The Contrarian Perspective

I’m sure you’ve heard of high-end stores that have no price-tags on their merchandise. Their motto is, “If you have to ask, you can’t afford it.” The same motto should probably be applied to annuities. The fact is that they are very rarely a good deal for anyone. The only exceptions are people who are so wealthy that their decision in unlikely to affect their lifestyle one way or the other.

Annuities are investment vehicles sold by insurance companies. They come in a number of different varieties which are based on different investment schemes. What they all seem to have in common, though, is the tendency for sub-par returns and high fees. Of course, along with the high fees come high sales commissions. Thus, annuities are among the most over-hyped investment vehicles in the marketplace. Sales agents will talk up their benefits until they are blue in the face. Rarely do they explain all the fine print, however.

Don’t Believe the Hype

Take variable annuities, for example. They are typically tied to the performance of a stock index. Many have guarantees against loss, so that you will never lose money no matter what the market does. It sounds enticing, but take care. Although contract terms vary greatly, they invariably have provisions capping the return you can receive in any given year, shaving points off the actual index performance, excluding dividend payments, etc. the net result is that these contracts by and large underperform simple index investing over time, even with their downside risk protection. And the substantial fees charged eat even further into your returns.

No Good For Retirees, Either

Many retirees see annuities as a good way to generate steady income from their retirement savings. Their simplicity is certainly appealing. But again, over all, this is a poor choice for most, even those in retirement. In nearly all cases, you can generate a superior return with similar levels of safety in other conservative investments.

The Rare Exception

The one aspect of annuities that can make them decent investments for a few people is that many of them are tax-deferred. Thus if you are one of the few people who has maxed out all tax-deferred investment vehicles available to you (and there are more options out there than you probably think), and still have excess cash that you can afford to have tied up for the long term, and are willing to earn an inferior return in exchange for tax deferral, some variety of annuity might make sense. Even then you should think carefully. If you are a ways off from retirement, and your tax bracket will likely be higher then than it is now, it may not be worth it to get tax deferral now, when your tax rate is lower. Many will be better off taking the tax hit up front, but achieving a better return in the long run.

In sum, you can’t go too far wrong by avoiding annuities entirely. If you’re one of the very few people for whom they might make sense in limited cases, chances are your finances will be in fine shape either way.

Warren Buffett famously says that the time to invest is when “blood is running in the streets.” Investing in great companies that have fallen on hard times has been shown to be a highly profitable strategy, but it takes courage. Every now and then, however, what the market views as bad news is in fact great news for a company. A contrarian lives for these situations, and it’s going on right now with Insituform.

You may recall Insituform from our recent article on investing in water stocks. Their core business is a patented technology for repairing deteriorated water pipelines without the staggering expensive of excavation and replacement. Their technique is quite ingenious. They insert a specially-designed bladder into a pipeline. The bladder expands until it lines the inside surface, sealing off any and all links. The material making up the bladder is strong and flexible, and makes for a lasting repair, with no need to dig up the pipes. This is known as in situ reconditioning (which explains the company’s rather odd-sounding name).

The state of the water infrastructure in the U.S. is a dirty little secret. It is in fact in woeful shape, and deteriorating rapidly, as any municipal utility worker will verify. Many of our older water lines are actually made of clay, which as you might imagine is highly vulnerable to cracking and corrosion. Insituform’s technology can make even these old clay pipes effective for many years to come. Naturally, demand for this product should experience explosive growth in the years to come.

The trouble is that, for much of its history, Insituform was carrying some serious deadweight in the form of a tunneling division. This division was expensive and unprofitable. In late March, however, the company finally announced that it will be divulging the division. This is great news for the company, as it means it will be focusing on its core business, which is a veritable cash machine with a rosy future. The market saw it differently, however. The company announced it will take a $21 million charge on the divestiture, and the shares plummeted 20%, approaching a 52-week low. We love it, the market hates it. A perfect time to buy.

You have a golden opportunity to get a great stock at a great price in a sector that’s hot and will only get hotter. Take advantage while you can.

Whenever the market gets a little jittery, a whole crowd of paranoid characters crawl out of the woodwork and declare that the fiscal apocalypse is nigh, and the only way to protect yourself is to buy lots and lots of gold.

There’s nothing magical about gold. In truth, gold is like any other commodity. It has a certain intrinsic value based on supply and demand, which is independent of currency values. Thus it is a good hedge against inflation. But then, so are all commodities.

100 years ago, an ounce of gold would buy you one decent quality men’s suit. Now, in 2007, gold is trading for about $675 an ounce. Which will buy you — one decent quality men’s suit. This is a fine testament to the ability of gold to hold its value. However, if you had taken that same ounce of gold and sold it in 1907 for about $21, then invested it in an index fund earning a 10.5% return (the historical average of the S&P 500 index), you would have $455,456 today. Which sounds like the better long-term investment to you?

In the short run, though, things are more complicated. Commodities tend to rise in price as interest rates increase, due to the interest rate component of the futures and options contracts most often used to trade them. Because a common method of combating inflation is to raise interest rates, commodities of all varieties can have periods of superior performance as prices are pushed up both by the inflation itself, and by the interest rate hikes used to combat it. Gold is no exception.

What many people forget is that good businesses, like commodities, have intrinsic value and thus can serve as reasonable inflation hedges themselves (the exception being businesses likely to be hurt by inflation). However, stock prices tend to go down with rate increases, rather than up. If the fed chooses to raise rates, the combination of the herd waking up and saying “uh oh, inflation” with the rate increases themselves could cause gold to outperform stocks for while, at least until current contracts priced for lower rates expire.

I like gold as a short term play right now, but that’s it. Timber is a smarter long-term investment. It has the same inflation-hedging benefits of gold, with the added benefit of income production, and ever-increasing demand from China. Gold doesn’t grow on trees. Timber does.

The doom-and-gloomers can be very convincing. But remember, the four greatest enemies of investors are greed, fear, ignorance, and hope. Which do you think they are catering to?

It’s a dangerous world out there for investors. Investment scams are rampant, and their promoters are relentless. When searching for investment knowledge on the Internet, it’s best to keep the following words in mind: “here there be dragons.” When it comes to regulation, the Internet is the Wild West. Shysters selling snake oil in the form of the latest investment scam lurk in every corner, waiting to separate you from your money. Further, many popular investments, while not unethical, just aren’t a very good deal. This collection of articles focuses on what to watch out for.

Short the Spammers 2 — GWSO - Time to review the performance of TUBR, our first Short-the-Spammers pick, and add a new short pick: GWSO. This company supposedly is devoted to curbing global warming, but in fact its business is just more hot air.

Short the Spammers - TUBR - Today we launch a new series of articles and a model portfolio entitled “Short the Spammers.” I have long claimed that investors would likely do far better selling short any stocks mentioned in unsolicited ads they receive than buying them. It’s time to put the theory to the test, and perhaps to have a little fun at spammers’ expense. Our first featured stock is Tubearoo (OTC:TUBR), which was touted in a full-color brochure we received this week.

Investment Scams: Anatomy of a Pump and Dump - As part of our ongoing series of articles about investment scams, we’d like to have a look at one of the oldest, yet most dangerous tricks in the book — the pump-and-dump. We’ll show you a real pump-and-dump scam that arrived in our mailbox this month, and have a look at how it played out in the markets. As you might expect, the results were not pretty.

Language is a Slippery Thing - Stock marketeers use all kinds of language tricks to make outrageous claims while avoiding legal responsibility. Get wise to their tricks.

Unscrupulous Stock Marketing: Our First Banned Advertiser - Our first banned advertisement is a great example of the kind of marketing you should ban as well, from your inbox and your mailbox. Outrageous claims of sky-high returns are a sure sign of an unscrupulous operator. Heed them at your peril.

It can be difficult to separate the wheat from the chaff in the investment book world. So check here first before buying a new investment book. Our financial book reviews can help you decide which are worth investing in.

Anyone who has spent any time in Detroit recently will tell you it is by all apparent indications a dying city. Crumbling buildings, widespread decay and a population in flight make for a depressing landscape. Detroit’s fortunes have always been tied intimately to the fortunes of the U.S. auto industry. So it’s hardly surprising that a look at Ford’s and General Motors’ balance sheets will show just as much decay and devastation as a trip through Detroit’s worst slums. The only real question is, Which automaker will declare bankruptcy first?

Let’s start with GM (nyse: GM). Instead of talking about its autos, I’ll just focus on the numbers. Over the past decade, GM’s gross profits have declined from $40 billion to $22 billion, while its debt has increased from $199 billion to over $450 billion, all during a period of historically low interest rates.

The low rates won’t last forever, though. Just over the past three years, GM’s interest expenses have risen 77% from $9 billion to $16 billion and are projected to rise to $18 billion this year. Rates are still very low by historical standards. One of the reasons the Federal Reserve cuts interest rates is to make it easier for companies to get the cash they need to finance growth. Unfortunately, free-flowing cash also makes it easy to dig yourself into a hole. GM supposedly took on all that debt to get its profits back on track, but as you can see, the opposite has occurred.

The simple truth is that GM can’t make enough money selling cars to pay for its overhead, upkeep, salaries and dividend payments. Its solution has been to take on more and more debt, rather than spending its cash reserves, so that it can show a “profit” on quarterly income statements. In other words, GM is kiting checks all over town, using its MasterCard to pay off its Visa, burying itself ever deeper under a crushing mountain of debt.

At present margin levels and interest rates, it will take more than 20 years to pay down its debt load. Imagine what will happen when rates return to their long-term average level, as they inevitably will. With inflation looming, the Fed will have no choice but to raise interest rates at some point. It’s only a matter of time. Plus, GM’s credit rating has been downgraded, meaning future rate hikes will hit it even harder. GM couldn’t get its act together during an era of cheap, easy money. What reason is there to believe it will be able to do so when the ocean of capital dries up?

Ironically, GM’s recent divestiture of GMAC relieved it of its only hedge against rising rates, while leaving it on the hook for any and all default risk. It’s a no-win deal for GM, the sort only a desperate company would agree to. The fact that this deal went through at all is enough to show that GM is a company in crisis, but it’s only one indicator among many.

GM can try closing plants, renegotiating its union contracts, laying off workers and asking for a government bailout of its staggering employee medical care expenses. In fact, I predict it will try all of the above. Doubtless it will be watching Chrysler’s private-capital transformation like hawks. If Chrysler squeezes any concessions out of the unions, you can bet your bottom dollar GM will demand the same. But none of this will erase GM’s massive and ever-growing debt burden.

GM has had its chance to save itself. It has taken liberal advantage of plentiful cheap, easy capital, and matters have only gotten worse. The bottom line is, in order for GM to survive, it needs to make rapid, substantial gains in profitability. Of course, this was just as true three years ago as it is today, and the results speak for themselves. Whatever its massive PR machine may say, GM is already effectively bankrupt. All that remains is for the company to admit it.

A visit across town to Ford (nyse: F) will do little to improve the gloomy atmosphere. The situation is dire indeed for GM, but Ford is no better off. Ford’s balance sheet is overflowing with red ink from unfunded pension and health care obligations. According to The Wall Street Journal, even assuming Ford somehow manages to negotiate with unions a 25% decrease in its health care costs, it will still face a $58 billion deficit, which adds up to well over three times its total market capitalization. The book value of Ford’s non-car assets including cash and equity holdings comes in at about $52 billion.

Ford predicts it will burn through $17 billion of its cash over the next three years. Assuming Ford’s predictions are correct, that leaves $35 billion in assets apart from the car business. Subtract $48 billion in liabilities, and you are left with a value of negative $23 billion for everything Ford owns except the car business. In other words, Ford’s car business would have to be worth $23 billion simply for the stock to have zero value. In order to justify Ford’s current market cap of $16 billion, its car business would have to be worth close to $40 billion.

Is Ford’s automobile business worth that much? Not likely. For a number of years, Ford sold cars at a loss in order to subsidize its more profitable SUV and truck models. Now, just like in the ’70s, the big gas guzzlers are falling out of favor with consumers, who are turning to more efficient Asian models, like those sold by Nissan (nasdaq: NSANY). The results have not been pretty. SUV sales are down in excess of 30%. Ford can no longer rely on high-end models to prop up its profits. It will have to learn to make money selling cars again if it is to survive, and as of yet there are no promising new models with the potential to fulfill this need.

According to the same article in the Journal, Ford can only realistically hope for about a 2% pretax margin on its car sales. 2006 sales were $132 billion, but Goldman Sachs predicts Ford’s sales will decline for 2.5% annually for at least the next three years. Frankly, I believe even this estimate is optimistic, but let’s go with it. That leaves sales of $122 billion. A 2% margin on this gives $2.44 billion in pretax income.

If I value the business at 10 times its annual pretax income, that means Ford’s car business is worth about $24.4 billion based on pretax earnings. Subtract the $23 billion deficit from the rest of Ford’s balance sheet, and you’re left with a valuation of $1.4 billion. Subtract taxes, and Ford is worth less than zero. It’s difficult to imagine how Wall Street justifies a $16 billion market cap for this company.

Perhaps the most telling sign, however, is Wall Street’s reaction to recent rumors that the Ford family was considering selling some or all of its stake in the company. The family now controls about 40% of the outstanding shares. When rumors of a possible sale began circulating, the shares went up 4.8%, the biggest jump in over six months. This despite repeated statements by the Ford family that the rumors were false. That kind of a reaction to a potential unloading of the Ford family’s 40% voting power speaks volumes about the confidence level of the investing public in the company’s current owners and managers. The sum total amounts to roughly the same as Ford’s true valuation: less than zero.

In sum, Ford and GM are both effectively bankrupt. Whether they end up declaring Chapter 11, or undergo a massive “restructuring” that amounts to the same thing, is hardly material. The only real question is Which will go first?

According to the Random House Unabridged Dictionary, the definition of contrarian is “one who rejects the majority opinion, as in economic matters.” While it is important to understand what this says, it is even more important to understand what it does not say. Many investors believe the definition of contrarian strategy consists of nothing more than looking at what the market as a whole is doing, and doing the opposite. The crowd is running North? Run South. (This applies to many “contrarian” mutual fund managers, by the way.)

This misses the point. Think about it. If you always do the exact opposite of what the crowd is doing, you’re still controlled by the crowd. What’s more, the crowd isn’t always wrong. As the saying goes, even a broken clock is right twice a day.

The Herd Mentality

Ignorance, Greed, Fear and Hope. As Edwin Lefevre wrote in the investing classic Reminiscences of a Stock Operator, these are the greatest enemies of investors everywhere. Regrettably, they are also the primary driving forces behind most investors’ decisions. Ignorance causes them to rely on the word of self-styled pundits, brokers with ulterior motives, or other talking heads that are long on extravagant claims and short on performance. Greed causes them to jump on spurious promises of outsized gains from penny stock pumpers, internet hucksters, and other shady characters. Fear causes them to sell winning positions too early, wanting to “lock in gains.” Hope causes them to ride losing positions all they way down into the gutter, hoping in vain for a recovery.

Investors tend to move in herds. A market analyst from a big, impressive-sounding institution changes his rating of a stock from “hold” to “buy,” and the herd stampedes to their brokers to load up. The herd never wonders why the analyst never publishes reports of his historical results. He’s a highly paid professional, so he must know what he’s doing, right? The herd never considers that the institution’s only incentive is to get them to trade as often as possible, so they can collect their commissions. They just run for the troughs to load up.

The contrarian, on the other hand, sees analysts, pundits, and brokers for what they are: a bunch of emperors with no clothes. The contrarian views all mass movements of the herd with great suspicion. Rather than spend time studying trends, the contrarian looks for hidden treasure in the form of great companies that have been ignored by Wall Street mouthpieces.

Why be a Contrarian?

James Montier, author of Behavioural Finance: A User’s Guide, puts it best:

“A recent paper by Dasgupta et al shows that the stocks which institutional fund managers are busy buying are outperformed by the stocks they are busy selling! Over a two-year time horizon Dasgupta et al found that, on average, the stocks that fund managers had bought most over the last five quarters underperformed the stocks they had sold most, by 17%! They found that this strategy worked for large and small caps, and value and growth stocks, so regardless of your universe, being a contrarian seems to make sense.”

In our minds, the true definition of contrarian strategy is simply thinking for yourself. If the herd is running north, we might run South. But we might also run East, West, or sometimes even North. But always for our own reasons, never just because of the way the herd is running.

In fact, a contrarian often makes his biggest profits along with the herd. We invest in boring, forgotten, undervalued companies, then ride the wave when the crowd finally discovers them. It’s hard to lose when you buy things for less than they’re worth.

Being a contrarian can be scary at times. It can take courage to go the other way when everyone you talk to is gushing about how they’re getting rich in the hot trend in fuel-cell stocks, junior mining corporations, oils sands stocks, or whatever the next paper tiger turns out to be. But which takes more courage, in the end? Thinking for yourself, or following the herd — off a cliff?

So start a revolution — think for yourself. And only take advice from someone who has a vested interest in your success.

Political developments are indelibly intertwined with your personal wealth and well-being. It is vital, therefore, to keep abreast of politics and to be aware of how government affects your business and your investments. It likely will come as no surprise that we at QuiteContrarian.com have a strong libertarian streak. We are all about individuals taking control of their own lives and achieving success and financial independece. We are therefore dedicated to rooting out all the subtle ways politicians get in the way, whatever their intentions may be.

The Dollar - Dead Cat Bounce?

Ron Paul for President Update

Ron Paul for President

Thoughts on Tort Reform - Your editor is excused from jury duty at the last minute, but can’t help pondering the asbestos-related mesothelioma case he might have sat on, and the ongoing debate over tort reform.

A Record Day for the Mailbag

Peak Oil is a Paranoid Delusion - Over the past few years, more and more apocalyptic stories have been

popping up about a supposed phenomenon known as “peak oil.” The

theory is that we’re running out of oil, the big powers are keeping it

quiet, and as supplies dwindle, world-wide economic chaos will ensue. In light of the facts, however, it’s clear that this fear is unjustified.

There’s Nothing Magic About Gold - Gold is not the magical refuge that some would have you believe. In fact, in the long run, it is a poor investment. Find out why.

Net Neutrality: An Urgent Call to Action - The Internet is the most democratic, open channel for communication and exchange of ideas in the history of human civilization. We value individuality, self determination, and independence above all else. Until now, the ability to reach a large audience was strictly limited to the wealthy and powerful, due to the great expense of getting the message out. The Internet has changed that. Now, anyone with a great idea can reach a virtually unlimited audience. The only thing standing in the way is whether people find your idea compelling or not. If they do, it is bound to spread and reach its full potential, no matter who you are.

Al Gore’s Bright Idea - Al Gore has come up with a way to reduce carbon emissions, increase wages and employment, and maintain present government tax revenues, all in one fell swoop, without raising taxes a single penny. How can this be possible?

As our regular readers know, there’s more to contrarian investing than just being contrary. To be sure, contrarian investing is about rejecting the herd mentality and thinking for yourself, but it’s also about finding techniques and ideas that have been overlooked by the crowd. This collection of articles will help you find hidden treasure in the form of overlooked companies, as well as new ways of investing to reduce risk and increase your profits.

Short the Spammers Portfolio Update - With the markets bouncing all over the place, unsure what to make of the Fed’s recent less-than-hoped-for rate cut, we thought we’d take a moment to see how our short picks are doing. A quick look at the charts showed that we’re up 68.5% in just 5 months. Not a bad start.

Changes at Zecco - Zecco Trading announced a new commission structure today. So are they still a good deal for traders? Get the details and our take on the changes.

The Rex Agreement - A New Option for Home Owners - A finance firm called Rex and Company has recently begun offering a new way to cash out the value of your home. It allows you to free up equity without moving, taking out loans, or making any payments, ever. So how does it work?

The Million-Dollar Dime

Why You’re Still Poor - Why are most of us still poor? The simple answer is that we lack discipline.

Jack Brynaur’s Latest Article Leads at Forbes.com

Why We’re Not Selling Short - As the overall stock market rally continues, and the Dow has reached new record highs, now seems like a good time to comment on why we haven’t yet made any short recommendations for 2007. After all, in a bull market, wouldn’t a proper contrarian be betting on the downside? Not necessarily. Find out why we don’t like selling short, even when the market is surging.

Update on Insituform - Despite Stanford’s recent downgrade, we remain confident in the rosy future for Insituform’s core business, and pleased by the divestiture of the tunneling division.

Insituform: A Blessing in Disguise - Warren Buffett famously says that the time to invest is when “blood is running in the streets.” Investing in great companies that have fallen on hard times has been shown to be a highly profitable strategy, but it takes courage. Every now and then, however, what the market views as bad news is in fact great news for a company. A contrarian lives for these situations, and it’s going on right now with Insituform. It’s time to buy.

Investing in Water Stock: Options for Profiting from ‘Blue Gold’ - Until recently, few were aware of the large and growing worldwide shortage of clean, fresh water. Even in the U.S. water infrastructure is crumbling, and will soon require a major overhaul. Awareness of the problem is growing, however, and investing in water stock is now a hot topic among investors of all stripes.

Sorry, But Your Baby is Ugly - We personally love the Netflix service, but we invest in companies, not products, and Netflix as a company has trouble on the horizon.

Single Stock Futures - What are single stock futures, and why should you care? Find out why this little-known investment tool belongs in your arsenal. Short-sellers in particular should take the time to learn about them.

A Yen for Yen: Profiting from the Japan Carry Trade Rollout - The Yen is bound to strengthen against the dollar in the coming months. Some experts estimate that the yen is up to 40% undervalued. The Japanese are incentivized to keep the price low, but they can’t keep it there forever. Find out how to profit as the valuations even up.

Let’s Get Real: Investing to Combat Inflation - The best way to combat inflation is to invest in real assets. Timberland is one of the best options available. Find out why.

The Definition of Contrarian - An introduction to the mindset of the contrarian investor.

Warren Buffett’s Warning - Warren Buffett issued an ominous warning about our fiscal future in this year’s shareholder letter. Find out how to prepare for fiscal uncertainty.