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CAPITAL PORTFOLIO

Special Reports
Crossing the Desert: The Essential Tools Every
Investor Needs to Survive
February 1, 2017 Special Reports

Chapter 1 – Crossing the Desert

Let's start here... in the desert...

Imagine you had to walk across the Rub' al Khali – the "Empty Quarter" – of the Arabian
Peninsula. This 250,000-square-mile desert is the largest sand desert in the world. Sand dunes
there reach as high as 800 feet. It rains less than two inches a year. The surface temperatures
reach 125 degrees. Think about the three most important pieces of equipment you'd need,
beyond the most basic stuff like shoes, clothes, food, water, etc.

This isn't hypothetical. Three guys decided to try and walk across this desert completely
unassisted. In 2013, South Africans Dave Joyce, Marco Broccardo, and Alex Harris became the
first humans to walk completely unassisted through the Empty Quarter. They plotted a 1,000-
kilometer course from Salalah, Oman to Dubai. Their story is completely nuts... but
fascinating.

The most obvious piece of advanced equipment you'd need? A GPS, right? Nope. What they
needed most wasn't a GPS... or even a map. What they had to have to make it across 1,000
kilometers of desert in 40 days (after which they would have quickly starved to death) was
Google Earth. They needed to know their precise position in the desert relative to the giant sand

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dunes, which you can only see using Google Earth's satellite photos. Before the advent of publicly
available satellite photos, walking across this desert would have been impossible. GPS alone
wouldn't have been enough.

They also needed a strong, lightweight, easy-to-pull cart, so they could carry enough water for
the journey. Obviously, they needed food, too. But the water was far more critical and heavy to
carry. They spent about three years testing various designs for carrying enough water. The key
to success was using mountain bike tires on their cart, rather than wide full tires, which were
too difficult to pull through the sand.

And finally... to make sure they had continuous access to Google Earth, they needed to use a
solar-based charger to power up a satellite phone. They lost the charger on the 10th day of the
trip. So one of them had to turn around and follow their tracks for 25 kilometers to find the
charger before it got dark. Without it, they probably would have died. Imagine trying to find
that charger... before dark... in the desert... by yourself... knowing that if you couldn't find it,
you and your friends would probably die.

So what the heck do three crazy South Africans hiking across a giant desert have to do with
investing? It's obvious (to me). For most individual investors, the process of trying to manage
their savings in the stock market is a lot like trying to cross the Rub' al Khali desert on foot.
You have few landmarks to guide your way. And there are lots of ways to die. Most people don't
make it.

Learning the story about the guys crossing the desert, I started thinking about the most
important things investors need to understand if they're going to be successful in the stock
market. Not the obvious stuff... like the way dividends compound returns or the time-value-
money formula (which explains that your returns will be driven by how much time your
investments are allowed to compound and how much money you save). Nor am I talking about
the more advanced, but still simple, concepts like position sizing, trailing stop losses, and
avoiding taxes (where possible).

It's not that these things are unnecessary. They're critical. But they're like shoes, hats, and
sunglasses when you're crossing a desert. Nobody would go without them, and they really don't
require much foresight or wisdom. Instead, I wanted to answer a more difficult question:

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What are the three things every investor in common stocks must know to succeed, but that you
believe most people don't know how to do? Where is the greatest gap between the value of
knowledge and the inexperience of most individual investors?

I thought about this question for a long time. Here's my list...

No. 1: The most important thing for investors to understand about investing in stocks is
simply what kind of businesses make for great investments and how to properly value
these kinds of businesses
businesses. You can think of this knowledge as your personal Google Earth for
crossing "the desert" of investing. Knowing how to recognize great businesses and knowing
what they're worth is like knowing where the sand dunes are and how to get past them.

Here's an example of what I mean: Do you think the fast-food chain Chipotle (CMG) – trading
around $390 a share – is an expensive stock? Why or why not?

If you can answer this question within 30 seconds by looking at a few key statistics, then you're
ready to cross the desert. If you can't... you're just not ready. You have to power up your
satellite phone and spend more time studying your maps.

If you have no idea whether Chipotle is expensive or cheap, don't worry. You're not alone.
Judging by my experiences with wealthy and business-savvy subscribers, I would estimate that
less than 10% of our subscribers really understand these concepts. Without this knowledge, I'm
nearly certain you can't be successful as an investor. Not for long, at least. But that's why I've
written this book.

No. 2: The second thing I know you must have to "cross the desert" successfully is a
strategy that will continue to make you money even when you're wrong about the big
picture.

When we grow worried about a serious crash in stocks, we trim our long positions by selling
some stocks. And we hedge our exposure to the market by selling short some stocks.

But we don't sell everything. And we don't move to a 100% short portfolio. As a result, we've
done well even when the market has defied our expectations.

The idea that you don't ever want to bet the farm on any particular outlook (or any particular
investment recommendation) is hard for most investors to understand and implement. When

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events in the world spook most individual investors, they simply pull out of stocks completely.
They generally do so at the worst possible time. You have to learn how to make money even
when you're wrong about the market as a whole. And you have to follow your strategy... even
when it's scary.

No. 3: The last thing I think most individual investors either never learn or only learn
the hard way after several big beatings is to never, ever chase what's "hot."

These investment "mirages" will cost you almost every time. It takes a lot of discipline to stick
with great businesses that you can personally understand. It takes discipline to buy them when
you can get them at a reasonable price. It takes discipline to follow your position-size limits.

When a great new business comes along – like online auctioneer eBay (EBAY) in the early
2000s – learn to be patient. Follow it for years, and buy it when it comes into your range.

If you had bought eBay back in 2004, you'd be up a little more than $3 per share today (from
$58 to $61) more than a decade later. Sure, eBay was and is a great business with a huge
"moat." Nevertheless, investors who chased after it while it was "hot" saw their investments
decline almost 90%. It was far better to have bought it for less than $15 a share back when it
was trading for a reasonable price.

Over the first five chapters of this book, I'll be going over these three concepts in detail. I hope
you'll take the time to read these chapters and think about them. In the book's final chapters,
you'll be ready to look at some alternative techniques, unique ways to ease your way across the
investing "desert" that you won't hear about anywhere else.

As a member of Stansberry Portfolio Solutions, we'll provide you with a one-stop way of
investing and explain exactly how to build a diversified, allocated portfolio. However, to get
the most out of our services, we think it's critical that you understand how we analyze the
market and the specific security we recommend.

Chapter 2 – Exploiting Market Inefficiencies

Out of all of the things I've said or written in my career, the thing that gets me in the most "hot
water" is my view that you can and should time the market. When I write "you," I don't mean

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some representative sample or some investor somewhere. No, I mean you... the person reading
this book... the person who is going to put his savings at risk when he invests in the stock or
bond market. You.

A lot of people – even some smart ones – believe trying to time the market is a fool's errand.
They argue that the best you can do is simply plow your savings, year after year, into a mutual
fund or index fund. These folks make a whole range of arguments and back them up with
plenty of "facts."

They'll cite academic studies and average investor results. They will say, again and again, that
"no one" can beat the market, so why should anyone try?

I disagree... completely.

Let's start here. Let's say they're right. If the market is really efficient, then it shouldn't matter
when you invest or what you buy. If that's really the case, then why not try to do better? As
long as you're investing in something, you should do alright, according to these folks. So what's
the harm in trying to beat the market?

And here's another way to look at it. The efficient-market folks love to argue that it's
impossible for the average investor to beat the market because it's impossible for most people
to beat the average result. At some point, it is a mathematical certainty that not everyone can
beat the market. But just because something is "true" on average or across a population doesn't
necessarily mean it must be true for you.

For example, I might argue that on average everyone who marries will end up with a marginally
attractive spouse of normal intelligence. Therefore, you're probably wasting your time trying to
find a beautiful and intelligent person to marry you. In theory, that might be good advice. But
was that your dating strategy? If you had dated any dog who would have you, would you have
married the spouse you wanted?

In short... when it comes to a lot of important things in our lives, getting better-than-average
results is a worthy goal. Luckily for investors, I don't believe beating the market is nearly as
hard as trying to date a supermodel. I'm 100% convinced that anyone with normal intelligence
and a modicum of emotional stability can do it. There are a few simple and logical reasons
why...

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The reasons come from Wall Street's irrational focus on short-term "earnings" and most
investors' total lack of discipline. In this chapter, I'm going to give you my five steps to timing
the market. If you use my strategy, I guarantee you can double your average investment results
over 10 years... or maybe even do a lot better.

But listen... there's an entire army of people out there whose careers depend on you never
doubting the idea that the markets are perfectly efficient and can't be beat. If you speak to any
of these millions of people in the financial services industry about my ideas, they will tell you
I'm a fool, liar, or fraud. So get ready for an argument. Listen carefully. You'll notice these folks
won't ever discuss the merits of my actual strategy.

You see, the financial industry can only survive and prosper if you're willing to give it your
assets to manage. The industry needs you to believe that it's always a good time to put your
money in the market. And it needs you to believe that you can't do it yourself. That's why when
I write things that contradict that message, folks in or supported by the financial industry go
bananas.

As far as who is right and wrong... listen to what the legendary newsletter writer, Richard
Russell, said about market timing:

In the investment world, the wealthy investor has one major advantage over the little guy, the
stock market amateur and the neophyte trader. The advantage that the wealthy investor enjoys is
that he doesn't need the markets... The wealthy investor doesn't need the markets because he
already has all the income he needs...

The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields
are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are
attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art
or fine jewelry or gold is on the "give away" table, he buys art or diamonds or gold. In other
words, the wealthy investor puts his money where the great values are.

And if no outstanding values are available, the wealthy investor waits. He can afford to wait. He
has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for,
and he doesn't mind waiting months or even years for his next investment.

But what about the little guy? This fellow always feels pressured to "make money." And in return,

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he's always pressuring the market to "do something" for him. But sadly, the market isn't
interested. When the little guy isn't buying stocks offering 1% or 2% yields, he's off to Las Vegas
or Atlantic City trying to beat the house at roulette. Or he's spending 20 bucks a week on lottery
tickets, or he's "investing" in some crackpot scheme that his neighbor told him about (in strictest
confidence, of course).

And because the little guy is trying to force the market to do something for him, he's a
guaranteed loser. The little guy doesn't understand values, so he constantly overpays... The little
guy is the typical American, and he's deeply in debt.

– Richard Russell, "Rich Man, Poor Man"

Now... think about what Richard Russell said. Ask yourself, do you invest like the poor man or
the rich man? How much do you know about the value of what you've bought? How long did
you wait for the right opportunity to buy it? What's your downside? What are you expecting as
your result? In a year? In three years? In five years? In 10 years?

The poor man can't even imagine a 10-year investment return. Nothing he buys lasts that long.
Of course, if you want to get rich in stocks, almost everything you buy should last that long. It's
the compound returns that will make you rich, not the quick trades.

What does Warren Buffett, perhaps the greatest investor ever, say? Is the market so perfectly
efficient that knowledgeable and patient investors have no opportunity to earn excess returns?
Buffett argues that all the value investors he knows – those who broadly followed the tenets of
Ben Graham and David Dodd, authors of the value-investing bible Security Analysis – have
beaten the market by a wide margin.

This isn't an accident or a coin flip. These investors all used the same principles to guide their
choices. Their picks were not random or lucky. They involved all different types of securities
and strategies. The only common theme was an intense focus on understanding the value of
each security purchased.

The common intellectual theme of the investors from Graham-and-Doddsville is this: They search
for discrepancies between the value of a business and the price of small pieces of that business
in the market.

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I'm convinced that there is much inefficiency in the market. These Graham-and-Doddsville
investors have successfully exploited gaps between price and value. When the price of a stock
can be influenced by a "herd" on Wall Street with prices set at the margin by the most emotional
person, or the greediest person, or the most depressed person, it is hard to argue that the
market always prices rationally. In fact, market prices are frequently nonsensical.

I have seen no trend toward value investing in the 35 years that I've practiced it. There seems to
be some perverse human characteristic that likes to make easy things difficult. The academic
world, if anything, has actually backed away from the teaching of value investing over the last 30
years. It's likely to continue that way. Ships will sail around the world but the Flat Earth Society will
flourish. There will continue to be wide discrepancies between price and value in the
marketplace, and those who read their Graham & Dodd will continue to prosper.

– Warren Buffett, The Super Investors of Graham and Doddsville; 1984.

Step 1 in our guide to beating the market is based on the ideas of the men above. Before you
buy a stock or bond (or anything else), ask yourself, "What's the intrinsic value of what
I'm buying? And how does that intrinsic value compare with what I'm going to have to
pay for it?" Always make sure you're buying at a good price.

There are lots of ways to estimate intrinsic value. And as with the value of a house, there's no
one right answer. If I asked you to estimate the value of your home, you could give me a range
based on similar sales in your area. You could tell me "replacement cost" based on what a lot of
land nearby would cost and the construction costs. You could give me the tax basis. And I
could look up what the insurance company estimates your house is worth. (That's usually the
most accurate.)

The point is, people of normal intelligence can figure out what something is really worth.
When it comes to publicly traded stocks, plenty of information is available to help you do the
same.

When we look at stocks, we generally assign them an intrinsic value that's based on cash flow
(how much cash this company can generate) for operating companies or a "take out" price for
asset-development stocks. In general, public companies fall into one of these two categories.
They're either operating businesses (which are designed to make annual profits) or asset-

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development businesses (which may have many years of losses as they build out something like
a gold mine, oilfield, or new drug).

Simple rules of thumb? Never pay more than about 10 times the maximum annual free cash
flow for operating companies. Never pay more than half of the appraised value of an asset-
development company.

The next part of our strategy to "time" the market – Step 2 – is even easier. There's not really
any math involved: Become a connoisseur of value. Look around the world. What are other
investors running away from? Is there a safe way to invest? Is it extremely cheap? Does this
opportunity seem like one of the greatest deals you've ever seen?

That's how you become a connoisseur of value. Be patient. And wait for the "dinner bell" to
ring.

Step 3 in our guide to beating the market is even easier. Learn to make big commitments
only when other investors are clearly panicking, stocks are cheap, and extremely safe
investments are available. This is what most people mean when they refer to market
"timing." This is what I mean when I say "allocate to value." Two quick examples...

First, in the fall of 2008, investors were clearly panicking. Warren Buffett wrote a letter to the
New York Times explaining why it was time to buy stocks hand over fist – and was criticized on
CNBC for doing so! If there has ever been a better contrarian indicator, I've never seen it.

Meanwhile, you could have bought shares of iconic beer maker Anheuser-Busch (BUD) for
around $50 for several weeks in October and November. At the time, global brewer InBev had
an all-cash deal in place to buy the stock for $70 per share. I told investors the situation was so
safe, they should put 25% of their assets into the shares.

It was the easiest and safest way to make a lot of money that I'd ever seen. Even if the deal fell
through (and it couldn't; it was an all-cash deal at a reasonable price)... the stock was worth far
more than $50 a share. In my view, there was zero downside, and an almost certain $15-$20
profit in just a few days.

A few months later – in February 2009 – shares of renowned jeweler Tiffany were trading for
less than $25. The company has large inventories of gold and precious stones. Subtracting the

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value of its inventory from its debt load and dividing by the shares outstanding gave you a
liquidation value of around $24 per share. In short, you could buy Tiffany – one of the premier
luxury brands in the world – for the value of its current inventory. That means, you could have
gotten the real estate, the brand, and all the future profits for free. It's at times like these when
you must be willing to make large commitments.

Fine, you might say. But what should I do, just hold cash for years or decades, waiting for a
perfect situation? Stocks were only as cheap as they were in 2009 three or four times over the
last 100 years.

No, I don't argue that you should stay 100% in cash until stocks crash. That is probably the
biggest misunderstanding most investors have about our advice. We never advocate selling
everything. We didn't sell everything in 2008, even though we knew the mortgage associations
Fannie Mae and Freddie Mac were going to zero and that Wall Street was going to collapse.

We never believe that we can predict the future accurately. Instead, we want to build a portfolio
that will thrive over time, no matter what happens.

Step 4: Stay reasonably diversified, use trailing-stop losses, and always maintain a large
cash reserve. Here, we part ways with most value investors. A lot of good value investors
refuse to use trailing-stop losses. Instead, they hope to sell when stocks become too expensive.

But in our experience, it's nearly impossible for most investors to know when to sell.
Therefore, we want to focus on buying at the right time. Then, we simply admit that we're not
going to sell at the optimal point. We just can't predict how high stocks will go. And we want to
capture as much of that upside as possible. Using trailing stops allows us to do this.

Also, it's important to never give your stockbroker your stop-loss points. And never, ever base
your stops on intraday prices. If you put your stops in the market (which is what happens when
you give them to your broker)... events like a flash-crash can wipe you out.

If you remain dedicated to only buying stocks at a discount from their intrinsic value... if you
become a connoisseur of value... and if you only make large investments when other investors
are panicking, then you should actually find that it's easy to keep a cash reserve.

But how many stocks should you own? What's reasonably diversified? I recommend never

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owning more stocks than you can completely understand and follow. A good test is this: Can you
explain the stocks in your portfolio and why you bought them (the elevator pitch) to a friend
without using notes or looking at your portfolio? If you can't, then you don't know your
investments well enough to own them or you're trying to follow too many. You're not going to
be able to find more than a handful of extraordinary investments at any given time. Why own
anything that's not extraordinary?

Another good test for your portfolio is to make sure that there's not a single position that could cost
you more than 5% of the value of your overall portfolio. Don't end up with so few large positions
that a catastrophe in one stock wipes out all of your other gains for the year.

What's the last of our part of our strategy (Step 5) to always beating the market? Do
everything you can to avoid the damage from fees and taxes, to maximize your long-
term, compound returns. Whenever possible, keep your assets in vehicles that allow you to
compound your investments tax-free. Minimize trading and fees, which enrich your broker, not
you. Look for companies whose management is well-known for doing tax-efficient deals and
rewarding shareholders in tax-efficient ways. And always reinvest your dividends – either in
the same companies or in new ones that offer better value.

Studies show that most investors perform terribly when managing their own assets. That
doesn't mean that you can't do well. It does mean that the odds are stacked against you. So print
out this list. Start living by it.

Never buy a stock whose intrinsic value you can't estimate reliably – and always get a big
discount when you buy.

Become a connoisseur of value. Follow the cheapest, most hated segments of the market
carefully. Wait and watch for moments of maximum pessimism, like the homebuilding carnage
of 2007.

Allocate to value: Wait to make major investments when other investors are panicking and
truly safe, outstanding opportunities abound.

Use good money-management techniques. Follow position-sizing guidelines and trailing-stop

losses. Never own more positions than you can carefully follow. Always keep a large cash
reserve.

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Do everything you can to avoid fees and taxes. Simply avoiding a 2% annual fee against your
asset base (by not using money managers) is the No. 1 surest way to outperform your peers.

These are the basic principles we'll use to build our recommended portfolio. You'll see us
return to these concepts and principles time and again as we introduce new investments to the
portfolios.

Chapter 3 – The One Business I'll Teach My Children

By now, I hope I've convinced you that you can cross the financial desert… as long as you
follow a few guidelines and use the right tools. In this chapter, I'll introduce one of the most
important tools anyone crossing the desert.

I'll start by asking an important question: If you were going to limit all of your investments to
only one sector of the economy – only one type of business or one kind of stock – what would
you buy?

We've come to believe that, for outside and passive investors (common shareholders), only
three sectors offer truly extraordinary rates of return and that don't require taking any material
risk. Let me be clear about what I mean. There are three sectors of the economy where
companies can establish and maintain a truly lasting competitive advantage and outside
investors can identify attractive values.

As I teach my children about investing, I will focus almost entirely on examples from these
three sectors. And truly... I will spend most of my time explaining only one business to my children.
If they come to understand this business thoroughly, I know, with a reasonable amount of
saving discipline, they will be financially secure by the time they are 30 years old... and wealthy
long before they reach 50.

I want to show you why the investment returns in these businesses are so incredibly good over
the long term. I want you to know how to think about these businesses... how they work... and
know a few simple keys to making great investments in these sectors.

I promise... this is all far easier than you're imagining right now.

Let's start with this chart.

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This chart shows four of the best-managed property and casualty (P&C) insurance companies
in the United States.

Company No. 1 started in the 1930s insuring jitney buses and later long-haul truckers. Now, it
serves niche markets and underwrites specialty insurance products. The company is worth $12
billion.

Company No. 2 got its start insuring contact lenses. It now focuses on things that other
companies won't touch like oil rigs and summer camps. It's a small public company worth $2.7
billion.

Company No. 3 was founded by a Harvard Business School graduate 50 years ago. It is still
mostly a family business (even though it has public shareholders and is worth $7.3 billion). It
insures almost anything commercial, from yachts to elevators.

Company No. 4 is a major global company that insures virtually anything and is worth $31
billion.

You might think, outside of being in the insurance industry, these companies have almost
nothing in common. Some are small and insure essentially niche items. Others are huge,
operate globally, and insure virtually anything. Yet to us, these companies look nearly the
same: They are among the best underwriters in the world.

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That means these insurance companies almost always demand more in insurance premiums
than they will end up spending on insurance claims. As you will soon learn, nothing is more
valuable in the financial world than having the skill and the discipline to underwrite insurance
profitably.

Over the long term, all of these companies have generated returns that are more than double the
S&P 500. They did so without taking any risk – something I'll explain more fully below. And...
here's the best part... their success was both inevitable and repeatable. These are not "lucky
guesses" or fad-driven product sales.

One of our overriding goals at Stansberry Research is to give you the knowledge we'd want to
have if our roles were reversed. Knowing what I know now about finance, I wouldn't have
gotten into the investment newsletter business. I would have gotten into insurance.

There is nothing more valuable we can teach you than understanding how to invest in good
P&C insurance companies. And with the legwork we do for you, it's as easy as pointing and
clicking. If a company passes our tests and you can buy it at the right price... you can be next to
100% sure that the investment will produce outstanding returns. It's like painting by numbers.
Only it will make you rich.

Let me say it one more time... I believe if individuals would limit themselves to only investing
in P&C insurance companies – and no other sector – they would greatly increase their average
annual returns. We don't believe that's true of any other sector of the market.

There's a simple reason for this. If you'll think about it for a minute, it should become intuitive.
Here's why insurance is the world's best business: Insurance is the only business in the world that
enjoys a positive cost of capital.

In every other business, companies must pay for capital. They borrow through loans. They
raise equity (and must pay dividends). They pay depositors. Everywhere else you look, in every
other sector, in every other type of business, the cost of capital is one of the primary business
considerations. Often, it's the dominant consideration. But a well-run insurance company will
routinely not only get all the capital it needs for free, it will actually be paid to accept it.

I want to make sure you understand this point. All of the people who make their living
providing financial services – banks, brokers, hedge-fund managers, etc. – pay for the capital

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they use to earn a living. Banks borrow from depositors, investors who buy CDs, and other
banks. They have to pay interest for that capital. Likewise, virtually every actor in the
financial-services food chain must pay for the right to use capital. Everyone, that is, except
insurance companies.

Now just follow me here for a second... Insurance companies take the premiums they've
collected and invest that capital in a range of financial assets. Assume, just for the sake of
argument, that they earn 10% each year on their premiums. (That is, they make 10% on their
underwriting.) And assume they invest only in the S&P 500… What do you think the average
return on their assets will be each year? In this hypothetical example, their return would be
10% plus whatever the S&P 500 returned.

In reality, of course, few insurance companies can make such a large underwriting return. And
few insurance companies invest a large percentage of their portfolio in stocks. Most stick to
fixed income to make sure they can always pay claims. But the point remains valid. By
compounding underwriting profits over time, year after year, into the financial markets,
insurance companies can produce very high returns.

Here's the best part: Insurance companies don't really own most of the money they're
investing. They invest the "float" they hold on behalf of their policyholders. Float is the money
they've received in premiums, but haven't paid out yet. Underwritten appropriately, this is a
risk-free way to leverage their investments and can result in astronomical returns on equity
over time.

Just look at insurance company No. 1 in the chart above. It has produced five times the S&P
500's long-term return. Can you think of any investor, anywhere, who has done anything like
that? There isn't one. That kind of performance was only possible because, using a small equity
base, the firm has profitably invested underwritten float into solid investments, year after year.

Do you like paying taxes? If you do…well, you won't like insurance stocks, then. They have
huge tax advantages. Insurance is, far and away, the most tax-privileged industry in the world.
Many of their investment products are totally protected from taxes.

And their earnings are sheltered, too. Insurance companies don't have to pay taxes on the cash
flow they receive through premiums because, on paper, they haven't technically earned any of

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that money. It's not until all of the possible claims on the capital have expired that the money
is "earned."

So unlike most companies that have to pay taxes on revenue and profits before investing
capital, insurance companies get to invest all of the money first. This is a stupendous advantage.
It's like being able to invest all of the money in your paycheck – without any taxes coming out
– and then paying your tax bill 10 years from now.

I realize that I can't make you (or anyone else) actually invest in insurance stocks. And I know
that no matter what I say, most of you – probably more than 90% – never will. It's a tough
industry to understand, filled with financial concepts and tons of jargon. But there are two
reasons the smartest guys in finance wind up in insurance, one way or another...

First, it pays the best. Second, it takes real genius to understand. But... my goal is to make it so
easy to understand and follow that any reasonably diligent subscriber can do so. I want to
simply show you the one number you've got to know to invest safely and successfully.

Normal measures of valuation don't apply to insurance companies. Why not? Because regular
accounting considers the "float" an insurance company holds as a liability. And technically, of
course, it is. Sooner or later, most (but not all) of that float will go out the door to cover claims.
But because more premiums are always coming in the door, float tends to grow over time, not
shrink. So in this way, in real life, float can be an important asset – by far the most valuable
thing an insurance company owns. But there's one important catch...

Float is only valuable if the company can produce an underwriting profit. If it can't, float can turn
into a very expensive liability.

That's why the ability to consistently underwrite at a profit is the key – the whole key – to
understanding what insurance stocks to own. Outside of underwriting discipline, almost
nothing differentiates insurance companies. And they have no other way to gain a competitive
advantage. Warren Buffett – who built his fortune at Berkshire Hathaway largely on the back of
profitable insurance companies – explained this in his 1977 shareholder letter:

Insurance companies offer standardized policies, which can be copied by anyone. Their only
products are promises. It is not difficult to be licensed, and rates are an open book. There are no
important advantages from trademarks, patents, location, corporate longevity, raw material

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sources, etc., and very little consumer differentiation to produce insulation from competition.

Thus, the basis of competition between insurance companies is underwriting. That is... to be
successful, insurance companies must develop the ability to accurately forecast and price risk.
And they must maintain their underwriting discipline even during "soft" periods in the
insurance market when premiums fall.

Our team tracks nearly every major P&C insurance company in the U.S. and in Bermuda (where
many operate to avoid U.S. corporate taxes completely). We rank every firm by long-term
underwriting discipline. We've done the legwork for you. All you have to do is know what price
to pay.

So if normal accounting doesn't apply for insurance stocks, how do you value them? Again, we
went to the master, Warren Buffett, to see what he was willing to pay for very well-run
insurance companies.

Back in 2012, we found data on three of Buffett's biggest insurance purchases. In 1998, he
bought General Re for $21 billion, which added $15.2 billion to Berkshire's float and $8 billion
in additional book value. So Buffett paid $0.94 for every dollar of float and book value.

Before that, in 1995, Buffett bought 49% of GEICO for $2.3 billion, which added $3 billion to
Berkshire's float and $750 million in additional book value. So Buffett paid $0.61 for every
dollar of float and book value.

And way back in 1967, Buffett paid $9 million for $17 million worth of National Indemnity
float. That's $0.51 for every dollar of float. Looking at these numbers, we expect to pay
something between $0.75 and $1 for every dollar of float and book value.

In short, there are two fundamental rules to investing in insurance stocks. Rule No. 1: Make
sure the company earns an underwriting profit almost every year, no exceptions. And Rule No. 2:
Never pay more than 75% of book value plus float.

Most investors will never be able to make these investments because they don't understand
why underwriting discipline is so critical. And they have no ability to accurately calculate float.
We've done all of the hard work for you. And when we find a P&C insurance company that
meets our standards, we're happy to add it to our model portfolios.

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Chapter 4 – Stocks That Go Up… Even When You're Wrong

Pro baseball Hall of Famer Ted Williams didn't bat .406 in 1941 by swinging at every pitch.

He carefully broke down the strike zone and decided to only swing at pitches that were in his
favorite spots – his own personal strike zone. He knew he had a much better chance of hitting
those pitches than the pitchers had of throwing it into the few places where he wouldn't swing.
Ted Williams only struck out 27 times that season.

As an investor, you'll be inundated with "pitches" everywhere you go – cocktail parties, the
dentist office, and, of course, CNBC. Most investors swing at every hot stock tip they get.

This is a surefire way to get yourself killed while "crossing the desert." You've got to avoid "the
herd" like the plague.

Sometimes the signs of this herd behavior are easy to see. For example, you can usually find a
handful of stocks whose shares are valued for more than $10 billion and trade at more than 10
times their annual revenues. Only a handful of businesses are created every decade that are
worth this kind of valuation. And even if they're worth it, it's almost dead certain that, sooner
or later, you'll have the opportunity to buy in at a much more reasonable price.

As a recent example of what usually happens to these kinds of stocks, I'd point to the social-
media service Twitter (TWTR). In 2015, Twitter traded for a $19 billion in market cap and 10
times sales.

This company has serious business problems, but has been hyped by promoters and has caught
the public's eye. Meanwhile, it's down big over the past two years and suffered a fall of more
than 70% from its peaks.

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When you hear about companies like Twitter, it's best to just let those pitches fly by. Like Mr.
Williams, it's best to simply wait for an easy, fat pitch coming right through the sweet spot.

The more time I spend in the financial markets, the more convinced I become that most
investors should only buy stocks in these few "sweet spots." In these areas, outside investors
have the tools to decide whether or not a stock is in the strike zone. If you can learn to limit
yourself to only making capital commitments in these areas – your personal "strike zone" – I'm
certain you can vastly improve your results.

In this chapter, I'm going to show you how to find outstanding long-term results in what I call
capital-efficient stocks. And lucky for outside passive investors, one sector of the stock market
is both easy to understand and crowded with capital-efficient companies.

Simple question: Do you think you could name any of the 20 best-performing stocks in the
S&P 500 in the 50 years between 1957 and 2007? Wharton economist Jeremy Siegel wanted to
answer this question thoroughly.

It's not as easy to figure out as you might think because the composition of the S&P 500
changes frequently. Siegel had to go back and get the actual list of stocks from 1957 and then
follow each one, carefully, to see how much they paid out in dividends, spinoffs, mergers, and
liquidations.

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So... what were the real best-performing stocks over that 50-year period?

What I'm sure you can see for yourself is that, almost without exception, these companies sell
high-margin products (some are extremely high-margin), in stable industries that are
dominated by a handful of well-known brand names.

Look at the top 10 names on the list – the ones that produced 15%-plus annual returns. My bet
is that most of you have at least three or four of these companies' products in your house at all
times.

Crane, by the way, is the obvious exception. What is it that Crane (a maker of high-margin
industrial parts) has in common with these other companies? It's extraordinarily capital-

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efficient. Because of Crane's excellent, storied reputation (it has been in business since 1855),
the unique, proprietary nature of its products, and the stable, long-term nature of its business,
Crane doesn't have to spend a fortune on brand advertising or building new manufacturing
plants to come up with new products every few years.

This means that as sales grow, the amount of capital that must be reinvested in the business
doesn't grow much – or at all. Over the last 10 years, Crane has earned gross profits of about
$8.5 billion and spent just $346 million on capital investments.

I learned the basic concepts behind capital efficiency by carefully studying the few large
investments Warren Buffett made in the 1970s and 1980s. If you read his 1983 letter to
shareholders, he basically gives away the whole strategy. But it's hidden... at the end of the
letter... underneath the title: "Goodwill and its Amortization: The Rules and the Realities."

You can read Buffett's letter if you'd like... but I think you'll learn more from the practical
application of this strategy with my December 2007 recommendation of chocolate maker
Hershey (HSY).

I've said many times, and in many places, that I believe my recommendation of Hershey will
likely be the best stock pick I make in my entire career. As I said when I recommended it, "The
longer you hold this stock, the more rapidly your wealth will compound and you'll never have to sell
– ever."

In my initial recommendation, I noted how capital-efficient Hershey is...

Over the last 10 years, the company's annual capital spending has remained essentially
unchanged. In 1997, the firm invested $172 million in additions to property and equipment. By the
end of 2006, the annual capital budget had only increased to $198 million – a paltry 15%.
Meanwhile, cash profits and dividends nearly doubled.

This is the beauty of capital-efficient businesses: As sales and profits grow, capital investments
don't. Thus, the amount of money that's available to return to shareholders not only grows in
nominal dollars, it also grows as a percentage of sales. In 1999, dividends paid out equaled 3.4%
of sales. But by 2006, the company spent $735 million on dividends and share buybacks, an
amount equal to 14.8% of sales.

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Today, roughly eight years later, Hershey's sales have grown to almost $7.5 billion, but capital
investments remain incredibly small – less than 5% of sales. In 2015, with gross profits of $3.4
billion, Hershey distributed $960 million to shareholders. That's roughly 28% of gross profits
and far more capital than it invested in its operations ($330 million).

That's another hallmark of capital-efficient companies: They almost always return more
capital to shareholders each year than they spend in capital investments. Why doesn't Hershey
distribute even more? It could... Cash flows from operations were more than $1.2 billion. But
companies like Hershey will wait to buy back lots of stock (or make wise acquisitions) when
prices are low. How can you do the same? How do you know when is the right time to buy these
stocks, which almost always trade at rich premiums to the average S&P 500 stock?

You want to buy these stocks during the rare times when they're cheap enough to safely take
themselves private. Again, I explained the concept when I made by 2007 recommendation...

Hershey's enterprise value is $11.5 billion. That's the amount of money it would require to pay off
all of the company's debts and buy back all of the outstanding shares of stock at the current
price.

The company earns more than $1 billion before taxes, interest, and depreciation. Its earnings are
very consistent, and its brand places it in the upper tier of all businesses around the world. It

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could easily finance a bond offering large enough to buy itself – or "go private."

Thus, I think it is extremely unlikely that investors will lose money buying the stock at today's
price... Given the company could easily finance the repurchase of all its stocks and bonds, I
believe buying this stock is no more or less risky than buying its bonds.

That is the true definition of a "no risk" stock – an analysis of its cash flow shows it could afford to
buy back both all of its debts and all of its shares... These situations are extremely attractive
because, while you're only taking a risk that's similar to a bondholder, you're getting ownership of
all of the company's future earnings.

You know when it's safe to buy these businesses by figuring out if they could finance a debt
issuance in excess of their enterprise value. That can be a little tricky. So use a rule of thumb.
These stocks are safe to buy (and likely to produce incredible long-term results) when you can
buy them for around 10 years' worth of current cash flows from operations.

You can find businesses like these by looking in the portfolios of high-quality investors. I've
noticed that Mario Gabelli's GAMCO team loves these kinds of businesses. Likewise, of course,
the exchange-traded funds focused on shareholder yield – like Meb Faber's Cambria
Shareholder Yield Fund (SYLD) – will always feature a lot of these names, as companies have to
be reasonably capital efficient and reasonably priced if they're going to rank in the top spots in
terms of shareholder yield. And they will make up a critical part of the foundation of our
Stansberry Portfolio Solutions recommendations.

Here's another big helpful hint when it comes to this type of investing: It's critical to avoid
companies that are returning huge amounts of capital to investors simply because their
businesses have become obsolete. Companies like Western Union, for example, might look
good on paper, but its future cash flows are seriously in jeopardy by new technologies.

If you're going to invest using this strategy, you want to stick to the highest-quality businesses,
whose products are timeless. I always ask myself this question: "Are my grandkids likely to want
this brand and this product?" No brand or business in the world will last forever, but you should
try to focus on the stuff that's as close to forever as possible.

Here's another valuable tip. This is one of the few, genuine secrets to investing that I've ever
learned. In fact, it's a little creepy, but… A lot of the companies that fit into our model of capital

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efficiency sell products that are highly addictive.

Many of the 20 best-performing S&P 500 stocks sold habit-forming products: Phillip Morris
(cigarettes), Coca-Cola and PepsiCo (sugary sodas), Hershey and Tootsie Roll (chocolate and
sugar), McDonalds (fast food).

A lot of drug companies also show up: Abbott Labs, Bristol-Myers Squibb, Merck, Wyeth,
Schering-Plough, and Pfizer. People often grow very loyal to brand-name drugs they need (or
think they need).

When a business produces something that people love and build habits around… it's freed from
having to spend lot of money developing new products. They can send a larger percentage of
revenues can be sent to shareholders. That's the essence of a capital-efficient business.

I don't expect all (or even most) of the market's leaders from 1957 to 2007 to remain at the top
of the performance charts. But what I hope you'll notice is that the characteristics of the
leading companies are the same. New brands come along and make small changes... and get
very popular. New medicines are invented. New forms of addiction are marketed successfully.
If you keep your eyes open, it's not all that hard to figure out which of these products and
businesses are likely to do extremely well over the long term.

Here's the list of the 10 best-performing stocks in the S&P 500 over the last 20 years (on an
annualized basis):

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Four of the top five firms sell high-margin, branded drugs – as long as you agree that caffeine
is a highly addictive drug. Most people don't think about Monster Beverages as a drug
company, but its Monster Energy drink contains more caffeine than McDonald's regular coffee
does.

What does the company really sell? From the beginning of 2006 through September 2016,
Monster Beverages produced gross profits of $10 billion. It only spent $980 million on capital
investments.

The company doesn't pay a cash dividend. But it does look after shareholders by repurchasing
stock. This lowers the share count, which means shareholders get a larger stake in the pie.
From 2006 to 2016, Monster repurchased almost $2 billion worth of stock.

Investors who bought the stock in 2006 are up more than 600% in 10 years. By comparison, the
S&P 500 is up around 93% over the same period. Soda giant Coca-Cola (KO) liked Monster so
much, it entered into a partnership and bought 17% of the stock in 2015.

In short, even though the company has grown significantly, it has still been able to improve
operating margins and spend more on share buybacks than the capital expenditures required to
keep the business running.

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By buying capital-efficient companies at good prices, I believe will make you money in almost
any market condition. Even when you're bearish or afraid of stocks in general. And here's the
best part: These secrets will also show you how to outperform in bull markets. In short, these
are the most valuable ideas anyone could give you about investing in stocks...

They will help you make money even when you're dead wrong about the market as a
whole or the sector you're buying.

Chapter 5 – A Four-Step Test for Great Investments

In Chapter 1, I told the story of three South African adventurers who became the first men to
ever walk (unassisted) across the Rub' al Khali – "the Empty Quarter" – desert of the Arabian
Peninsula. This had never been done before, not even by the famous "Lawrence of Arabia."

These men didn't have camels. They didn't have Bedouin guides. And they didn't travel across the
Sinai Peninsula. They traveled 1,000 kilometers across Rub 'al Khali.

What I didn't mention was why they did it. Why in the world would a sane person risk his life
trying to walk across the largest, most inhospitable landscape on earth?

Their motivation was drug addiction. These men needed something in their lives that was

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harder than dealing with their addiction. Walking across this desert was the only thing they
thought would be hard enough to make not doing drugs seem easy in comparison.

If you've ever faced any kind of mental illness – whether addiction or depression or anxiety –
or if you've been close to others facing those challenges... I think you'll recognize this approach
works for a lot of people. A friend of mine starts his day every morning by doing two sets of 80
push-ups in a row. He says, "After the push-ups, everything else in my life is easy in comparison. I
like to get the hard part over with first." It works for him.

In this chapter, we're going to do something that's hard for most people. It involves some
math. It involves thinking hard about rather abstract ideas. For most of you, it will involve
learning new jargon, which is probably the hardest part. No, it's not as hard as walking across a
giant desert for 40 days. But it's something most people will go to great lengths to avoid. So let
me tell you why you should first calculate these four things every time you buy another stock.

What you'll find below is a nearly foolproof way to evaluate the quality and the value of any
business. This four-part test will allow you to quantify, with surprising precision, exactly what
makes a given business great, average, or poor. This knowledge will allow you to make vastly
better and more informed decisions about what any business is worth and what you should be
willing to pay for it on a per-share basis. But that's not the best reason to learn this four-part
test...

The real secret is, once you develop the discipline to always do this work before you buy any
stock, you'll never make a quick decision to buy a stock ever again. Once you add something
that's hard to do, that requires a little bit of time, a little rigor, and a little discipline to your
investment process, you're going to greatly reduce the number of stocks you buy.

You're also going to radically improve the quality of the stocks you're willing to invest in
because you'll have the skills to do so. And that will eliminate more than 90% of your
investment mistakes. Remember... you don't need to find a great investment every month or
even every year. You just need to find them every now and then... and have capital ready to put
to work.

As I explained in Chapter 4, I believe the No. 1 thing you need to know to be successful as an
investor in common stocks is what type of business makes for a great investment. Investment

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legend Warren Buffett says the same thing. He puts it this way…

Your goal as an investor should simply be to purchase, at a rational price, a part interest in an
easily-understandable business whose earnings are virtually certain to be materially higher five,
10, and 20 years from now.

So... what makes a great business? How can you be certain its earnings will materially grow
over reasonable periods of time? To figure it out, let's take one of Buffett's most famous
investments – Coca-Cola (KO).

Coke sells addictive (caffeine-laced) sugar water for more than the price of gasoline all around
the world. It has integrated its brand into people's lives through decades of advertising
spending – an investment that has paid off tremendously. Coke has one of the world's most
universally recognized and admired brands.

But how do these advantages translate into hard numbers? The most obvious characteristic
of a great business is high profit margins. High margins are proof of a great brand, a
superior product, or some form of regulatory capture that permits greater-than-normal
profitability. On every dollar of revenue last year, Coke earned nearly $0.24 in cash. And it
brought in $44 billion in revenue.

To figure out exactly how much money Coke earns in cash, we simply look at the company's
Statement of Cash Flows, under the line: "total cash flow from operating activities." We see
that in 2015, this was $10.5 billion. (The "Statement of Cash Flows" is one of four financial
statements published in every Securities and Exchange Commision (SEC) form 10-K, along
with the Income Statement, Balance Sheet, and Statement of Comprehensive Income. You can
access these statements by looking at a company's annual report, which is available on the
"Investor Relations" section of its website, or by using Yahoo Finance or any number of other
online databases, like Bloomberg.)

Next, we divide those cash profits by the company's total revenues ($44 billion), which you can
find on the income statement. Doing the math gives you a fraction that is commonly expressed
in percentage form: 24%. Coke's cash operating profit margin is 24%. It's earning $0.24 in
profit on every dollar it generates in sales. In our experience, businesses with cash operating
margins in excess of 20% are world-class. If you were putting together a checklist, you could

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start there. A great business must have cash operating margins greater than 20%.

The next "mile marker" you're looking for is capital efficiency, which we covered extensively in
the last chapter. This is another concept that, like profitability, is easy for most people to
grasp. All you're trying to understand with this test is how much capital the company requires to
maintain its facilities and grow its revenues. For example, oil and gas companies are notorious
for spending every penny they make on drilling more holes and building more facilities. Their
capital-spending programs leave little of their profits to be distributed to shareholders (often
less than zero).

One simple way to assess a company's capital efficiency is figure out whether the
company in question distributes more capital back to shareholders... or spends more
money "on itself" via capital-spending programs.

A great business is able to distribute more profits to its shareholders than it consumes via
capital investments. Coke, for example, spent $2.5 billion on capital investments in its own
business in 2015. It spent $5.7 billion on dividends and $2.3 billion on net share buybacks in
the same period. You can see that Coke is spending far more on its shareholders than it spends
on itself. (By the way, all of these numbers are labeled clearly on the cash flow statement I
mentioned earlier.)

What's powerful for investors about businesses like these is that you don't need lower interest
rates or a raging bull market to be successful. As these businesses grow, they're going to
increase their payout amounts, year after year. It's the compounding effect of this growth that
will make you wealthy. That's why Buffett says you should never buy a stock you wouldn't be
happy to hold for a decade, even if the stock market was closed.

The third part of our four-part litmus test for great businesses is "return on invested
capital." (Here comes the jargon.) Yes, it's a mouthful. But I promise, with just a little practice,
you'll be able to easily calculate this figure in your head. We use this metric because there's no
purer way of determining the value and the power of a company's "moat" – the degree to which
the company is sheltered from profit-eliminating competition.

The business school formula for determining the precise amount of invested capital is complex
and requires several different numbers (and judgments about each of them). It's a pain. And

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there's a much easier way to get a ballpark figure – just add the total amount of a company's
long-term debt and the total value of the company's equity capital. You'll find both numbers as
simple line items on the balance sheet.

Coke has $26 billion worth of equity capital and $44 billion worth of debt (adding the short-
term debt to long-term debt). So in our book, the company has invested capital of $70 billion.
On this capital last year, the company reported $7.4 billion worth of net income, or "earnings."

You'll find Coke's net income on the aforementioned income statement. Once you have the
numbers, you just do the basic math (7.4 divided by 70) to derive another percentage – 11%. As
you'll see, this is where Coke falls a bit flat. The beverage market is ultra-competitive and
Coke's brand only provides a small measure of protection against competitive pricing.

The last part of our great business test is also a bit "wonky" and will make you sound like a
finance geek. It's called return on net tangible assets. This number gives you the best
overall measure of the quality of any business. It's similar to the more commonly used ROE
("return on equity") with two important differences.

First, measuring returns against net tangible assets takes goodwill out of the calculation. So
companies with large amounts of goodwill (like companies with great brands) will typically
show a much higher return. Second, this measure of quality rewards companies that can
borrow most of the capital they need because their results aren't cyclical.

Calculating this number is also really easy. Yahoo Finance lists "net tangible assets" among its
balance sheet statistics. Alternatively, you can use the company's Balance Sheet to calculate
the number yourself. Simply subtract Total Liabilities, Goodwill, Trademarks, and Other
"Intangible" Assets from Total Assets. Then, compare this number with the company's net
income for the last year. In Coke's case, net tangible assets total only $1.4 billion. Coke earned
a profit equal to 528% of its net tangible assets – a truly outstanding figure.

(Note: In some cases, a company will actually have more liabilities than it has tangible assets.
In those cases, the math you see above no longer works because you can't divide using a
negative net tangible assets figure. When that happens, we'll subtract out only the long-term
portion of total liabilities. This provides a more meaningful number, while still measuring the
company's ability to safely replace equity with debt in its capital structure.)

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Putting all of these factors together, our test of business greatness starts with profits. How
much money, in cash, does a business earn from its operations, expressed as a percentage of its
sales? The higher the margins, the better. This tells us that the company owns high-quality
brands and products, as well as market position. We expect great businesses to produce
cash operating margins of at least 20%.

Our second test is capital efficiency. Does the business produce substantial amounts of excess
capital, and does management treat shareholders well? We test this by seeing whether
shareholders receive at least as much capital each year as the business reinvests in itself.

The third test is return on invested capital, which is the best measure of a company's moat.
Here again, we would expect to see returns on invested capital of at least 20% for it to qualify
as a great business.

Finally, our last measure of great companies – return on net tangible assets – combines brand
value, capital efficiency, the quality of earnings, etc. No surprise. We expect returns on net
tangible assets in excess of 20% annually.

Business quality is extremely important, but the stock price is equally important for
investment outcomes. Our best advice is to value high-quality businesses by the amount of
cash they earn before interest, taxes, depreciation, and amortization. In finance jargon, this
measure of profits is called "EBITDA." You can't use this measure with lower-quality
businesses, but it works well for high-quality businesses because it allows you to quickly judge
companies in different industries against each other.

Now, let me show you a trick that will show you when to buy a high-quality company: We try to
avoid paying more than 10 years' worth of EBITDA per share when we buy a business. We measure
the cash earnings against the enterprise value of the business (the value of all of the shares and
all of the debt, minus the cash in the business). But you don't need to do all of this work
yourself. You can find this multiple on Yahoo Finance on the key statistics page for any given
stock. Valuing businesses is a lot more difficult than evaluating their performance. You should
be willing to pay more for a high-quality business that's growing.

The Four-Step Test of Greatness:

1. Cash operating profit margin: cash from operations / revenue (should be greater than

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20%).

2. Shareholder payout ratio: capital returned to shareholders / capital expenditures (should

be greater
than 1).

3. Return on invested capital: net income / long-term debt + shareholder equity (should be
greater than 20%).

4. Returns on net tangible assets: net income / net tangible assets (should be greater than
20%).

Bonus Step:

5. Share price multiple: enterprise value / EBITDA (ideally less than 10).

Chapter 6 – The Funds Your Broker Should Tell You About

Most people don't know that they don't have to settle for poorly run mutual funds or "buy
everything" exchange-traded funds. A handful of nearly secret investment funds that trade on
the public market have excellent track records and treat their shareholders with great care and
respect. Best of all, outside of paying a one-time brokerage fee, it costs nothing to own these
funds.

In earlier chapters, I showed you how I "time" the market by focusing on intrinsic value,
investor sentiment, and asset allocation. I also wrote about how to evaluate and identify some
of the best companies in the world. Specifically, we covered some sectors I believe outside,
passive investors (aka, you) should focus on if you're going to do your own investing: insurance
(profitable underwriters) and capital-efficient businesses (especially those with addictive
products).

Now, you'll learn a slightly more advanced tools for "crossing the desert." In this chapter, I am
going to detail the funds you can join and the secret "backdoor" way you can buy them below.

The summary is pretty simple: You can invest alongside the best and brightest investors in the
world... You can gain substantial tax advantages (in some cases) by doing so... And executing
these trades is no more difficult (or more expensive) than simply buying a stock.

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Let's start there: Do you have any of your assets with renowned investors Prem Watsa or Carl
Icahn? What about Sardar Biglari? He's one of the most talented young activist investors in the
world. Do you think having at least some of your long-term savings with these guys would be a
good idea?

I would argue that even if you're a professional investor and working on your portfolio full
time, you're unlikely to produce long-term results on par with these guys. They're the best in
the world, and they have the best analysts working for them – guys in their 20s and 30s who
are blindingly smart and working 80 hours a week.

There are three reasons why more investors don't invest with these guys. First, obviously, most
people don't know how. They think they have to have millions to get into their hedge funds.
They don't know that many of the most successful investors in the world offer their portfolios
to public market investors.

The next problem is harder to solve: These holding companies typically have complex
structures that make them difficult to analyze and understand. I'll do what I can for you to
show you how to make sense of them. But if you're going to invest in these firms, you really
have to read their annual reports and their quarterly reports.

You should really go to the annual meetings, too. There's no substitute for looking these guys
in the eye and hearing about their plans.

Finally... you have to be prepared for significant volatility. These guys are essentially leveraged
financial firms. That means when a cold wind blows in the financial sector, these stocks are
going to get "blown around."

Remember… Warren Buffett's Berkshire Hathaway saw its share price drop 50% twice during
Buffett's tenure (1974 and 2000). The intrinsic value of Berkshire Hathaway didn't change
much at all.

With these kinds of companies, you have to really understand what you own and what it's
worth. The public equity markets do a terrible job at pricing these kinds of companies.

Let's start with the most famous – Carl Icahn. One public vehicle owns essentially all of Icahn's
investment assets – Icahn Enterprises (IEP). The company owns his direct investments,

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including automotive, railcar, casinos, energy, metals, mining, food packaging, home fashion,
and real estate.

Carl Icahn personally owns 90% of the stock, which has a market capitalization of $7 billion
and holds around $13 billion in debt.

In 2016, the stock traded at a significant premium to book value. Wait to get in until it's
trading at book value or less.

I believe the next investor we'll discuss is on his way to becoming a financial titan, and it may
well pay huge dividends to hop on the boat before he's as big as someone like Icahn.

His name is Sardar Biglari. His company is Biglari Holdings (BH).

Like Buffett, Biglari holds an annual meeting worth attending every year that features a tough
Q&A session that lasts for hours. He, like Buffett, also writes annual letters that are brilliant.
But unlike Buffett, he's known for being arrogant and doesn't suffer fools gladly... at all.
Naturally, I like him.

Whatever you think of his personality, his track record is among the best in the world. He used
a private investment fund to take over and turn around fast-food chain Steak & Shake, a move
that required tremendous financial risk-taking and true operational excellence.

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Biglari is one of the few executives who can operate at a high level both on the financial side
and on the business side – something that Sears Holdings CEO Eddie Lampert, for example,
has failed to do so far.

Biglari began to funnel Steak & Shake cash flows into activist campaigns (against fellow
restaurant Cracker Barrel). In 2014, he bought his first insurance company (First Guard
Insurance).

Out of all the young guys in finance these days, Biglari is the most fascinating... and I believe
he will become the most successful.

The company is still small – the market cap is less than $1 billion. From 2011 to 2016, Biglari
grew the firm's book value an average 13% annually. I believe the insurance operations will
grow this figure substantially. In late 2016, Biglari Holdings traded at a premium to book value.
We would rather not pay more than book, so you need to be patient. Meanwhile, learn
everything you can about the company. And buy when you can get shares closer to book value.

The last "secret" fund I'd like to show you isn't a secret at all. It's a well-known insurance
company – Fairfax Financial – headquartered in Toronto. What makes Fairfax unusual is that
like Buffett's Berkshire Hathaway, the company invests most of its insurance float in value
stocks. Its chief investment officer – Prem Watsa – is one of the world's leading value

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investors.

Over the last 30 years, Fairfax Financial has grown its book value an average of 20% annually.
In late 2016, Fairfax Financial traded at a slight premium to book value. And it announced it
was buying Allied World Assurance – a high-quality P&C company – for about $4.7 billion.

You can find it under the Canadian ticker symbol FFH. The stock also trades on the U.S over-
the-counter (OTC) market with ticker symbol FRFHF. However, the Canadian listing has much
more liquidity in the daily trading volume.

What should you do with this information? First, read whatever you can from these companies'
public filings. Fairfax Financial, for example, has to report its positions in a "13F" report to the
SEC each quarter, giving you a free look at what one of the world's best value investors is
buying.

I recommend buying shares of these firms when they're selling for book value or less. They will
grow their book value at a faster rate than you will grow your overall portfolio. Nothing is
certain, of course... but the odds favor these investors in a massive way.

Here's a tip: From time to time, these shares trade for less than book value. That's because
most investors don't understand insurance stocks or because, in Biglari's case, most investors
simply think he's going to fail in his efforts to turn around or take over new businesses.

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What you should do is wait, read, meet, and learn. By that, I mean watch the stocks carefully.
Read their quarterly and annual reports. Attend their annual meetings. (Buy one share so you
can attend.)

Learn what makes these businesses work... and when you feel comfortable that you really
understand what they do and why, begin to invest. Do your best to buy when other investors
won't. And try to pay less than book value.

You might also wait to see when these financial gurus – Icahn, Watsa, Biglari, etc. – begin to
buy their shares. If you're patient, you'll get those opportunities.

Here's another tip. During periods of market uncertainty, these stocks will fall – usually more
than the market falls. That means the prices on options for these stocks will tend to be rich.
That makes these stocks great vehicles on which to sell put options. You can sometimes garner
huge premiums, which can greatly reduce your acquisition cost. This strategy can reduce the
cost of buying stocks like these by 25%-50% over the course of a year.

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