Fear Factor

Dan Ferris advocates a profit strategy that makes most people cringe…and you don’t even have to eat cockroach sandwiches!

"I will tell you the secret of getting rich on Wall Street. You try to be greedy when others are fearful, and you try to be very fearful when others are greedy."

– Warren Buffett

"If you eat this raw pig’s rectum, it’ll put you one step closer to a check for $50,000." Is it worth $50,000 to you to eat a raw pig’s rectum? How about lying in an open glass casket with live rats crawling all over you? Or maybe driving a car off a ramp at high speed, crashing headlong into a half acre of cardboard boxes while you sit helpless in the driver’s seat?

Not worth $50,000, you say? I don’t blame you.

Perhaps you recognize these dangerous, disgusting stunts from the hit TV show Fear Factor. Every week, young people commit risky and repulsive acts on national TV in order to compete for a $50,000 cash prize.

There’s a much easier way to make $50,000 that’s neither difficult, dangerous nor disgusting, and which requires very little time, talent or energy undefined but which most investors are less likely to do than eat a raw pig’s rectum.

Beating the Market: Buying Amazon

Uncomfortable as it is for most people, this simple strategy I’m talking about is without a doubt one of the single greatest secrets to getting rich in stocks. Rather than telling you the secret outright, it’s much more effective to show you a pristine example…

Amazon.com’s initial public offering was 3 million shares at a price of $18 each (presplit). Bill Miller, manager of the Legg Mason Value Trust, bought Amazon’s stock at the IPO, back in May 1997.

Miller sold that first position, later saying it was, "the dumbest thing we ever did." Miller bought Amazon again at $80 a share in 1999.

Amazon’s stock price fell apart, just like every other Internet stock. Miller responded by doing the only sensible thing he could do. He bought more. A lot more. As he told Fortune magazine, "We started [buying] again in mid-2000 when the stock was in the $40s, and then we bought it all the way down. Our buying increased as the stock fell. If the stock was $35, we’d buy 50,000 shares; at $25, we’d buy 150,000 shares; and at $14 we’d buy 300,000 to 400,000 shares." Miller says he finished buying "between $7 and $8."

Miller’s buying strategy goes by a name you might be familiar with, dollar cost averaging. Dollar cost averaging is when you spend the same dollar amount no matter what the stock price is. If you spent $700 for 100 shares last December, that same $700 will buy you about 139 shares at today’s prices. If you bought $10,000 worth back then, $10,000 would buy you 39% more shares today, and so on.

Today, Amazon is around $37 a share. Miller’s average cost for the stock is around $19.69 per share. He paid as much as $82 for some of his shares, and he’s still up 88% with the stock 55% below his initial entry price. From his highest price to his lowest price, the stock fell 91%! And he’s still up 88%! I doubt many people can say that they’ve ever made an 88% profit from a stock that fell 91% while they were holding it.

Beating the Market: Stop Losses

Brilliant as Miller’s strategy is… the "trend is your friend" crowd reacts to Bill Miller’s behavior like an ape in front of an obelisk. Buying stocks that are falling in price? Throwing good money after bad? It’s sacrilege! William O’Neill, editor of Investor’s Business Daily, advises investors to sell stocks of perfectly fine companies if they commit the apparently unforgivable sin of falling by as little as 8%. This is known as the use of a stop loss. I’ve yet to find a wealthy value investor with a successful long-term track record who advocates any such thing. Eight percent is not enough of a price fluctuation to get the attention of a Bill Miller or a Warren Buffett. Nor should it get yours, as long as you’re confident that nothing has changed about the company’s business. Better to heed the advice of Warren Buffett, who once said that you shouldn’t be in the stock market if you’re not ready to watch your stocks fall by 50% without selling in a panic.

Bill Miller is the one and only investor who has outperformed the S&P 500 every single year for the last 13 years. Miller manages the Legg Mason Value Trust, and he’s got $20 billion in assets under management.

And now you know how he makes more money in stocks year after year than any other mutual fund manager. Miller’s strategy, his secret, is so utterly simple. It boils down to a single phrase, one that he repeats to anyone who’ll listen: The long-term investor wins.

Long-term is why Bill Miller bought Amazon shares at $7 after he’d already bought them at $82. Long term is why Warren Buffett is the second-richest man in the world. It’s one of the great secrets of success in the stock market: Think long term. Long term is a perspective on investing that almost no one has the common sense, character and discipline to take; that’s why long term-oriented investors have an instant advantage over the vast majority of amateur and professional investors alike.

Miller doesn’t practice a discipline for the sake of practicing it. He does it because he is constantly trying to beat the market.

And the way you beat the market, the way you get rich in stocks, is to be a long-term investor and hold the lowest- cost portfolio you can.

Regards,

Dan Ferris
for The Daily Reckoning
August 19, 2004

We are still trying to figure it out. We must be missing something…

The "symbiotic" relationship between the United States and China…

China has a problem. It has hundreds of millions of people for whom it has to find gainful employment. The most gainful employment it can find is to follow the typical Asian model: making things to sell to the rest of the world. China, being the largest of the Asian countries, has set out to make and sell everything to everybody.

So far, so good.

How much China can make and sell is limited to how much other countries can buy. In this regard, China has become the world’s No. 1 beneficiary of America’s great credit boom and amazing dollar. Were it not for Alan Greenspan’s Fed and the reserve currency status of the dollar, Americans would have had to stop buying Chinese goods long ago; they would have run out of money. Were it not for Americans’ ability to go more deeply into debt than any other people have ever done, there would be far fewer Chinese products on the shelves of Wal-Mart…and far fewer factories in China…and far fewer Chinese schlepping and busing, toting and lifting in order to quench American’s thirst for things they don’t need and can’t really afford.

Having a currency that is also the world’s reserve currency has permitted Americans a degree of imprudence that no other people in the history of the world have ever been permitted. Who else could run $600 billion annual trade deficits? Who else could borrow so much money with so little hope of ever paying it back?

The Chinese are happy to make things; it brings them jobs, profits, capital and so forth. But in order to keep the orders coming, they know they also have to continue to finance their major deadbeat customer – America. "They have to buy our debt," say America’s hallucinating economists. "It’s the only way to keep their people working. Everybody comes out ahead."

We do not doubt that China benefits by financing America’s spendthrifts. It is industrializing at a pace that would not be possible otherwise. What escapes us is how America benefits.

Bankrupting yourself in order to help the Third World may be a noble thing to do, but it is only noble if you do it on purpose.

More news, from Baltimore…

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Tom Dyson, from Baltimore, Maryland…

– Readers may neither know nor care about the game of cricket, but it is one of your misplaced British editor’s favorites. Played in the summer using a bat and ball, cricket is to the English what baseball is to Americans.

– One of the most unplayable pitches in the bowler’s (comparable to the pitcher in baseball) arsenal is called a googly. It appears to the batsman as if the ball is going to spin in one direction when it bounces off the wicket, but spins in the other, drawing the batsman into a clumsy stroke.

– From our humble perch here at The Daily Reckoning, we are watching Google’s IPO with interest. We wonder if Sergey Brin and Larry Page are offering "the next Microsoft" or if they are bowling investors a googly.

– The shares start trading today…at $85 apiece, valuing Google at $23 billion dollars. That makes Google the same size as GM and almost 50% larger than Amazon.com, which only has a market cap of $16 billion. For readers’ reference, Yahoo! is worth over $38 billion.

– Google’s IPO has been a controversial affair right from the get-go. Investors have been skeptical, while the press has been outright negative…

– And the reason for the hullabaloo? Apparently Google annoyed U.S. regulators when the founders appeared in an interview published in Playboy magazine during the so- called "quiet period" ahead of stock sales. Then the dot- com company was castigated over 23 million shares and 6 million options it gave its employees and consultants.

– Now European fund managers are moaning because Google’s management couldn’t find the time to fit Europe into its global investor roadshow. The fund managers snubbed the auction.

– "Google’s initial public offering raised barely half the amount originally hoped for after the Internet search engine company was forced to slash the price for its shares well below its earlier targets," sneers an FT headline.

– "I always thought they would have to cut the price," said another analyst. "Google are doing a new thing at a bad time with no support…this is a very bad time to have a tech IPO. Tech stocks are heavily beaten down, we’ve had a parade of bad news…then Google decided to do the IPO in a different way, so there are two hurdles to jump. Finally what Google is doing [using an auction] is not exciting to the investment bankers."

– To us, it smells like a bad case of sour grapes…it seems Google snubbed Wall Street, and now the establishment wants retribution. This way, they make sure no future upstart tries a similar stunt.

– "Sadly, however, dreams of a new beach house in the Hamptons will have to wait," pooh-poohs The Economist. "The IPO market is looking rather tired."

– "Its rich valuation – probably above $100 a share – has put off individual punters," continues the magazine. "Along with institutional investors, they may also have been put off by its Dutch-style auction for pricing shares."

– While Google may still be an overvalued tech company trying to join the ranks of Amazon, Yahoo! and eBay, but here at The Daily Reckoning, we love the fact they tried to scorn Wall Street. And we think that all the negativity surrounding the auction is bullish.

– On Wall Street, yesterday’s action was bullish. Stocks soared. The Nasdaq climbed faster than a bouncer delivered from a West Indian fast bowler on a hard Caribbean wicket. It gained 2%, or 36 points, coming to rest at 1,831. The Dow knocked up a century, scoring 110 runs in the session, taking the scoreboard to 10,083. The S&P had a good innings too; it gained 1.24%, to 1,095, by tea.

– And all this despite the unfavorable batting conditions for stocks resulting from further gains in the oil price; yesterday, oil charged to record highs again, and is now looking like scoring a maiden half century. The black goo moved above $47 a barrel, to $47.27 by the end of the day’s play on the NYMEX in New York. Oil has now gained 27% in the last six weeks.

– "Is Google a buy?" asks our favorite columnist Alan Abelson. "Frankly it just isn’t our kind of stock. The problem with paying 40 to 50 times next year’s earnings, or any comparably astronomic multiple for a stock, is that we’ve never figured out when you sell it. Which is why we don’t have $4 billion, we guess."

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Meanwhile, back in France…

*** "Oil Hits Record on China, India Demand," says Reuters.

*** Yes, we are back at home.

"Oh, it’s so nice to be back," said Maria.

We all enjoyed our sojourn around the United States. But some of us enjoyed it more than others. Maria likes to be home. Jules likes to be away from home. Henry doesn’t seem to care. And Edward doesn’t seem to know.

"Are we still in America?" he asked yesterday.

"You little dope," Jules answered. "We left America two days ago."

But there are nine hours of jet lag between Vancouver and Paris. We have come to admire visitors from California; the adjustment is not easy.

"Daddy! Come quick. Edward’s outside, wandering around in the dark!"

Maria woke us up last night. For a moment, we couldn’t remember where we were either. We had a flash: Edward was sleepwalking toward the rim of the Grand Canyon…or wandering the streets of Vancouver at 3 a.m.

When we came to, we looked out the window. There in the yard was a white quilt lit up like a lantern…moving slowly across the yard. It was as if we were being visited by extraterrestrials who came all the way from Mars in translucent bedcovers.

"Edward?"

"Yes, Dad."

"What are you doing?"

"I’m just getting something out of the car…I can’t sleep."

*** "France is boring," said Henry, offering a counterpoint to Maria’s view.

What makes France boring is that its people are much less eager to experiment. In the Old World, people follow tradition more slavishly. That is what makes Europe so much more attractive, of course. People are more careful about what they build, what they do…and what they say.

"The Duboises aren’t coming to our party," Elizabeth explained. "They have never gotten over our snub."

What they never got over was a casual response made to an invitation. "No, we can’t come over right now…Bill has to work this evening…" Elizabeth had told them. But that was several years ago, before we realized how sensitive French social relations can be. Socializing is no casual matter, at least not in this part of rural France.

"We [Americans] are too busy," wrote Michael A. Ledeen, in his book of delusional praise, "to master the old rules of etiquette, and we are far more inclined to overlook boorish behavior than are members of more traditional societies. Even today, failure to address a member of the European, Latin American or Asian upper classes in precisely the proper way can end all hope of friendship or even a good working relationship."

Elizabeth, ever eager to improve us, has organized a large party. Tout Paris will be there. Except the Duboises. But the poor French are in for a shock: American country music. Your editor is going to perform his favorite Johnny Cash songs.

What makes America less boring is that people will do almost anything. They do not mind making fools of themselves, nor do they embarrass easily. America is delightful for its baroque exuberance…its inventive energy and its trashy casualness. These qualities do not make Americans superior; they are prone to the same errors, weaknesses and sins to which all flesh is heir. But it is more fun watching them.