DELEVERAGING & DEFLATION: SOMETHING SCARY COMES THIS WAY

I just finished reading Gary Shilling’s book, The Age of Deleveraging, and Harry Dent’s, The Demographic Cliff. Both authors are respected prognosticators who called the real estate and financial meltdown. Both of them are saying that we’ve begun a major deflation of our economic activity that is being masked by aggressive central bank intervention and that that intervention cannot successfully mask the problem much longer.

Deflation Due to an Aging Population

Harry Dent bases his prediction on the fact that my generation, the Baby Boomers, are slowing down their earning year, heading into retirement and were shocked by the financial crisis in 2008 into aggressively saving, rather than continuing to consume and that the next generation is much smaller and can’t possibly make up the slack in the economy. In effect, demand is going down and there is nothing anyone can do to pump it up. Retired people don’t borrow money, start businesses or spend like they have a job when they are on a limited budget.

Gary Shilling arrives at the same conclusion for the same reasons and backs his forecast up by pointing to Japan, an economy that is in its third decade of deflation for similar reasons to what we’re about to experience; an aging population that is slowing its spending pattern. Shilling points out that Japan has implemented far more aggressive bond buying and money printing than the US has done with little positive effect.

In spite of it all, deleveraging continues.

The Deleveraging Paradox: Less Consumption Means Less Profit

In essence the problem of deleveraging is a paradox of economics; what is good for you as an individual can be very bad for us as an economy. For instance, it is a solid long-term wealth strategy for individual families to save every penny they can save, pay off all their credit card debt, drive an old car and live three generations deep in one house. But, paradoxically if we all did that, consumption of iPhones, housing, clothing, furniture, movies, restaurants and cars would dramatically slow down. Less consumption means less profit for companies which in turn lay people off. Those workers, being unemployed, will necessarily cut back spending; less spending takes us deeper into recession and ultimately into a depression.

Bernanke certainly saw this as the real problem facing America. In spite of a great deal of criticism from the right, he used the power of the Fed to pour several trillion dollars into the financial system via banks and the US Treasury. It seems quite likely that doing so saved us from dropping off a fiscal cliff in 2009. The question is whether the Fed is powerful enough to keep the song playing while the whole country searches for chairs to sit in when it stops. Japan’s experience indicates they can’t.

Howard Marks Discusses Investment Risk

The list of bears is growing. Last week one of my favorite gurus, Howard Marks, the founder of Oaktree Capital and one of the best distressed debt buyers in the world came out with a memo where he discusses Risk. He suggests we’re getting toward the end of the game and that we should adjust our thinking and our portfolios for the conditions we are in.

Conclusion: Prepare, Protect and Grow Your Wealth

Here’s what I’m doing; I’m only buying companies I want to hold through a drop at prices that reflect a margin of safety. Nothing new here. However, if I get all the signals screaming to get out all at the same time I may liquidate several positions even at a small loss to stack up cash like I did in 2007. It can be scary to do that too soon and be sitting on the sideline in cash but to not do it at all leaves you with everything on sale and no money to spend.

What are you doing to prepare for winter? Click the button below to download my FREE 6 PRINCIPLES FOR MARKET CRUSHING INVESTING video now.

 

Now go play.

market crushing investing

About Phil Town – Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.

  • Garrett

    Herbert Koehler / Rulers,

    BWLD – great company. Love it. Bought it years ago and sold out way too early. One of the companies I owned and it got away from me!

    First, before you make any more decisions on buying BWLD, I’d read 100% of the articles available at SeekingAlpha.com. Right now, BWLD is correcting downward and we want to see where the dust settles on that new price. In the meantime, we focus on “The Story” and get our 4M analysis.

    We can share BWLD’s Valuation on the blog and use it as an example for the other Newbie Rulers.

    Nothing wrong with bailing out of BWLD if you bought at the top and are riding this down. If you only have $10,000 to invest and it’s dropping hard, you can get wiped out pretty early. Buying at the top can take YEARS to break-even. I’ve been there – done, did and continue at times to do that!

    Yesterday, I got more into cash – even took a few loses because I wanted to be loaded up on BP shares if the price drops to $40 or lower. It really stinks when things go on sale but you’re sitting there with nothing in the account to take advantage of the price drops.

    Bed Bath and Beyond – looks like good news but I sold out before earnings because it was never a “Just One” for me. I had always entered the position with the idea that I’d trade it at about mid $70’s. However, with BP dropping and BBBY making a nice pop since I bought it, I wanted to lock in profits and have cash for more BP/other “Just One” companies if/when the market drops.

    My personal investing strategy for the next 12 to 24 months is to be a very conservative investor. I don’t like where the overall MACRO view of things are headed and I want cash to buy stuff at great discounts.

    To Your Wealth!

    Garrett

    • Ross

      Garrett,

      How much percentage of your portfolio does Rule # 1 advise when entering a new position (“assuming all 3 signal’s are saying buy”), and when does it make the most sense to increase your position after you’re already in? I find myself struggling with that one b/c I don’t necessarily like to put 20% right out of the gate but then I find the price goes up and wishing I bought more. I know you can always buy more if the price drops back to the MA line and signal’s still saying “buy” but curious what your experience has been.

      Thanks,
      Ross

      • moncho

        Ross,

        If you find a R#1 company you are looking to get into, have a plan before you purchase a single share. We Rulers prefer to buy in 4 separate blocks if possible. So if you have $10K for this one company, buy in $2500 increments.

        Does it stink that you may miss out if it decides to take off? Absolutely, but what we need to remember is no one, NO ONE, not Phil, Garrett, you or me knows where the market price (aka your R#1 company) will go day by day. It has taken years to drill that into my head but it is one hard core fact of investing. That is why we buy in 4 increments. If it goes up, maybe we need to re-evaluate and see if our calculations are correct. If they are, then we can employ some R#1 Cash flow strategies while we wait for the price to come back to MOS. If not and the price is still within our MOS, then we go ahead and buy our second/third or fourth tranche.

        I learned the lesson the hard way, just like many other rulers. We are trying to stop you from making the same mistakes. Buy in four tranches, and in the long run, you will be better off.

        Moncho

        • Ms.MP

          Moncho,
          What kind of time frame, or triggers do you look for before buying in the next block of stock?

          I was also wondering if there were some helpful suggestions for small time new investors in what/how to look at businesses (other than the basics from R1 book) if you had quite a bit less than that 10K starting out?
          Ms.MP

          • moncho

            Ms. MP,

            There are numerous triggers that could happen based on a given situation. One instance in Phil’s book, he mentions CMG and even though it was going up. Doug and Susan stepped back, revalued the company and decided that based on the market sentiment and current information, the stock was going up, so they purchased again. It didn’t matter whether the stock price was up, it was that the VALUE of the company was greater than price and then made their next tranche.

            New news that changes the potential and possible value of the company, can make a good entry point. A good example would be BBBY and DE stating new share repurchase plans.

            Last but not least would be a R#1 EVENT. If we are sure of the VALUE of our company, buying during an EVENT is the best of both worlds.

            As for small investors with less than $10K or even <$2K, you can just purchase less shares. You may even need to look at cheaper stocks within an industry you know. The issue you will face will be keeping fees below 1-2% of each transaction. You will probably want to go all in on one purchase to help keep those costs down.

            Moncho

          • Ms.MP

            Moncho,
            I was concerned with buying less shares….
            Say you had $2000…According to your 4 tranche rule you would only spend $500 per block. Business X stock goes for $234 so you can only get 2 shares at a time. At the end you could have 8. I had read that having odd numbers or small blocks could be hard to sell later…if it starts going down fast.
            Anyone have any experience or concerns with this?

        • Ross

          Thanks Moncho, however, not sure I agree with the 4 tranche rule. Unless something material is announced that will increase the intrinsic value of your company you have the most chance of making the most money when you invest when you have a large MOS and all three signals are screeming “buy”. From my experience, I tend to go in say a little larger amounts up front and buy 1 to 2 more tranches if the stock retreats (a little – say back to MA line), but all signals are still indicating buy. Take a look at simbols CELG, and GILD for good examples of companies that I bought with big MOS’s and have held throughout there uptrend while buying a ilttle more when they decrease in price after hitting new highs. However, I will sell as soon as all three signals tell me to get out, or I’ll sell a lilttle earlier to lock in profits once they hit or slightly exceed my Sticker Price.
          I’m wondering how much as a percentage of people’s total portfolio’s they are willing to invest in one holding. I’ve held as little as 10% and as much as 40%. Thoughts?

          Thanks,
          Ross

          • Moncho

            Peter and Ms MP,

            Ms MP – At a small $ level, you will need to buy all in at once and may not be able to do tranches. That is OK as we want to keep fees at bay. You are exactly correct, odd lots can be difficult and I would try to keep them at 10’s or 100’s. If the stock has a lot of volume, sometimes odd lots may not be an issue.. I have been stuck in this situation before and it took a while to get out.

            Peter – Four tranches is just a guideline and you may choose as many as you like. I know a person who likes five and I noticed you did two. If two works for you, excellent. The only reason we like four is it gives us a chance to purchase at better prices if the stock moves against us so we can lower our basis. Plus it helps lower ERI and that is always a winner.

            As for GILD and CEG, Great Job on those. :-) I have a few shares (literally, only 20 shares) of GILD. I did it to help a friend calm ERI. My friend felt much better when I went along for the ride. I wish I would have done more homework when it was in its 70’s but it was only a trading stock for me and that was it. Biotech and Pharma scare me so I tend to stay away from them. One day they’re here, the next day they’re gone.

            Garrett has mentioned “Early Retiree” on SA. If you haven’t already, you should check out some of his valuations on a couple pharma stocks. They are pretty sweet when looking at the future of pharma sales.

            Great Days,
            Moncho

    • Haley

      I don’t know where the original chart came from (ZeroHedge maybe) but this popped up on my FB feed and I thought some might be interested in this chart about BBBY stock buybacks. Interpret it as you will…

      https://www.facebook.com/thebubblefilm/photos/a.326841860736894.83223.271964312891316/709835332437543/?type=1&permPage=1

      • Mike Mac

        Lots of talk about BBBY being a buyout candidate due to yhe large stock repurchases.

        • B

          it could just mean they have been using share repurchases to boost their EPS. as the number of shares is the denominator in the EPS ratio, when there are fewer shares floating, the EPS ratio goes up. sometimes, the CEO’s compensation bonus is tied to EPS performance, so they are incentivized to jack this number up in any way possible.

  • Garrett

    Chris,
    I have to work with multiple platforms for various reasons. I’m very familiar with TradeKing, Etrade, Fidelity and Charles Schwab.

    Of all those, I think TradeKing is the most user-friendly and intuitive. Plus they have low commissions.

    And I always have the free account from Think or Swim working in the background as I use that for looking at the charts.

    I think if you’re looking for a simple platform and low/reasonable commission, I think you’d be happy with TradeKing.

    To Your Wealth!

    Garrett

    • Chris

      Thank you Garrett!
      Hope next time I can help you out somehow!
      See you around!
      Chris

  • Chris

    Hi!

    Could one of you suggest me a trading platform which is good for Rule#1 investors?
    (Not much trades in a year and it is available from many countries) Ameritrade is not available here where Iive in the EU.

    Maybe Interactive Brokers?
    But as I have heard they want you to make 10 trades a month.

    It would be nice if in the Toolbox we could even buy and sell :)

    Kind regards,
    Chris

  • King

    Hi, I know some of you are keen on BP, but the energy sector as a whole seems to have been sold off. I’m looking at the offshore drillers, specifically Noble Corp.

    Their paying a 6% dividend yield at current prices, which costs about $400~500mil in earnings per annum, and their Free cash flow is almost 2billion. The company has just finished a large Capex (almost 2billion per annum for the last couple of years) and theres going to be a large free cash flow coming in next year. Debt is in line with the sector.

    Anyone heard of this company? Their growth is all good and margins are strong but their getting hammered because of concerns over oversupply of oil.

    • King

      oil & oil rigs*

      • Moncho

        HI King,

        I know NE pretty good. Yes they are getting hammered but is Mr Market correct at this moment? That is the question. Their FCF should expand next year but what do you think about the industry itself? The analysts are estimating their EPS to be $2.54 at the end of 2015 which is a 20% drop from 2014 estimates.

        Looking over the oil and oil drilling space, we all know they will not be going anywhere anytime soon so this could be a temporary glut in their long and continuing history. What made you decide to look into oil industry and specifically oil drillers? Do you work in the industry?

        Moncho

        • KIng

          I decided to take a look at the oil industry during the Macando disaster and came across the offshore drillers, they had sold off decently back then, I bought some then sold out with a small profit. Its come down again recently and I thought now might be a good time to buy. I did a quick check back then using the big 5 and almost everything was good, management is truly excellent. Even with low growth prospects, the valuations are just so compelling, they are trading at around 3~4x FCF and below book, there is no issue on debt as repayment is spread out over 10 years. Market cap is about 6 billion and their FCF is about 1.5~2billion, rig utilization for 2015 is about 70% booked. Management expects the slowdown in the drilling sector to last until early 2016, given their backlog, they would have ridden out most of the downturn in the industry.

          • moncho

            King,

            All those things are true but do you believe their backlog will keep its current valuation if day rates drop?

            Many of the rigs NE has are located in the Gulf of Mexico and day rates have been sliding pretty good and therefore will affect their total backlog and forward earnings.

            Right now they have a 6PE and if it stays the same, it will put the price near $17 at the end of 2015, even with their backlog (which may be 20-30% less). I do believe, like you, they have enough to satisfy their debt along with sustaining the dividend but we could be in for a long downturn, even into 2016.

            For me personally, I wrote some R#1 LEAP Puts into 2016 to making sure I stay near or under price levels based on analysts estimates.

            Moncho

          • King

            Hi Moncho, thanks so much for your input. I’ll probably wait longer and see how things turn out. In the long run I think theres still a decent future for the offshore industry. So I’ll still be keeping an eye on it.

            Best Regards,
            King

  • Peter

    PS If I haven’t done so already, I want to thank Moncho & Garrett and whomever for taking time out of their busy lives to help those of us just learning the ropes. It’s appreciated.

    • Garrett

      Thanks! I appreciate that!
      Personally, I think the downside potential of the market outweighs my upside risk. On Friday, I established more covered calls, took some profits (and some small loses) and decreased my position in other holdings moving more into cash.

      Like Phil said in his commentary, if in the next two years there is a big correction, I want to be able to take advantage of that.

      To Your Wealth!

      Garrett

      • Sam

        Dear Garrett,
        which bandwidth is “big”?
        • declines of up to 10% are considered pullbacks
        • drops of 10% to 20% are corrections
        • more than 20% falls are bear markets

        More specific, for some of my shares I’d need at least 30 percent downside in order to dive under the MOS.
        e.g. share X bought for 87 is now 135, share Y bought for 29 is now 82 – when selling now it might take another five or seven years to get this (MOS)price – if ever – no guarantee there – it needs actually a crash like 2007-8. It’s likely not going to happen – speaking of ‘don’t fight the FED’.
        So where is the added value of going into cash in this example?

      • Ross

        Garrett,
        From my experience, I would be less concerned about the direction of the overall market as there are always opportunities to buy great companies on sale. The trick is being there when the signal’s are telling us to buy and of course exit. If the market starts to turn and your rule # 1 company is impacted that the signals will tell us to get out. The market can be useful to perhaps help understand why a stock is declining or increasing in the absence of material new information (ie. market setiment), but I don’t think you should sit around waiting for a market correction. The market will go up, until it goes down. No one knows for sure when it will happen but in the meantime don’t lose good opportunities to make money. No one thought the market would have the year it did in 2013 and a lot of people were sitting on the sidelines. There are always great companies and opportunities to buy – you just have to look a lilttle harder :)

  • Peter

    Hi Moncho,
    I think that the phone craze is the single biggest cultural change to happen to people since underwear. People are camping out for a week or longer on the streets to be “first” to get the new phone. You would think that it was all 4 Beatles in the store giving a free concert instead of a damned PHONE. A phone.. I don’t know, I’m not all orgasmic over my phone. It rings and I say “hello”. That’s about it.

    People are scared and I think they’re distracting themselves.

    • Garrett

      In America, people line up to get phones.

      In some countries, people line up to get fresh water.

      FACT:
      In America, “poor people” get free phones, desktop or laptop from US Taxpayers via our government:

      “If you meet certain low-income requirements, you can receive a free basic cell phone with a free calling plan of 250 minutes per month. You may also be eligible to receive a $10 per month broadband Internet connection and a low-cost desktop or laptop computer for your family.”
      USA Today
      http://usatoday30.usatoday.com/tech/columnist/kimkomando/story/2012-06-01/low-income-lifeline-plan/55315532/1

      To Your Wealth!

      Garrett

    • Moncho

      Peter,

      I get what your saying about the whole “Standing in line” thing. I don’t understand it either. The only thing I use to stand in line for was concert tickets only to get good seats when I was younger.

      I do know many of the individuals around me believe in “ignorance is bliss.” When I go off on my tangents, I catch the blank, kinda boring, look on their face and then immediately work down the conversation because It is going in one ear and out the other.

      Anywho, 6+ million iphones, pre-orders sold out, backlog of iphones and will AAPL have enough for Christmas rush? Plus the new Apple-Pay that will be accepted at stores and Whole Foods. Will their iWatch make a dent? It looks to be affecting FOSL and other watch makers. Those are questions I am looking into myself with regards to AAPL.

      Great Days!
      Moncho

      • Peter

        I think maybe the whole scene out there gets to me and I just need to vent with some acerbic social commentary. I really do think that the online world, including Fakebook, Twitter and especially cell phones and all their trappings, have changed society at a cellular level. (no pun intended). Where once we had to worry about some idiot drinking and driving and not looking at the road, now we must contend with huge numbers texting while driving down the highway. People cannot stand the sound of silence and solitude any longer and have to take the 1000 Fakebook friends they’ve never met with them wherever they go.

        OK, venting complete. Back to learning this stuff for me…

        • Peter

          PS If I haven’t done so already, I want to thank Moncho & Garrett and whomever for taking time out of their busy lives to help those of us just learning the ropes. It’s appreciated.

  • Garrett

    Rulers,

    This just came in the email – Phil’s going to be joining an “A – List” of motivational speakers in October – Tony Robbins, John Maxwell, Steve Harvey, etc… Last time I attended something like this, Phil graciously met me at his hotel and brought me backstage to meet everyone and then gave me a first row seat for the event. Definitely a fun day!

    Check out the link:

    http://powerofsuccess.us/?ssid=2d47a26a-c79c-4480-8256-85e560f042f3

    To Your Wealth!

    Garrett

  • Garrett

    In case you all are wondering if I have a life or if I just read Phil’s blog…

    My lovely wife is in Michigan with her company – and I got stuck hosting dinner at our house for the entire Girl’s Varsity Soccer Team – 17 teenagers – ugg!

    Tacos, Chilli and Hotdogs…those girls can really eat!

    …But I must pat myself on the back because I thought I did a darn good job on my own – and I even got a big hug from my 17 year old, Alexandra for doing such a great job! …and that is worth more than a BP Jan 2016 $45 LEAP! (Rule #1 humor if you understand options!)

    To Your Wealth!

    Garrett

    • Peter

      No Garrett,
      We didn’t question your life outside of the blog. But some of us were secretly wondering if you were, in fact, Phil himself, posting under an assumed name, since you’re the only one who replies to these questions we post… :)

      17 teenage girls? You are indeed a brave man. Kudos.

      • Garrett

        That sir is indeed very funny! I’ve had time this week to help and I emailed Phil and Jeff Town that I’d be available if any of their students needed help – otherwise I’d be writing on the blog this week.

        Phil is here – he reads just about everything. Many of the blog Rulers don’t see the volumes of material Phil writes on a weekly basis for his “Phil Town Live” Students. He writes a Mon, Wed and Friday commentary on whatever happens to be on his mind – consistently good stuff. He also teaches classes during the week via webinars that are usually 90 mins long.

        I’ve been mentored under Phil for a long time (I think 4 years now) and I’ve just kind of taken it upon myself to spread the Rule #1 Revolution by volunteering my time helping Newbie Rulers here on the blog. Phil’s generously given me a fairly long leash to do that however at times I get too deep into things and Phil shoots me an email reminding me to keep it to Rule #1 Fundamentals – but I do cheat a little and drop some seeds about Rule #1 PUTs and Rule #1 Covered Calls.

        I do my own investing – sure many times we’re all looking at the same company. BP, Whole Foods, etc..Phil may invest in a company after an “inch wide – mile deep” analysis of a company, but to me if it just doesn’t have a lot of to MEANING to me, I’ll definitely pass. If you can’t handle reading the 10K, then it’s a “no go” in my rule-book.

        I still make some mistakes – but I’m quicker to acknowledge them and mitigate huge losses – I’m better at knowing when to take profits or buy more because the price dropped . Over the years my confidence and ability to be patient/rational have improved significantly and I’ve made up the big losses I had in my retirement account.

        I suppose that’s helped raise my confidence that we can all recover from our mistakes.

        I’ve also learned some rules for myself regarding capital allocation and finding a “Just One” company. I won’t invest in a new company until I’m making money in the one I’m currently investing. You need to leave money on the side to buy more if it goes down, lower basis, etc.

        Take BP for example. It peaked at $53 this year and then dropped like crazy to $46ish. I only had half of what I would have liked to own because I wasn’t willing to buy more above $50. So now I have a chance to buy more and lower basis.

        I’ve also noticed that over the last several weeks I’ve gradually added covered calls to my other holdings. Things appear to be hitting ceilings in the MACRO and in some of my individual holdings.

        When that happens, I’ll either sell something to free up some cash or do some covered calls going out a few months like the Jan 2015 / Jan 2016 LEAPs.

        Here’s a link one of my Rule #1 Wealth Buddies sent me this morning written by Seth Klarman, author of Margin of Safety and an investor we follow on Gurufocus.

        http://www.zerohedge.com/news/2014-09-17/seth-klarman-we-are-recreating-markets-2007

        Be careful out there! Not much seems to makes sense to me and Seth’s article kind of reiterates that.

        To Your Wealth!

        Garrett

        can recover eventually and the next 20 years

        • Peter

          Here’s an interesting comment posted on Seth’s article, for what the comment’s view is worth. Does seem to ring true, at least in my neck of the woods:

          “I’m on ” vacation” with the wife, and another couple who are our friends. 500 miles from home.
          The wife keeps asking,imploring, why can’t you just have fun?
          And I try. It’s not as if I have stopped living, or enjoying life, it’s simply that everywhere I look, I see signs of what I believe is coming. Vacant storefronts, lackluster crowds, etc.

          This whole game of life simply feels like a big game of musical chairs.
          And it’s never been like this before. Previously, we could at least imagine a solution that did not require extreme pain. Now, not so much.

          And if the folks around you don’t get it, or see it, ( and most don’t ), you are on your own. “

          • Garrett

            Sounds like Atlas Shrugged.

            To Your Wealth!

            Garrett

          • Moncho

            Peter,

            I get what your saying. I have chats with many individuals here at work and they don’t care for much other than playing with their new iphones and staring at the sky. I am generally a very happy and enthusiastic person (Just ask Garrett), but when I am asked general questions about the market, economics and such, I tend to go off on many tangents and end up looking like a curmudgeon. I’m working on changing that. There is always a positive somewhere. :-)

            Learning about the economic world around us and getting different view points from very intelligent people we can trust like Phil and other gurus out there, it does get a little rough to handle. Sometimes “ignorance is bliss” but I can’t live that way and will take the red pill 1000 out of 1000 times.

            Great Days!
            Moncho

        • Peter

          Hi Moncho,
          I think that the phone craze is the single biggest cultural change to happen to people since underwear. People are camping out for a week or longer on the streets to be “first” to get the new phone. You would think that it was all 4 Beatles in the store giving a free concert instead of a damned PHONE. A phone.. I don’t know, I’m not all orgasmic over my phone. It rings and I say “hello”. That’s about it.

          People are scared and I think they’re distracting themselves.

  • Garrett

    Rulers – sometimes I’m a knuckle-head….I just didn’t notice it …..so in the right corner of Phil’s new blog site is the box to sign up to receive “6 Principles for Market Crushing Investing”

    If you haven’t already done so, sign up to get those dripped into your inbox and WATCH THEM! They supplement Phil’s books. It’s good stuff and gives us all common ground / vernacular to discuss Rule #1.

    To Your Wealth!

    Garrett

    • Ross H.

      Garrett,
      Are you familiar with the right approach to starting and managing a fund? I currently manage family money but don’t charge them anything. Are there professional investors that would be willing to have me manage their money?

      • Garrett

        This is something Phil has talked about on the last day of some of his events – kind of a bonus of sorts for those that have the time before they have to catch flights back home.

        You can do it – takes some time, SEC Filings and some licenses. Phil started a small hedge fund last year that he manages and has taken other regulatory steps for the Rule #1 Company. You can even google “How do I start my own hedge fund” and find some places to start. But probably getting Phil to dedicate a few hours at the end of a Transformational Investing Seminar would be a great place to get the seeds planted.

        Phil’s Rule #1 Company has been growing and they have a vision for where they want to be. Phil gave me an update in an email a few weeks ago and it’s exciting to see them growing the Rule #1 Revolution.

        I don’t want to post anything about where they are with some of their Rule #1 growth plans as things are constantly in-flux at the ol’ Town house. Things and plans change rapidly! Perhaps Phil can add some commentary on where they’re headed with all that.

        To Your Wealth!

        Garret

        • Ross H.

          Thanks Garrett. I am somewhat familiar but would need to do more research on this subject.

  • Garrett

    Ms. MP, Peter and fellow Rulers,

    You are correct that Phil did not mention basis reduction via dividend re-investing. If you want to hear Phil teach more on that topic, you can try to get yourself to one of his free Transformational Investing Seminars – usually in Atlanta (and get a free BBQ at his horse ranch too!) – but I understand the logistics and time for that make it difficult – so here we are sharing together on Phil’s blog!

    What I was introducing (I’ve brought this up in the past, but we’re always getting newbies to the blog site) is what we call a “Rule #1 Equity Bond”

    – don’t know if Phil has trademarked that term yet. But like all good investing, it comes from Buffett’s Annual Letter to Shareholders – off the top of my head I can’t remember what year Buffett wrote about it.

    So we reduce basis to zero over time through a “Rule #1 Equity Bond”

    I probably have something in my notes about this and will share more if I can dig some of them off my computer along with what Phil may have said in past blog posts.

    Try to “get it” though – because it’s pretty darn sexy!

    And yes, Peter, BP doesn’t make sense based on the numbers you’ve crunched from reading Rule #1. I’d certainly place BP’s valuation and analysis in the graduate level of Rule #1 Investing – don’t stress over this – I’ve had amazing mentors like Phil who have trained me over the years and I’m still always learning.

    Now, Bed Bath and Beyond – that was pretty easy to value. So that was a fun one to share on the blog and see some people make a little money.

    This concept of basis reduction via a growing dividend has been lived out by my 74 year old father and is commonly mentioned in dividend investing circles – however, I have to give Phil credit for getting the word out to the little guys.

    Regarding BP’s Valuation – like Wal-Mart, Coke, etc…some companies just don’t show their value based on the discounted cash flow valuation method as introduced in Phil’s first book, Rule #1.

    So we look at several other ways to determine value – Payback Time being one of them – see book #2, Zombie Value – see Phil’s tutorials that he’s headlined.

    If you haven’t seen Phil’s short video series introducing some of these concepts, make sure you get the “6 Market Crushing Principles” in your inbox.

    I’ll get in touch with Michelle at Rule #1 and see what we need to do to make sure you all are getting those short videos – warning – Phil’s hair is grayer than his 2006 Rule #1 book cover :) – I still don’t know who that young guy is posing on that book cover! :)

    Specifically with BP, I look at their Payback Time via operating cash flow, Dividend Payout and Dividend Yield, and a little number crunching based on their investor slides regarding their “proven reserves.” Last year when I did that calculation I figured BP had about $37.00 per share of “proven reserves” in the ground. Essentially, that would mean if BP never explored another drop of oil and just sold what they got…and oil was $100 bbl, then what’s in the ground would be worth $X and when you convert that to a per share value, it comes out to about $37 per share.

    I also like to compare my dividend yield, PE Ratio, and Book Value Per Share to their competition – like Exxon, Royal Dutch Shell and Chevron. You can read a plethora of this stuff on Seekingalpha.com.

    And that’s how it works…stick with a company for a few years, read EVERYTHING and eventually you start to get an understanding of the industry and your company.

    To Your Wealth!

    Garrett

    • Peter

      Thanks Garrett,
      I realise that there’s much more to be learned than what was covered in Phil’s first book. Obviously there’s advanced techniques and strategies. I was made aware of an investment meetup in my town. But it isn’t really Rule1 stuff. It’s based on what they call “Can Slim” investing. I’ve not even heard of the author, so I don’t really know what it’s all about. I suppose all knowledge can be useful. Have you heard of it? The author is a William O’Neil I believe.

      • Garrett

        Yeah…CanSlim – I remember that one. I’d skip it. Years ago…like 20…I read O’Neil’s books. Later, he tried to manage a fund based on his CanSlim princples…the thing lost tons of money and eventually was shut-down. He’s also owner of Investor’s Business Daily. So apparently he’s made more money publishing his paper than he has collecting fees with his dead fund.

        Stick to Rule #1 – 4M’s…it’s all Buffett has ever done. Hardest part is staying rational and knowing the Value of what you’re buying. Buying more as the price goes down is HARD! But if you know the VALUE then it’s exciting and easy.

        To Your Wealth!

        Garrett

  • Ross H.

    Hi Phil,

    Thanks for your post and constant sharing of information which I find very interesting. I have been using Rule # 1 investing now for about 3 years and have seen my portfolio grow substantially (over 100%) during this same period . My goal is to hit the million dollar mark within 5 years. I have question I’ve been meaning to ask you though. You’re Rule # 1 investing methods are based on building wealth over time and earning 15-20% returns annually, etc. However, you turned $1,000 into over $1MM in 5 years. I’m curious how you were able to do this because I can’t imaging you were investing in Rule # 1 companies to accomplish this? I could be wrong but interested in your journey to financial independence.
    Regards,
    Ross

    • Garrett

      Ross,

      The way to do that is to start with a killer track record. Most people, believe it or not, don’t like to invest their own money and would rather pay you to do it for them.

      When you are successful, people will start throwing money at you to manage. Then you can collect fees from being successful.

      Many of the wealthy people I know raise money to invest for others and collect a fee for doing so.

      For example, suppose I had an 250 unit apartment complex and needed to raise $10 Million to complete the renovation, management, etc…

      If I raised the $10 Million through my network of other wealthy investors, I might collect a 2% fee for getting the deal together and raising the money. That’s a nice $200K check that goes right into my pocket (well, the gov’t will get about 40% of that!)

      That’s how it generally works one way or another. Get a track record, get your team of investors, make them successful, the word spreads, more money comes, more deals get put together, the deals get bigger, the 2% doesn’t change but the amount of money needed gets bigger with bigger deals.

      I was in that game for awhile. I raised over $1 Million in some investments. Being airline pilot is less profitable, but it’s a great lifestyle. So the investments got sold off one by one and I stopped raising capital. People LOVE you when they make money, but HATE you when they lose money. And they are NEVER happy!

      …but sometimes I think about doing it again – but it is easier to just fly 3 days a week and take two months off during the summer!

      To Your Wealth!

      Garrett

      • Ross H.

        Hi Garrett,

        I totally understand and have been thinking of doing this myself. I didn’t know Phil did this in his early days but makes sense if he did. I’ve been able to generate returns of 23% in 2012, 69% in 2013, and 19% YTD 2014. I would love to run my own investment company/fund but obviously lots of work to get started and like you said; a pain to deal with investors demanding returns. I have a good job currently (Corporate Banker) and tough to make that switch, but am determined to be financially independent through Rule # 1 style investing.

        • Garrett

          Ross,

          That’s amazing and congrats! Perhaps you can share some of your lessons learned…failures/success with the Rulers.

          One thing I’ve tried to analyze about myself is “Was I lucky or good?” in my investments. There is no doubt that luck plays a part in some of one’s success. Sometimes the timing is just right…other times not so great!

          To Your Wealth!

          Garrett

  • Sam

    Hi all, regarding
    “… liquidate several positions even at a small loss to stack up cash like I did in 2007 …”
    I have my doubts. The problem is, even when shares I own drop 20%, the price is still higher as my MOS price – kind of went ‘all in’ during 2008.
    Hence selling isn’t an option, a) I don’t need the money yet, b) there is no alternative to invest which gets me the same or better return.
    So I’ll stay invested and buy puts.

  • Angelaw

    Phil,

    Fascinating! I see this demographic/economic movement follows the Tao of nature. The expansion and subsequent contraction, the going out and the subsequent coming home. I came from another country/ culture. It is appalling to me how much consumption and waste exist in this country. So from an individual citizen’s view, I welcome contraction and balancing to a more equilibrium point.

    To your point, what is good for individual may not be good for the economy. So what’s the best way to invest in a deflationary environment? I have always found your thoughts to be the most balanced and pragmatic of all so would love to know.

  • Garrett

    Rulers,

    I was doing some of my Valuation / Cost Basis analysis on BP and thought I’d share some of my hypothetical forecasts that seemed relatively rational to me.

    IF, IF, IF BP can continue to pay their dividend (lots of Seeking Alpha articles to read and gather different opinions on that) then BP has a very, very attractive dividend yield around 5% right now.

    (Newbie Rulers, if you don’t know what dividend yield is or are confused what a Rule #1 Investor would get excited about a 5% Dividend Yield – just ask and we’ll go through it on the blog)

    Here’s a breakdown of my decreasing market risk by a growing dividend with a 5% yield. THIS is why I’m a long-term shareholder for my retirement account (and many other reasons)

    Let’s run the numbers the best we can on this format and suppose we bought 1000 shares of BP at $46.00 per share. We’ll assume BP can grow the Dividend 10% for 20 years with our $46,000 investment.

    Looks like this in Year 0:
    Dividend: $2.00
    BP Price: $46.00 per share,
    My effect on basis: $44.00 ($2.00 per share less)
    Return based on Div: 4.35%
    Portfolio value: $46,000,
    Annual Div Received $2,000

    Now we grow that at 10% and our cost basis gets reduced from receiving the dividend and the share price goes up to reflect the increased dividend. Let’s run the numbers for the next year:

    Next Year:
    Div: $2.20
    Basis: $43.80
    Div Yield: 5.02%
    BP Stock Price:$50.60
    Portfolio Value: $50,600
    Div Received: $2,200.00
    Total Div Received since inception: $4,200.00 ($2,000 + $2,200)

    Now let’s take a look at where our Market Risk is essentially ZERO…where we no longer care what the price of BP does on a day to day basis because we’re living on increasing dividends:

    That happens on Year 11…no more risk…
    Div: $5.71
    Basis: $5.23 (We’ve dropped our basis to almost zero in eleven years!)
    Div Yield: 109%
    BP Stock Price:$131.24
    Portfolio Value: $131,243
    Annual Div Received: $5,706
    Total Div Received since inception: $4,2768
    Total: $131,243 + $42,768 =’s $174,011

    Sweet…Let’s run this out 20 Years from now when I’m living off my BP Investments:

    Year 20:
    Div: $13.45
    Basis: $Below Zero!
    BP Stock Price:$309.46 per share
    Portfolio Value: $309,465
    Annual Div Received: $13,455
    Total Div Received since inception: $128,005
    Total: $309,4653 + $128,005 =’s $437,470

    That’s all pretty cool. What I like about it is I have a hedge against the devaluation of the US Dollar. Oil is currently traded in dollars AND owning BP is a hedge against rising US Interest rates. Eventually, interest rates will rise. Today the 10 year Treasury is about 2.6%…stinks…that’s the Fed Central Bank’s manipulation. But what happens when they can no longer keep interest rates down because the risk of owning US Dollars becomes to problematic? Well, the rate goes up to take on that risk which in turn would likely be followed by an increase in my dividend / share price of BP.

    To Your Wealth!

    Garrett

    • Peter

      Ok Garrett,
      So I posted a comment on that other post, Zombie Value, and I hope someone gets to see the numbers I posted. Now, BP. The ROIC is at 7.45, so doesn’t that automatically disqualify this as a Rule#1 company? Are there pieces of the puzzle I’m missing?

      • Peter

        To continue from my last comment: You mentioned BP could be a rare opportunity after a thorough 4M analysis. Here are the numbers as I calculated:
        ROIC 1 year: 7.45
        Equity Growth Rate: 1 year: 2.18 – 5 year: 10.3 – 10 year: 6.57
        Sales Growth Rate: 1 year: 2.04 – 5 year: 1.62

        Again, strictly following the Rule#1 (first book) guidelines, this is pretty much a “no way” company. Again, as in my last comment, what pieces of the puzzle am I not seeing?

    • Ms.MP

      Garrett,
      Is this info from the Payback book, because I have no clue what you are talking about based on Rule#1.

    • Mike Mac

      “Oil is currently traded in dollars.” Good use of the word currently…not sure that will be true in the future. At least Rickards suggests it might not be.

      • Garrett

        ahh yes…I’ve read both of Rickards books – The Death of Money was the latest and it’s on my Ipad. Phil read it too. I asked him what he thought about it, because I actually enjoyed it. Perhaps Phil can share his opinion, but sometimes authors don’t want to publicly comment on other author’s books.

        To Your Wealth!

        Garrett

  • Garrett

    Rulers,

    I’ve been a BP Shareholder for quite some time and honestly, I missed the opportunity to sell covered calls shortly after the $53.00 peak and the short-term tools signaling to “Get Out” around July 8th.

    I have a pretty descent position relative to my account portfolio in BP, so when it dropped, so did my overall portfolio return.

    Did I freak out? No way. This is a lifetime investment for me and I’m buying more to get a larger dividend 20 years from now.

    On September 4th, BP was found grossly negligent for the 2010 Gulf Spill with the possibility of an $18 Billion dollar fine. Plenty to read on Seeking Alpha, so I won’t rehash it. But look at what Mr. Market did on that day. Prior to the announcement, BP had a market cap of about 147 Billion. After the announcement BP’s market cap dropped to $138 Billion.

    (for our Newbie Rulers, Market Cap is just the total price of the company that day…take the shares outstanding and multiply that by the current stock price – you can look up a companies Market Cap for free on any website)

    Effectively, this was a tug-of-war between the buyers and sellers – worse case BP was worth $18 Billion less or best case through the appeals process it would be nothing at all.

    Those those were the two extremes…$18 Billion or $0.00.

    Where does Mr. Market price it? Pretty much right smack in the middle – $9 billion less at the end of the day.

    This shouldn’t have been a surprise either because in 2010 when the spill happened, BP was either going to be worth $60 or $0.00. Mr. Market basically settled on $30.00.

    Not rocket science is it?

    So BP finds itself in a lower than lately price of oil, a Russian/Ukraine Crisis with their 20% ownership in Rosneft and an $18 Billion fee which will get dragged on in the appeals process. This is what we certainly call a “Rule #1 Event”

    I believe BP has found a pretty solid bottom for various reasons at about $45.00 per share. If that’s the case and if after a through 4M Analysis, this could be one of those rare opportunities to buy BP at a significant discount.

    To Your Wealth!

    Garrett

    • Mike Mac

      And the Scottish independence vote can also negatively affect BP due to drilling off the coast. They are getting hit from many sides these days.

      • Garrett

        yeah – but the other big oil players are all involved too. Its’ a shared pain.

        To Your Wealth!

        Garrett

  • Garrett

    Phil,

    Thanks for the book summary – they’re on my request list.
    I thought it was interesting that you wrote, “I’m only buying companies I want to hold through a drop at prices that reflect a margin of safety. Nothing new here. However, if I get all the signals screaming to get out all at the same time I may liquidate several positions even at a small loss to stack up cash like I did in 2007. It can be scary to do that too soon and be sitting on the sideline in cash but to not do it at all leaves you with everything on sale and no money to spend.”

    That’s a gutsy move – historically we’re wrong however, I understand what you’re probably saying is that if the MACRO View in DOW, S&P 500, and RUT all read “GET OUT” within a short time span of each other, that could be a relatively bearish position. In the past, I’ve sold LEAP Calls to mitigate the risk of a significant market correction. Worse case, I make money, lose the shares and have to do a lot more homework finding a “Just One” company to invest.

    Perhaps Rulers could supplement that MACRO by looking at the insider’s “Sell/Buy Ratio” at http://www.insidertrade.net, Shiller PE Ratio and the Market Cap to GDP Ratio.

    Also worth mentioning that George Soros added significantly to his huge bet buying a PUT (Newbie Rulers, that means he can make a lot of money if the market goes DOWN )- lots of articles to read if one just google’s “George Soros PUT” Hmmm….and if we’re into a 7 year September cycle, i.e. Sept 2001, Sept 2008…Sept 2015 could be an interesting year/month.

    To Your Wealth!

    Garrett