This is the most expensive stock I am recommending relative to its growth rate, but I am willing to accept that because P&G has another enviable record: it is the most consistent raiser of its dividend of any company in the S&P 500, with fifty years of higher dividends. That means you as an investor must reinvest this dividend and allow the growth to work magic for you. That should produce a phenomenal core holding that may be the most perfect stock for any portfolio.
17. New York Stock Exchange. Here’s a controversial pick that I think, long-term, could be the biggest stock out there. The New York Stock Exchange wants to be the dominant global stock and futures exchange. It wants to trade everything everywhere and it wants to be the low-cost trader. It already dominates stock trading in both the United States and the far faster-growing European markets. It’s been public for only a couple of years, and it’s getting its costs in line so that it can add new business without adding a lot of cost. NYX is controversial because there are many doubters about its ability to compete with the Chicago Mercantile Exchange in the faster-growing world of derivatives and futures. My bet is that NYX, with its fantastic, recognizable brand name and scale from the Euro acquisition, will be able to wrest substantial business from the CME in the next five years. I believe analysts are drastically underrating this company’s ability to cut costs—I suspect that there will be a smaller and smaller trading space in downtown New York over time—and its ability to increase both volume and companies that want to list in its valuable and prestigious ranks. I think the stock will see great gains in the next five years as it dawns on the market that this is the best brand name in the financial services industry. It would not surprise me to see this stock at $200 five years from now.
18. Union Pacific. For years the railroad industry was an awful industry, with terrible price-cutting and vicious competition from both other rails and trucking. That’s all changed now. The road infrastructure in this country has been falling apart for years, and the declining ability of trucks to navigate traffic makes them far less reliable than in the old days. Railroads are now much more energy-efficient and they can compete on favorable terms with truckers. Plus, the rails have pretty much divided the country into territories and don’t compete with each other any longer.
Why Union Pacific? It’s the nation’s largest rail, operating in twenty-three states in the western portion of the United States. That’s the vital place to be because it handles the vast majority of the nation’s voracious Chinese imports. Its rail lines also connect with Canada’s rail system and all six of Mexico’s major gateways. UNP is benefiting from strong demand for coal and agricultural products, particularly corn, as both are being used to supplement high-priced and dwindling oil supplies. It’s been growing at double digits for some time, in part because of growing traffic but also because it can hike prices, given the lack of competition. If oil comes down in price, UNP might not have as much coal or corn to ship, but it will more than make that up in reduced fuel costs that it will most likely not pass on to its customers. It won’t have to, because of the paucity of competition.
19. Boeing. Few companies dominate their industry like Boeing, yet it fails to get the credit it deserves for that domination. This is a quintessential double-digit growth story that sells below the average stock, because big money in the United States looks at domestic airlines and figures they are unlikely to have the orders to make Boeing a great stock, despite the fact that it has a new plane, the Dreamliner, that should boost earnings for at least the next five years. Why am I so confident? First, because the big orders are going to come from overseas, particularly China, which could have ten times the number of planes it currently uses just to service its own country’s growth. But there are many nations with growing populations and solvent airline companies, particularly in the Middle East, Asia, and Latin America, that I believe will be buying Boeing planes for many years to come. Second, Boeing’s new planes carry far more people and use far less jet fuel per passenger than the planes currently in use. That means airlines that upgrade over the years can increase profitability at a time when energy is the biggest wild card facing the industry. Third, Boeing’s blessed with a competitor that at one time was all-powerful but now can’t even produce its own planes: Airbus. Over the next three years, as Dreamliners come out of the factory in the state of Washington and Airbus stutters to produce anything, let alone a competitive plane, I expect you will see more and more orders of a far greater magnitude going to Boeing.
Boeing also has one of the largest defense businesses in the United States. I expect the defense budget to continue to grow as a percentage of the gross domestic product, no matter who is in the White House.
Boeing’s management has been wildly pro-shareholder, plowing everything that is not needed for R&D into one of the best buybacks in the Dow Jones average, exceeded only by the likes of P&G and Exxon Mobil.
20. Sears Holdings. Am I saving the best for last? Some would argue otherwise, mostly the people who haven’t gone into Sears lately or who think the one-two punch of Sears and Kmart is an anemic play that will never recover. I urge you to think differently about this stock. Long time viewers of Mad Money might know this story, but let me tell it to you so you know the faith I have in Sears. The company’s vision is set by Eddie Lampert, someone I met at Goldman Sachs more than twenty-five years ago. He sat next to me in a place we called “the swamp,” a sweltering closet of an office where all trainees huddled during Goldman boot camp. We would work hard and play hard, most of us going out for beers after a solid twelve-hour training day. Every night I would ask Eddie to join us, but he always said no. Finally, one day, frustrated as all get-out, I asked him what was so wrong with me that he kept dissing me. The answer: “Jim, I’m only 15.” Well, now Eddie’s in his 40s, having worked for Bob Rubin for years at Goldman and these days running his own hedge fund, which has the best long-term gains after all fees are taken of any fund I know. (When I was in the hedge fund business, Eddie and I were vicious competitors and frequently were neck-and-neck in performance numbers before I retired in 2001. We are now good friends.)
Eddie backed into owning this retailer. He had taken a position in Kmart and then attempted, with a group of banks, to buy the whole company. At the last minute, Eddie was kidnapped and the banks walked away. Eddie ran from the kidnappers, who are now serving life in prison, when he got the chance. Without the banks, Eddie bought the rest of the company himself with his partners. He quickly rationalized the business and then merged it with Sears. People are concerned that Eddie hasn’t been able to implement the changes that would stabilize sales, which is where the leap of faith comes in. Sears looks a lot like Berkshire Hathaway did in 1981, when you could buy it for about $200 a share. The business seemed pretty dowdy; I know I passed on it. But the bet was on the manager, Warren Buffett, who turned a $200 investment into a $100,000 stock twenty-five years later through sheer investing prowess. I believe Eddie Lampert will do the same thing with Sears Holdings.
I do not believe this is a stock for the squeamish, and Eddie has far more doubters than Buffett had. I don’t know if Eddie can repeat what Buffett, his idol—and mine—was able to accomplish, but I turned down a chance to be with Buffett once, and I am not going to ignore the chance to be with the next Buffett, even if I have to hold my nose when I go into a Kmart or a Sears. I think that the real estate alone is worth the price of the company, and the brands—Craftsman, DieHard, and Lands’ End—have a great deal of value too. In the end, though, it is a play on my friend Eddie, and I am betting on him.
Some would sneer at this list. Why so few financials, given that 20 percent of the market is made up of banks, brokers, and insurance companies? Where are all the utilities? How about more tech? More drugs? Where are the big conglomerates? I believe that you have to pick sectors that will be great for many years and then pick the best of breed in those sectors. That’s what I have done here. I skewed them to the sectors I like, because if you can pick only fi
ve stocks—my original formulation for the minimum number of stocks you need to be diversified—then you will at least know the sectors I care the most about. I have often emphasized that if you know a company that is local—a local bank or a local retailer—then I can get behind a decision to invest in it, but I cannot help you do the homework, as I will be doing for years to come on these twenty stocks. These are the stocks that I invest the most time in, the ones I follow the most closely, and the ones I think will offer far better returns than you will get from an exchange-traded fund or an S&P 500 or total return fund. In the next chapter, I list the best mutual funds for all occasions, but if you want to pick stocks for yourself, if you want to stay with me, mad for life until we’re rich, pick from this list and play along with the Mad Money Man.
9
MY GUIDE TO MUTUAL FUNDS
Finding the right mutual fund is a notoriously difficult and confusing process. You can find ratings for funds all over the place, but who has any idea what those mean? You might find a fund that has five stars at one place, a B+ somewhere else, and a three with yet another service that claims to rank mutual funds. What are you supposed to do with those ratings? Some of the more basic attempts to rank funds just throw in the towel and rank them by past performance. A rating source might tell you they’ve got the top twenty-five funds over the past year, or the past five years. I have to tell you, that information is next to useless. Everyone warns you that you can’t pick mutual funds based on their recent performance. People love to pile into the mutual fund with the best performance over the past year or the past quarter, under the assumption that a big win says something about the quality of the fund. That’s certainly a mistake. As I’ve said before, making too much money usually is a sign that you’re doing something wrong. You could have made a killing in the late ’90s by keeping your money entirely in tech stocks. Anyone who did that had enormous gains for a couple of years, and then, because having all your money in one sector is the height of folly, that same person would have taken enormous losses as the market deflated. Most of the time, if everything you own is making you money so that you’re dramatically outperforming everybody else, you aren’t diversified. A portfolio without diversification is a portfolio that will eventually lose you money.
The same goes for a mutual fund. It could be that the fund isn’t diversified, but many funds are designed not to be diversified. For example, there are all of these so-called select funds that focus entirely on a single sector; they must be avoided at all costs. There is absolutely no reason to put your money in a mutual fund that invests only in stocks that are part of one industry. Why?
Let’s go back a few steps. The best way to make money, and the best way to keep it, is to invest in a portfolio of stocks (no more than ten stocks) that you yourself have selected and researched, doing at least one hour of homework on each stock every week. That’s your best option. I know this from what I have seen myself as a broker at Goldman Sachs, handling dozens of wealthy people who built their own portfolios; I know it as hedge fund manager who interviewed hundreds of people trying to get into my fund over a fourteen-year period; and I know it from the thousands of people I have interacted with on TheStreet.com and Mad Money. But a lot of people don’t have the time to manage their own money well, and even among those who do have time, there are plenty of people who just aren’t interested enough in stocks to make managing their own money a worthwhile decision. Those are the determinants, although the industry as a whole makes you feel you are too stupid to do it yourself or that you aren’t getting enough “technical” help in picking stocks, or the right charts and graphs. That’s all pablum. It’s the homework that’s difficult, and now that I have demystified the process you can see that picking stocks isn’t that confusing. Then again, you might not want to pick your own stocks even if you understand the process. And if you’re investing in your 401(k) plan, as you should, you won’t be able to invest in individual stocks or manage your own money. A 401(k) will let you choose only between different fund managers and index funds that aren’t managed. So two kinds of people want a good mutual fund: everyone who wants to get rich and doesn’t have the time or inclination to pick stocks, and everyone with money in a 401(k) plan who isn’t allowed to pick stocks, only funds.
Let’s assume that most people who want a good mutual fund are in the first category. The odds are good you’re one of them. So many people ask me about mutual funds. They’ll say, “Jim, we love what you do, but could you please recommend some mutual funds because we feel comfortable only with a professional managing our money?” Despite years of underperformance by mutual funds and revelation after revelation about how high fees and hidden fees can eat into your mutual fund gains, people still trust actively managed funds. What an amazing PR machine this industry is—almost as good as the hedge fund industry, which takes on a massive amount of risk and pretends it doesn’t! Investing in a fund with a manager to look after your assets makes an intuitive kind of sense. Passive investing, meaning simply putting your money in an index, is brainless investing. Shouldn’t a fund that’s run by an actual person, and someone with years of experience no less, do better than a fund that isn’t run at all? In fact, most of the time, index funds will outperform actively managed funds, especially after fees, because a fund with a manager obviously costs a lot more to maintain than a fund that’s simply tied to an index. But the idea that a fund with someone at the helm making the decisions should really do better than a fund that’s basically headless is an appealing one that fits in perfectly with our common sense. We have been raised to think that if some people are average, that means there are others who are better than average. Plus, despite the fact that most actively managed funds fail to beat the indexes consistently, there is a small group of funds run by expert managers that do consistently outperform the market. The existence of these people gives everyone in all the poorly run mutual funds hope that they can find a really great fund if they just try harder.
Going back to the question of why we shouldn’t put our money in funds that specialize in only one sector, we now have an answer. You invest in an actively managed mutual fund so that someone else with more experience, whose full-time job is money management, will take care of your investments for you. People like mutual funds because they don’t have the time or the inclination to manage their own money, and they appreciate that a pro is handling it. The whole point of putting your money in mutual funds is to find one fund with one manager who will invest for you. You might put your money in two funds, one for stocks and one for bonds. But beyond that, investing in multiple funds makes no sense at all. Some people have five, maybe ten mutual funds in their portfolio. That’s preposterous. You’re a mutual fund of mutual funds! You’re a giant fee-spouting, underperforming machine! To be an effective mutual fund investor you still need to spend time researching your fund, at least one hour a week, to make sure everything is running smoothly. If you’re going to own half a dozen mutual funds, you might as well just manage your own portfolio of stocks, because to be a good mutual fund investor in that many funds takes just as much effort as owning stocks does. If you’re investing in a fund that owns stocks in only one sector, that cannot be your only investment. Sooner or later, that sector will fall, and you’ll lose money. Remember, 50 percent of a stock’s movement is determined by its sector. You can’t have a really great bank stock if the banking industry is struggling. Owning a mutual fund that’s exclusively invested in one sector is like owning a stock, not owning a diversified, actively managed mutual fund.
To be honest, I don’t even know how someone would go about managing a fund that invests in only one industry. Just think of the poor guy running the fund that invests only in airlines. Lately these stocks have come back, but historically they’ve been some of the worst-performing stocks I’ve ever seen. How could anyone possibly manage a fund that’s allowed to invest only in airlines when all the airline stocks are going down? It just doesn’t make sense.
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Because so many people have had so much trouble picking the right mutual fund, and because many of them have come to me asking for help, I’ve done something out of character. It has always been my policy not to rank funds; I would only steer people toward mutual funds that I was very familiar with, to the point of being personally acquainted with the fund’s manager. In Real Money I recommended five mutual fund managers, and their mutual funds, with whom I was familiar and whose performance I trusted. That’s the thing about any fund: it’s the manager who matters. Forget everything you’ve ever seen about different fund categories; that’s not what truly differentiates a good actively managed fund from the rest of the pack. You’re paying such high fees for the manager when you invest in a mutual fund. When you evaluate the performance of a fund, you’re evaluating the performance of the manager. So in Real Money I recommended four managers whom I knew personally and one manager whom I hadn’t met, but who clearly does a fabulous job running his fund. These five funds were good selections, but there was nothing methodical about how I picked them. I just used my knowledge of twenty years of investing, at that time, to pick the guys that I thought were in the Big Leagues and who came to play every day. Yes, that was, alas, anecdotal.
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