Thursday, November 17, 2011

Foolish Newsletter Subscriptions?

The Motley Fool has been an interesting experience.

(In 2007, I became interested in diversifying my portfolio, which had come to be utterly dominated by my ballooning holdings in Apple. I started looking for other good ideas, and it was hard to find ideas as good as Apple. But I was committed to "diversifying" and tried. Oops. I'm sharing here some of what I learned after the crash of 2008 about getting advice on how to diversify.)

Over ten years ago, I heard David and Tom pitching a "Dogs of the Dow" strategy: in less than fifteen minutes every year, you could manage a portfolio mechanically by rebalancing a portfolio into some of the highest-yielding companies in among the Dow Jones Industrial Average's industrial stalworts. The strategy promised the security of buying only brand-name companies, the certainty of crystal-clear buy/sell signals that offered no room for judgment one could doubt, and a speed that would allow anyone to manage a portfolio that (the strategy proclaimed) would crush the market in just fifteen minutes a year.

Among the advantages of this system are (purportedly): (a) you don't lose built-in management fees to advisors, which sadly is the case with funds – including ETFs – because they typically siphon off about 1% of assets or more each year, whether they make you any money or not ... and TMF is fond of pointing out that this management fee becomes a big deal as one considers compounding; (b) advisors don't do particularly well, and you can do better yourself, champ! And sleep better! Because the system works! Besides, (c) investment professionals are dishonest scum. These points are made across the Fool web site and in the Foolish Four book to varying degrees. But the impact is the same: you can do better yourself, the pros aren't good, and the pros cost too damn much money.

In contrast to the mechanical investing thesis but in synch with the do-it-yourself meme, the Motley Fool web site offers a bunch of support to individual investors. The thesis is that like Warren Buffett, its readership should be able to spot undervalued investments and, by cherry-picking the best of the bunch, glean outsized returns without paying fund-manager fatcats premium fees year in and year out whether they earned or lost on the money entrusted to them. The Motley Fool web site was chock full of discussion about individual stock picking, and began vending newsletters to aid investors hoping to cherry-pick stocks, or small-cap stocks, or dividend stocks, or options plays . . . the list seems to be growing. These newsletters are available by subscription. They cost money. The good news? The subscription doesn't scale with your investments; if you have infinite capital, your transaction costs associated with any given subscription approaches 0%.

But investing based on the no-charge site involves work and it involves judgment. These are diametrically opposed to the mechanical investing thesis blessed by the Motley Fool in The Foolish Four. They invite homework, open-ended analysis, judgment . . . in short, a mess.

The subscriptions aren't much help in that regard, whatever their cover price. They recommend such a huge variety of stocks – especially in the aggregate – that no investor would plausibly pursue them all. One would need to be involved in so many positions that there was no possible way way to stay informed about them all, unless it was full-time work. Unless one chose to buy everything advocated by one of the newsletters without the exercise of judgment, one would drown in homework staying abreast of a portfolio. Unfortunately, the list of stocks that are "active" as recommendations of its flagship newsletter – Stock Advisor – has over a hundred and five (that's 105) different issues listed. Just counting them is a trick, though: every time David or Tom "recommends" a stock, it gets a new line and is tracked as a new recommendation. When calculating the newsletter's "performance", Stock Advisor's management count each recommendation from inception to close date. So the "active" list has over 140 entries, and much of the newsletter's "market-crushing performance" consists of re-recommendations of the same good idea.

What's a subscriber do to mirror the newsletter's "performance" – re-purchase Apple or Disney each time it's (re)recommended? Is that even plausible? The newsletter identifies a group of "core" stocks, but doesn't really tell new subscribers at what price they should consider stocks off the list. There's a list of "best buy now" stocks, but the newsletter's management doesn't help investors figure out what off the "best buy now" list is worth getting into immediately. In what proportion does one invest?

And the newsletter can be slow to react to reality. GameStop – which evolved into a sort of Blockbuster for computer games sold on physical media, and you can see how Blockbuster is doing by following how Blockbuster in bankruptcy (OTC:BLOAQ) converted into BB Liquidating Inc. (PK:BLOAQ), which has negative earnings – was listed as a "hold" (what does that mean, anyway?) for a couple of months before finally calling it a sell in 1Q2010. That company was in (what I concluded was) an obviously-dying business for a long time, folks. Yes, it was still up from its two recommendation dates at the end of 2005 and the third quarter of 2006, but let's look at the graph:

Until December of 2009, GameStop was still an active recommendation. (Well, it was "active" until the March issue of 2010, but on "hold" – whatever that means.) So subscribers were led from 4Q2007 (for example) until 4Q2010 to think it was a Stock Advisor pick, and encouraged that it was the dominant game retailer in a world awash in video games, and one of Stock Advisor's picks for crushing the market. Maybe you'd beat the market trading on the dates of the recommendations – which might be hard, if you read it when it arrived in the mail; the sell rec is in the March issue but bears a sell-rec date of Feb 18 – but investors are given no advice what to do between recommendations if they show up mid-movie, so to speak. And with 100+ recommendations, it's hard for investors to figure out what on Earth to do with them all.

Since the Motley Fool offers a nice tool for working out weighted, annualized rates of return on your self-reported portfolios, I can report this about my post-2008 investments:

In case it's hard to read, it says that the Stock Advisor recommendation Dreamworks Animation is my worst-performing investment entered since the last market crash, whereas my decision to nearly double up on American Capital Ltd. at $1.80 in early 2009 has more than quadrupled my money (while my overall performance of an annualized 23.7% in post-crash purchases has to date outperformed the S&P by 9.6% on an annualized basis). ACAS has, over time, dropped from a 5-star ranking at the Motley Fool to a four -star ranking, and it's never appeared in Stock Advisor.

I was going to write that I have no idea what the publishers thought about entering a position in Dreamworks in the first half of 2010, and that if they had any reservations I was unable to find evidence they shared it with subscribers. However, this is not true. I've been reminded that in May of 2010, Dreamworks was re-recommended at $34.87, making it a loser – even for the Stock Advisor – in excess of 50% of the stock's value. Of course, you can't win them all. And it's not over until the fat lady sings, and all that.

But down 50+% is a painful start, because recovery to your starting point requires going up more than 100%. Apple gave me a few -50% days while I held it, but I first bought Apple at $20.35 per stub, after which it then split 2:1 twice, so losing from $100 to $50 wasn't so hard, particularly not with the perspective of $380 AAPL (after it's received a "haircut"). From the Stock Advisor commentary, I sense the editors are hoping someone acquires Dreamworks. I don't see the market-crushing behavior (I'm ignoring the stock price here, and looking at the company's performance in competition with its peer) the Motley Fool discusses in its sales materials for the Stock Advisor. DreamWorks isn't a Rule Breaker, it's a Pixar imitator which – until I saw How to Train Your Dragon – was failing to make movies anything like Pixar. (I discussed what I viewed as Dreamworks' evolution from a "me too" to a "real me" in this post.)

General Electric, which the Fool's performance-analysis tool cheered as a "two-bagger" (and here I sigh, because I read Peter Lynch's book in hardcover when it was first published, in which he lamented buying a washing machine instead of Berkshire shares in the 1960s, before there were any B-class shares to buy), wasn't a Stock Advisor recommendation, either. It was a Peter Lynch inspiration: I was familiar with some of its outstanding products, and realized that the stock was hated simply because nitwits thought GE Capital made GE a financial and after 2008 nobody wanted to own a financial so it was beaten like a red-headed stepchild. I looked at its historic dividends and glanced at its financials and said "of course!" This was while it was below $7. And that reminds me: the Fool's performance analysis tool won't give you your annualized yield on anything but the equity itself; it ignores dividends. GE pays a dividend, so my return is better than the Fool relates.

The Fool's return calculator's dividend-ignoring behavior stands at odds with the Fool's apparently normal practice (at least, in other places on of subtracting dividends from basis to calculate returns. This is crazy, of course: a stock held for ten years doesn't cost less in year 1 just because you later held for dividends. This only makes sense in a tax-deferred account with dividend-reinvestment engaged – but that's not what the Fool assumes, as it doesn't increment your share count, it decrements your basis. The Fool tool would treat each reinvestment purchase as a new investment, each with a declining basis. So folks who recommend big dividend stocks in the Motley Fool's CAPS system (the Fool's community-rating system) should appear to crush the S&P just by holding on until their basis approaches zero, no? Check out this player's recommendation of American Capital Agency – the Fool claims the player's basis in June of 2008 was less than $9, so of course he's crushing the S&P 500 now that AGNC is flirting with $30. The lowest I was ever able to pick up shares was $15, though it dipped a little below that. But AGNC never traded at $9, ever.

But ProEdgeBiker is up 213.33% on his AGNC recommendation! Yeah, right. I know this guy selling a bridge .... CAPS scores are flawed, and if you want to game them pick a dividend stock, yo.

The confusion generated by the dizzying array of stock recommendations and the drinking-from-the-fire-hydrant problem of trolling CAPS for ideas seems to be the chief selling point of the Motley Fool's costlier service, Million Dollar Portfolio (MDP). Entry is $1k/y, with a discount for new members. (There's a money-back guarantee, I'm just checking it out, though if impressed I'll naturally renew. But read on.) MDP invests a real-money portfolio that begain with $1m. MDP's deliverable is based on all the Fool's subscriptions, making it something of a best-of aggregator, but it does not include either all the newsletters or a list of all the recommendations. The managers have access to this, not you.

MDP gives concrete instructions to subscribers before each trade: not just the name of the stock, but the percentage of the portfolio that has been assigned to it so you can follow along at home. In advance, even. And for new subscribers, MDP offers "catch-up" plans, advising you what to pick up and when, to bring your portfolio in line with the MDP. If that's not fast enough for you, the portfolio lists "buy around" prices for each pick, so you can make your mind up as prices change. And some of the stocks are nice picks I myself have loved for years: Berkshire Hathaway and Markel, for example. Unfortnately, despite my Berkshire shares having more profit in them than MDP's (I bought before MDP picked it), both I and MDP have done worse than the S&P 500 in our BRK.B investments. And I read that for a while last year, the MDP pulled out of its picks and bought an index fund. True? If so: Would Buffett pull a move like that?

You either have a sound investing thesis (and damn the torpedoes! – until real information impacts your analysis) or you are a lemming. Period. If your own decision isn't so rock-solid that it withstands a criticizing public, you don't even believe in your ability to pick promising companies from the dregs that haven't yet been ejected from the S&P 500. Of course you can pick a few losers! Right? If not, why are you managing others' money?

MDP was down something like 10% last year. Since inception, the tale of the tape is:

This is at least honest. It might not be something I'd want to admit while selling a stock-picking service, but it's honest. The portfolio's first purchase was a symbolic one-share purchase of Berkshire Hathaway (a pre-split B share, $4,256 a stub) made four years ago in October of 2007. Losing only ~13% in the crazy time between October 2007 and the present is something to be proud of, but it takes some perspective to perceive it. I have to think carefully about my own performance to realize what a positive statement -13% really is over that time period. And they did beat the S&P by about 5%, which in a big enough portfolio might even be worth the annual fee. And let's think about that a moment. Berkshire Hathaway's 2008 result was a 9.6% decrease in book value per share, which beat the S&P by 27.4%. At $1k/y, MDP's charge represents a 1% management fee on a $100k portfolio, for what turns out to be a 5% advantage. Over what period? Is this a deal? Wasn't avoiding recurring management fees such a big part of the Fool's pitch?

And did they really allocate 80% of the portfolio into SPY in 2007 while they waited to figure out what to buy? While SPY charged a management fee? (The note says "Plus it has a really cool, James Bond-like ticker symbol." Thank goodness for that!)

But back to the cheaper subscription services for a moment. You can't use Stock Advisor as a substitute for judgment, because you'll end up with 100+ stocks and can't be assured that you will get advice to sell that's worth a nickel. In fact, you can't be sure the advice even makes sense. Check this out: in its latest issue, in discussing Stock Advisor picks that don't pay dividends, the Motley Fool wrote of Berkshire Hathaway:
a recent offer to start buying back shares has us thinking a new dividend may also be in the offing. Among our Core non-payers, Berkshire's our most likely candidate to start.
This is, of course, utter nonsense. Berkshire is doing a stock buyback in lieu of a dividend because of the double-taxation problem inherent in C-corp dividend payers. (A REIT like AGNC is a tax pass-through, so there is just one tax, levied on the dividend recipient; earnings retained by the REIT are limited if it is to retain its tax status, and subject to excise taxes.) Imagine you are a multibillionaire with the power to declare yourself millions a year in dividends, on which you will pay 35% taxes; or you could sell a couple of extra shares, raising the same amount of cash, and pay 15% taxes. Which would you pick? And if you don't for sure need the money this year, why would you subject the money to a personal income tax at all? Why not let it continue to enjoy reinvestment within the corporation that's already paid taxes on it once?

The third option is a share buyback. If management is right, and Berkshire's announced strategy of making purchases at a premium of 10% to book value (which is based on things like the carrying value of land that is being depreciated, and may bear no connection at all to the market value of any of the company's holdings) will lead to a purchase at less than intrinsic value (which presumably would be based on the company's expected present value of its entire stream of future cash flows), then buying shares on the open market will reduce the outstanding share count, concentrating the company's post-purchase assets in a smaller number of shares. As long as the purchase price is less than the real value of the company per share (whatever that speculative number may be), the remaining shareholders enjoy an increase in value per share. This has the same impact of AGNC's strategy, which is the same thing in reverse: by selling new shares above the net asset value per share of prior shareholders, the original shareholders end up with shares backed by more assets than before the issuance. The reason this is better for Warren Buffett than a dividend is that only the selling shareholders face any risk of a tax impact: remaining shareholders get this benefit tax-free until disposition. Since Warren Buffett has announced he's giving his wealth to charity, none of his shares should be expected to be subject to income tax. Nice trick, eh?

Warren Buffett has no reason to issue a (taxable) dividend to individuals in the hope they know what to do with the money, if he knows full well that he can invest it somewhere safe and undervalued like his own company. A dividend prediction like this is nonsense. Paying dividends also ties Berkshire's hands in the event it finds great opportunities: it either won't have the cash, or will have to worry about "confidence" issues associated with halting a dividend, or will have to think about liquidity in case a risk matures into a loss on one of its multibillion-dollar-premium reinsurance contracts. The only safe thing for Berkshire to do – and the only sensible thing from a tax perspective – is to hold the money patiently awaiting good buys, including good buys in Berkshire's own stock.

The other thing I noticed is that the Fool – despite having long railed against paid money managers – not only sells a subscription specifically to alleviate your need to exercise judgment as to capital allocation but also runs an actual, honest-to-goodness, publicly-traded fund. Launched in June 16, 2009, FOOLX (an open-ended fund; we don't know how long it's had the capital it's currently deploying, or how much of it is new) is worth $13.88 at the time of writing. After the advisory fee, which my broker informs me is 0.95%, and the fund has an expense ratio of 2.2% (which offsets the lack of transaction fees, though there is up to 2% redemption fee), FOOLX has returned (according to my broker's metrics) 17.04%, which beats the S&P's 10.04% by 10%. If the 17.04% total return is accurate, its annualized yield – the fund has been in existence a bit over two years – is less than 8%. Other than the fund's holdings in a cash reserve fund, its largest holding is (according to Google) the POSCO ADR (PKX) – a Korean steel producer I've never heard of. An unknown is a great place to look for underfollowed, unnoticed, and mispriced opportunity. It'd be nice if I'd heard about this opportunity in one of the Fool's paid-for services, if it's so compelling that it's the largest equity in its namesake fund.

The Motley Fool provides a diverse array of conflicting advice: mechanical investing so you have simplicity and certainty; do-it-yourself because individuals can beat institutions; paid-for services because you haven't the time to find stocks; super-premium paid-for services because you can't tell which of our recommendations to buy, or in what amounts, and you're tired of standing like a deer in the headlights while your subscription ticks by; publicly-traded funds because you don't really believe that with all the brainpower at The Motley Fool there isn't an institution that can beat the markets, and you don't believe The Motley Fool when it says professionals' fees will sap your returns, and you just want to pay someone to take the responsibility off your hands. The Motley Fool does this while stuffing your email box with advertisements for its many services, using pitches that run absolutely counter to its Buffett-style patiently-investing-forever party line (e.g., click to see free report on hot stocks about to take off; act now before it's too late! Entry to this premium opportunity will close quickly so act now before you miss out!). Worse, they sell your email address to third parties who send you the same drivel – except for more complicated schemes costing even more money, that you have even less inclination to actually perform as recommended by the service, though it's hard to click the stop button while they discuss their slick ideas for enriching you ... which, if they worked so well, they'd hog to themselves instead of poisoning with a bunch of traders who'd play it out.

I'll continue to read the material – The Motley Fool is certainly one place to get ideas – but I have sincere doubt that I'll be maintaining any of these subscriptions (even at the newbie discounts). The quality of the analysis in the areas with which I'm familiar makes me deeply concerned with the quality of the analysis in areas in which I am not familiar. Thus, knowing nothing about Dreamworks except the quality of its latest product and its track record for turning merde into gold, I was made susceptible to buying the worst investment I've made since the crash – because I assumed they'd checked out the fundamentals. As I better appreciate the depth of the analysis (or lack thereof) behind the recommendations made in The Motley Fool's flagship Stock Advisor product, the less confident I am about the content of the paper or the homework that may (or may not) lie behind the short paragraphs pitching the companies. Whether I re-up will turn entirely on the quality of the investment ideas I actually get from the services. And this soon in, it's far too early to tell.

But here's this to think about. If subscribers have to do their own due diligence after reading The Motley Fool's flagship advisory products and their premium subscriptions, what is it exactly they are being sold? If all the customers want are ideas, they should be aware that trolling CAPS for pitches and/or combing the markets with free screeners is, well . . . free.


Penny Stock Blog said...

Many of these so called stock market newsletter services are afraid of being flaged investment advisors when they give specific buy and sell prices on their stock recommendations. Even though investment newsletters are protected free speech I guess many of these services don't know this or their legal advice is bad but under the lowe verse SEC ruling by the supreme court in 1984. It should not be a problem for a stock market newsletter service to give the prices to buy and sell a stock.

Jaded Consumer said...

Judging by The Motley Fool's practice, extremely specific purchase/sale instructions are provided, together with what percent of the portfolio, etc.

Unfortunately for subscribers of multiple Fool services, the various services occasionally give exactly opposing instructions. This defeats the entire purpose of subscribers, by preventing their ready and confident adoption of the supposedly superior guidance of the Motley Fool.

Ahh, the joy of publication. The fact that some of the services run a real-money portfolio is designed to convince subscribers that they are getting "the real deal" in which the Fool itself invests. The fact that there's a pool of money following the same advice is an advertising expense for the service. With $999 subscriptions to some of the services, the size of the capital dedicated to the portfolio is a trivial inconvenience – and who knows, if things work out well, it may actually result in something better than a horrible loss.

Even if so, the subscriptions give the Fool (and the fund managers) more than enough compensation.