking for in their investments and seeing which of their ideas tend to work and which don't.
Richard Smith: Yup. And those are inexpensive newsletters, right? You might be spending $400 a year for all three of them. And now you've got probably 100 different investment ideas.
Porter Stansberry: Okay. Now what's step two?
Richard Smith: Step two is: You put those into TradeStops and you see which ones are green or yellow or red.
Porter Stansberry: All right. So you put – what's the smallest number of individual stocks you should buy with $50,000?
Richard Smith: I would say, with $50,000, probably 10 to 15 stocks.
Porter Stansberry: Yeah. I think that's right. And what's the most amount you would consider buying?
Richard Smith: Well, with $50,000, probably 25. But I have done some research on this question, Porter, and I have found that, for individual investors, the sweet spot is between 15 and 45 positions in a portfolio. Above 45 and you lose your edge.
Porter Stansberry: I agree with all that. I was going to say I would recommend a first-time investor buy between 12 and 20 stocks. I would never buy less than 12, and for a new investor, I wouldn't buy more than 20. Because I don't think you can keep that many stories in your head. And one important thing for investors is not to forget what you own and not to keep your eye on it. So TradeStops is going to help you do all that, but you put those – let's say you put those 12 ideas, Buck, into this system. And then you allow Richard to allocate for you. So you hit a button and it tells you exactly how many shares of each stock to buy to allocate your $50,000.
You take that list, you go to your brokerage account, you buy those stocks. And you can actually link your brokerage account to TradeStops so that TradeStops is going to be getting information from your brokerage account to know what's going on with your accounts to help you manage it. And then you don't buy the stocks unless they're in Richard's green-light mode, which means, Richard, they're in some kind of harmonic pattern, right, where they're trending higher? Is that the idea?
Richard Smith: Trending higher, with momentum, and staying within their expected volatility.
Porter Stansberry: Right. So they're trending higher in the right ways.
Richard Smith: They're trending higher in the right ways and they're behaving well [laughs].
Porter Stansberry: Now, let me ask you a question. If you've got a stock – let's say a stock like Hershey. This is a tough question, okay? So you know I'm a huge fan of Hershey's business, and I think Hershey's great long-term for investors because it's very capital-efficient and it grows its dividend. And so now every year – we're now 10 years into our Hershey investment – we're making like 12% or 15% a year just in the dividend on our Hershey investment. It's hard to beat that compounding. So if you've got a long-term holding like Hershey, how do you manage that with your system? Because you wouldn't want to necessarily just sell it because it got into a red-light mode. But you also wouldn't want to hold onto it until it goes to zero if there's something wrong with the company and you don't know it. So how do you manage a longer-term position like that that's paying such a good dividend?
Richard Smith: So I think you would agree with me, Porter, that trailing stops – I think you once called them training wheels, right? Wouldn't you say that?
Porter Stansberry: Yup. I would.
Richard Smith: If you've been investing for less than 10 years, you need the training wheels, right? You need the discipline of following a sell strategy. But what I've come to decide and conclude from my research over the years is that you can use discretion on 20% of your portfolio. Okay?
Porter Stansberry: I like that idea.
Richard Smith: For every two out of 10 stocks – you can choose two of your 10 stocks that you say, "Nope, I'm breaking the rules on this one. Hershey is just – I'm buying and holding it forever," right? You're still using position sizing. "But I'm not going to use a stop on this one. I've got a good reason for it, and I allow myself to do that on two out of 10 of my picks." I bet you'd like that idea.
Porter Stansberry: I do. And I also like the idea that if – this is advanced. But, for me, if I'm getting paid a very high return on my capital, even if I have to take a little bit of extra risk to get that return, I'm okay with it. And at Hershey paying me more than 10%, something would have to fundamentally change to threaten that dividend income for me to sell. And so it's kind of a little bit different than a new stock. I mean, this is a stock we've had for 10 years. So now it's in a different category.
You know, there's another category of stocks – and I don't want to confuse people too much. But I do want to point this out. The other category I've seen in my own investing that doesn't work very well with stops is actually the property and casualty insurance firms. And the reason is: Because when there's a catastrophic loss like a hurricane, the market dramatically overreacts to the potential losses that the insurers face. So after the hurricanes last summer, a lot of very good insurance companies got knocked down immediately 25% or 30%, which triggered all of our stops. Meanwhile, six months later they've come out and they've said, "Yeah, it's going to be a 10% loss for us. It's not the end of the world." And so I think there're certain things like that that trip up stops. But, overall, in a regular operating company, they're great to use.
Richard Smith: You know, in both those cases, Porter, what I hear is a very clear rationale for why you're going to not use a stop, right? Where you get into trouble is when you start making excuses for why you're not going to [laughing] use a stop. And one of my favorites that I ever heard was from a reader who had bought the stock that was going to mine gold on the ocean floor.
Porter Stansberry: Oh yes. What was that one called?
Richard Smith: Nautilus Minerals.
Porter Stansberry: Nautilus Minerals. By the way, I have to tell you. That was one of my favorite all-time newsletter articles we've ever published. It was such a fantastic story. Buck, there was a Russian billionaire who was putting up a bunch of money and the idea was they were going to mine gold off the bottom of the ocean off of Papua New Guinea. What could possibly go wrong?
Richard Smith: [Laughs]. What could possibly go wrong? So this subscriber – forgive me if he's on the call listening. But he's an explosives engineer at Lawrence Berkeley Livermore labs. He designs the explosives that make the oil rigs in the Gulf of Mexico sever from the ocean floor when there's a catastrophe. So they have to work once, only once, and always once. Right? So: Smart guy, right? But he was in Nautilus Minerals, and he said, "Yeah, I'm not using a stop on that one. I'm going to give it to my grandkids."
Porter Stansberry: Oh boy.
Richard Smith: That was the ultimate justification of why you're not selling, why you're not following a discipline. Hope springs eternal, right? "I'm never going to benefit from this but I'm sure my grandkids will. And so I'm going to give it to my grandkids and I'm still going to feel okay about the fact that I didn't have a discipline on this one – I didn't have an excuse for not selling."
Porter Stansberry: And where's Nautilus today? Does anybody know?
Richard Smith: You know, I don't even know.
Porter Stansberry: Country Club Guy?
Richard Smith: I'd be surprised if it even exists [laughs].
Richard Smith: My point is: You have to be honest to be a good investor, right? You have to be honest with yourself. And if you have a great reason for not using a stop loss, fantastic. If you don't, then I've put together a great system based on decades of research at this point. And it's a great way for investors to be in the market with some safety nets.
Porter Stansberry: Yeah. And, listen, I want to explain something. I'm sure there're some listeners who heard me say "This is the best newsletter story we ever published" and then I said the outcome for investors was a disaster. And they're wondering about that dichotomy.
Richard Smith: Yeah.
Porter Stansberry: And, listen, where is it now? Thirty cents? Yeah, it's probably not done well for people. You have to understand: I can appreciate a great story and I can also appreciate a great investment. And what I have learned over the years is: most great investments have a very boring story. And most great stories have a very bad investment outcome. And as a publisher, people are wanting to read great stories. And we find them for them. And they don't always end up as a disaster. For example, there was a natural gas company in Papua New Guinea that said they had the largest – somebody's typing on their mic.
Richard Smith: Yeah, sorry. That's me. I was trying to get into TradeStops to find the volatility on Nautilus Minerals.
Porter Stansberry: Well, we had InterOil, which was the story was: Someone found the world's largest natural gas deposit in a jungle in Papua New Guinea. And it sounded very much like the Nautilus story. Except for in this case, we sent the geologist out to Papua New Guinea, he saw the test well, and he was blown away. It looked like a dang jet engine pouring out of a mountain. I mean, it was an incredible natural gas well. And that ended up being sold to ExxonMobil for billions and billions of dollars. So sometimes the stories work out great. And sometimes of course they end up like Nautilus.
My point is that if you use the newsletter's position sizing and you use a trailing stop, you can invest in these great ideas, some of which will work out and some of which won't. And your returns over time will be fine. But what I know happens is that people fall in love with these stories and they do dumb things like put half their portfolio in Nautilus Minerals and tell themselves they're going to give it to their grandkids. And I'm sorry, but that's not our fault. Because that is not at all what we suggested you should do.
Richard Smith: And that's where TradeStops comes in to help. Because you look in and you see the volatility quotient on Nautilus Minerals at 75% and it's an eye-opener, right? You go, "Oh, okay. This isn't a stock I put half my portfolio into. I'm willing to risk $1,000 on Nautilus Minerals."
Porter Stansberry: Yup. That sounds about right.
Richard Smith: "That means if I'm wrong, I lose $1,000." So it can either be an all-or-nothing bet, or you can go in, and let's say it has a 50% VQ – you say, "I can invest $2,000, and if that $2,000 investment falls 50%, I'm down $1,000, I take my lumps, I move on to the next idea." That's a smart way to be in highly-speculative opportunities like that, because you only need to make about one out of 10 of them work, right? [Laughs].
Porter Stansberry: Yeah. And some of them do work out great. Seabridge Gold went up, I don't know, 700%, 800%, 900%.
Richard Smith: Incredible story.
Porter Stansberry: Yeah. And so we do hit some of these home runs. Regeneron – Dave Lashmet – one of his best picks ever went from $12 to over $600. I mean, you don't have to have many of those, and you actually don't have to have much money in them, to do really well. Let's say you got a $100,000 portfolio, you might put up to $2,000 in a stock like that, and if you make 12 times your money, great. You just made a 25% return on your total portfolio from 1 small pick. That's a great result. But of course you know what happens, Richard. A lot of people think they're investors, but what they really are is gamblers. And we don't encourage that kind of behavior, but ultimately it leads to failure.
The other thing I've always found is: A lot of people who say that they're a buy-and-hold investor – they really are a buy-and-fold investor. Meaning that they're very confident in their approach until they're down 50%, in which case they panic and sell.
Richard Smith: You know, I do want to speak just for a minute, though, to that idea, that impulse that people are in the markets as gamblers. You know, there's an element of that, right? But I think there's a legitimate way in which investing can be fun. But you can still put the odds in your favor. Going to Vegas and just throwing money at the craps table when you don't know how to play the game is stupid. But there is a way to be a smart investor and still enjoy the thrill of the market without having to have it be totally boring. What do you think?
Porter Stansberry: Sure. But you'll do better if you're totally boring [laughs]. If you build at least half your portfolio into really high-quality, capital-efficient P&C insurance companies that are good underwriters, stuff like – Blackstone commercial mortgage is a fantastic security. It's yielding 7% or 8% and it's designed in a way where it really can't fail. It's a really bulletproof thing. Same thing with Annaly, which owns mortgages and has an 11% yield. What I'm saying is: You build your portfolio around a solid financial foundation like that and then you stack on top of that just great businesses, things like Hershey, things like NVR, the home builder that is just an incredible business. Super high-quality companies – you buy them when they're trading at a reasonable price, and you're going to do great.
And the stuff that tempts you, the stories about undersea gold mines and stuff like that – it's fine to play along with that, but you have to understand that that's not really investing. That's speculating. And you really can't afford to speculate with more than about 5% of your portfolio. So if you want to have those names in your portfolio, that's fine. But you have to control your position sizing. And TradeStops will absolutely do that for you.
So, Richard, let's move on to how people can get involved with their portfolio that exists today and your software. How does that work? If I've got an account at say Ameritrade or something like that, how do I link up with TradeStops and start managing my portfolio better?
Richard Smith: So, you can subscribe to TradeStops. You can download your portfolio directly from over two dozen online brokers now. All the big ones: TD Ameritrade, Fidelity, Scottrade, Schwab, etcetera. And you literally synchronize your portfolio into TradeStops. So it's a read-only service. We download your data from your brokers. We don't actually execute any trades for you. But once you're in TradeStops, you can track your portfolio there. You can see the volatility quotients on all your stocks. You can do the position sizing and get alerts and monitor your whole portfolio right in TradeStops.
Porter Stansberry: I use it. It's great.
Richard Smith: And you can also see the newsletters that you're subscribed to.
Porter Stansberry: Yeah. That's the coolest part.
Richard Smith: Like if you subscribe to True Wealth.
Porter Stansberry: Yeah. You can look at your newsletter portfolios directly in TradeStops. So you can just go through there, figure out which ones you want to put into your model portfolio, rebalance them, and then you know exactly how many shares to buy at your broker. It's really easy to use and it's all point-and-click. There's not any – it's not hard.
Richard Smith: Absolutely.
Porter Stansberry: All right, Richard. So, people can go to www.TradeStopsOffer.com. Now, I'm not going to give my crew a hard time about this web address. It's not that difficult. TradeStopsOffer. So all one word: TradeStopsOffer.com. And sign up. And give it a whirl. And, Richard, thanks for being our guest. And, by the way, thanks for inventing this technology and this software that actually makes it easy for people to use our newsletters in the way we intend.
Richard Smith: All right. Thank you, gentlemen. Appreciate it.
Porter Stansberry: All right, Richard. Bye-bye.
Buck Sexton: Thank you.
All right. Here we go. Mailbag. Up this week, everybody. First, thanks to everyone. You know we love you all. Write to us at [email protected]. Number one up this week from Brett. "Dear Porter and Buck, love the show. You guys have a great dynamic together and it's engaging listening no matter what the topic seems to be. Porter, I've read a lot about how you value different types of companies. You wouldn't use the same metrics to value Hershey as you would to value Nvidia. I'm curious how you might approach a company like Apple. It seems to me that Apple's share price has moved the past few years based on whether the market is valuing it as a growth stock, as it was ascending in 2015 and 2017, or as a value stock, as it was correcting in 2016. How would you approach stock valuation for a company like Apple: growth or value? Keep up the great work."
Porter Stansberry: Okay. Well, that's a great question. And I can't really go into full details here. But I would tell you that we have a valuation video that I did somewhere on our website. Country Club Guy can probably find the link and put it on our webpage or our e-mail or something. We'll send you a valuation video to go through this. But you're wrong about – I don't know whether you're just misunderstanding what I've said or you've really got it wrong. I don't quite know, because I don't know why you think I would value Nvidia differently than I would value Hershey. I really wouldn't. They're both operating companies, and as a result, I put them through the same process. So we're looking for capital efficiency – we're looking for revenue growth.
Nvidia is a tricky company to value because it's growing so fast – it's very hard to value. So you have to apply a wider range of possible values with stock like that. But the process I would go through is the same for Nvidia or for Hershey.
In regards to Apple, I think what you're missing is: A lot of valuation is simply based on the current size of the business. Think about it for a second. My little newsletter business is right now about a $300-million-a-year-in-sales business, and serving investors globally is an enormous market. So we have a very wide runway of future growth. So if we started putting a lot more money into our marketing, we could grow this business to $600 million, to $900 million, to $1.2 billion in sales very quickly.
So investors who saw our model and wanted to help us grow and were giving us equity capital – they would probably value us as though we had already achieved that growth because the formula is there, the process is there, the marketing is proven. So you might value my company at a very high multiple of revenues or earnings because it's growing so fast and the runway for future growth is so clear. And that's why people put a very high premium on shares like Nvidia and other companies that are proven growth stocks that have a very long runway.
The trouble with Apple is: How big is Apple? It's already a $700, $800-billion company in market capitalization, and it already dominates its market. Its runway for future growth is not clear at all. Because it already has a huge segment of the phone market. It already has a huge segment of the music business. So think about how hard it would be for Apple to double its sales. It's going to be very difficult. Because it's already so big. And as a result, the growth expectations for Apple stock is much more modest, and therefore the multiples are much more modest.
So really when you talk about valuing a business, any business, any operating business, you're really looking at two variables, which is: What's the quality of this business? What are the return on assets? What are the return on equity? What is the capital efficiency? And what is the growth? So it's: How good of a business is it and how fast is it growing? And then a very important consideration with growth is understanding: how big is that runway? And that's what really drives all these valuations.
So, I hope that helps you, and if you need more, then see our valuation video.
Buck Sexton: So we will skip to one last one in the mailbag this week. We'll hold the rest until next time. So we've got Chris B. here writing the following: "Buck and Porter, I've been listening to you guys since you launched the podcast. I'm a Total Portfolio subscriber now and I'm using that solution for a good amount of my investment capital."
Porter Stansberry: Smart.
Buck Sexton: "With Porter continuing to pound the table on the advantage of safe, distressed corporate debt investing, I'd like to understand how he sees this type of investing fitting into an overall portfolio." Me too, Chris. "How do the rules of asset allocation, position sizing, stop losses, etcetera, apply when investing in bonds? Comments like 'You'll never buy stocks again' seem to imply that bonds could make up your entire investment portfolio."
Porter Stansberry: They absolutely could.
Buck Sexton: "This is of interest to me considering the Total Portfolio has no bond positions currently. Thanks, and keep the rants coming, Chris."
Porter Stansberry: Right. So the trouble with corporate bonds is that they're very illiquid. And if you have been a Stansberry's Credit Opportunities subscriber, you have seen that. We've made something like 22 different recommendations in SCO, but we've only hit our buy prices – we've only been able to get into maybe 60% or 70% of those opportunities because the market is so illiquid that it's very hard for a lot of people to try to buy the same exact bond. Now, I'm not saying it never happens, but I'm saying it's very difficult. And that's why you don't find distressed debt in the Total Portfolio. It's not that I would not like to have it. It's that it's very difficult for that many subscribers to get into an individual bond.
So if you're interested in distressed debt, I recommend strongly that you buy a subscription to Stansberry's Credit Opportunities, where you'll see our portfolio. You'll also see how we manage that lack of liquidity. The biggest thing we do is we show you a whole list of bonds that we think are attractive, not just the bond that we're recommending. So it allows for you to kind of look into the market with us and see what we're doing in addition to the actual recommendations that we make. So it's both.
And that's why – again, it's a liquidity issue that really prevents us from putting it in the Total Portfolio. We want the Total Portfolio to be very easy to use. And buying bonds often takes weeks and weeks and weeks of calling your broker. Now, I think it's worth doing. But I don't think that most of the users of the Total Portfolio would agree. And so we're not going to probably – I'm not saying we'll never have a bond in there. But it's certainly not something we can build a hold bond portfolio as part of the Total Portfolio. It just won't work. It's not liquid enough.
Now, having said all that, I think you should think of your portfolio as being a 50-50 proposition. You should have 50% of your investments in stuff that is a very firm financial foundation, whether that's distressed debt, whether that's property and casualty insurance companies, or whether that's very interesting kinds of fixed income that you can buy through the stock market that I mentioned earlier: Annaly and Blackstone commercial mortgage. So if you've got half of your portfolio in stuff that's going to make you around 10% a year or more, mostly in the form of coupons and dividend payments, half your portfolio is in that, it's going to be very hard for you to have a bad year in the stock market. And that I think should be everybody's goal.
I don't care about beating the S&P 500 when the S&P is up 20%. What I care about is not ever losing money. And I want to make at least 10% a year on my investments.
Buck Sexton: All right. That's going to be it for the mailbag for this week, everybody. Remember: you can write to us at [email protected] If we use your question on the show, we'll send some Stansberry Research goodies. And if you want to check out how Richard Smith's TradeStops beats the billionaires and how it can help you become a better investor, just go to TradeStopsOffer.com. That's TradeStopsOffer.com. Love us or hate us, just don't ignore us.
Mr. Porter, thank you so much, sir.
Porter Stansberry: Buck, it was a pleasure. Today was a long one. Thanks for sticking with us, everybody. And we'll see you next week.
Buck Sexton: Yeah. We had fun. See you next time, everyone.
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