Warren Buffett Next Door Outperforms Warren Buffett

For the past 3 years, value stocks have been out of favor, but the tide is turning. Randy McDuff, one of the Marketocracy Masters profiled in the book �The Warren Buffetts Next Door�, is up 9.70% so far this year.  It just goes to show you that even in a bad market (the S&P 500 is down 3.38%), there are still pockets of opportunity to make money.

Randy�s investment style is very much like Warren Buffett�s. Over the past 10 years, the compounded annual growth rate of Buffett�s Berkshire Hathaway Class B shares (BRK.B) is 5.20% while Randy�s RMG1 model portfolio is 25.91%. Both did much better than the S&P 500 which delivered 2.54% a year, including dividends. This long term track record of outperformance is the best evidence we have that both men are skilled investors. You can view Randy�s track record here.

More recently, however, both Buffett and Randy have disappointed their investors as value stocks have been out of favor. For the past 3 years, Berkshire�s B shares returned just 2.55% a year and Randy 3.01%. Both trailed the S&P 500's return of 12.42% by a wide margin.

But Randy is ahead of the S&P 500 by 13.08% so far this year which indicates to me that the tide has turned for his style of value investing. Warren Buffett�s Bershire B shares are behind the S&P 500 this year, but by a much smaller margin (only 2.40%).

The difference between Buffett and Randy this year is big and I think its attributable to the fact that Randy is swinging at his fat pitches, while Buffett is putting money into financials and technology, two sectors in which he does not yet have a great track record. While IBM (IBM) and Bank of America (BAC) have some of the strong consumer brand characteristics of the stocks Buffett has done well with in the past, they are not squarely in his sweet spot.

In contrast, Randy is doing well this year with many of the same stocks in which he has made a lot money in the past.  His strategy of buying companies that are becoming global monopolies due to economies of scale, government policies, or protectable product innovation has performed well for the past 10 years, and is starting to do well again.

A good example of the kind of stock that fits the profile of Randy�s fat pitch is Mastercard (MA) which is currently one of his top five positions. He first bought the stock in 2006 at about $46 shortly after it�s IPO. When Mastercard dropped 33% in 2008, during the financial crisis, Randy bought more. Today the stock is trading over $359 a share and is up 60.57% in 2011 year to date. When he first bought the stock, he told me it was because Mastercard and Visa are the only two companies that have the scale that is required to cost-effectively process credit and debit card transactions on a global basis and, at that time, Visa wasn�t yet a public company.

No investor can perform well all of the time because no one, not even Warren Buffett, is skilled at picking stocks in every sector, every style, and in any kind of market. Every great investor learns to recognize opportunities that their track record shows they can hit out of the park.

To define a manager�s fat pitch, I look for the common characteristics of the stocks in which a manager has made money on in the past. My challenge is to put the manager on my investment team only when I see the market offering the manager his fat pitch so he can hit it out of the park for us.

When I look at Randy�s portfolio, I see a group of stocks that have increased their sales and earnings at a time when the U.S. and European economies have been stagnant. As long as the global economy is growing, the market is going to be throwing Randy his fat pitches. This is why I am going to put more of our clients� assets in his model portfolio.

Ship Finance International Shares Sank: What You Need to Know

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Ship Finance International (NYSE: SFL  ) fell as much as 19% today after fellow oil shipper Frontline (NYSE: FRO  ) said it may run out of cash next year.

So what: The news today isn't specific to Ship Finance International, but Frontline's bomb has hit all oil shippers. Overseas Shipholding Group (NYSE: OSG  ) is down 17% on the day, as investors jump ship from these oil shippers.

Now what: You can't say we didn't see this coming. Earlier this year, a new tanker was taken straight from the shipyard to a war lay-up, meaning there wasn't enough work to make operating the ship profitable.

Fellow fool Chris Barker warned of the glut of ships way back in 2009, and I warned that supertankers were sunk earlier this year. That stance certainly hasn't changed after today's news, and I would stay far away from any ship transporting oil at this point.

Interested in more info on Ship Finance International? Add it to your watchlist by clicking here.

Bears Wrong On Gannett And News Corp.

In an earlier article, I argued that News Corp. (NWSA) was an undervalued company with strong upside. Challenges to the print business have highlighted investor's lack of appreciation for the amount of diversification that the media firm offers, as evidenced by across-the-line solid first quarter earnings outside of publishing. Demand for cable programming and film entertainment turned out particularly strong, resulting in a solid start to 2012 earnings. Similarly, the negative speculation about Gannett's (GCI) underperformance in newspapers is spilling over into its other business and unreasonably depressing valuation.

From a multiples perspective, only Gannett stands out as an undervalued investment. It trades at just a respective 6.3x and 6.1x past and forward earnings while offering a dividend yield of 2.4%. New Corp, on the other hand, trades at a respective 15.7x and 10.5x past and forward earnings while offering a dividend yield of 1.1%. Management is completing a $5B share repurchase program, but it is giving a signal that this is the high point. In addition to having higher multiples, Gannett also has gross margins that are 350 basis points higher than that of its competitor at 40.5%. Management is trying to get tough on costs, but third quarter EBITDA margins were below expectations.

On the third quarter earnings call, Gannett's President Gracia Martore noted:

"Our earnings per share were $0.44 when adjusted for special items. They reflect the positive impact of several strategic initiatives, particularly our digital efforts, but also the challenges of managing our businesses in the midst of a tremendous amount of economic uncertainty and the softening global economy.

We also had to compare against our own terrific success in garnering political spending last year. Total revenue as a result of all these factors was down about 3.5%.

An increase in digital segment revenues was another bright spot, reflecting double-digit revenue growth at CareerBuilder. They continued to capture market share domestically, leading to solid revenue growth, and CareerBuilder's international operations achieved substantially higher revenue growth."

Third quarter results were in line with revenue expectations, but below EBITDA expectations. Circulation, broadcasting, publishing ad sales and total revenue were all down while TV revenues were a bright spot. Going forward, management indicated a challenging market and that it will likely use free cash flow to pay off net debt.

Consensus estimates for Gannett's EPS indicate a rocky ride: it will decline by 12.7% to $2.13 in 2011, grow by 2.3% in 2012, and then decline by 7.3% in 2013. Assuming a multiple of 8x and a conservative 2012 EPS of $2.13, the rough intrinsic value of the stock is $17.04, implying 27.7% upside. Even if the multiple were to stay at 6.3x and 2012 EPS turns out to be 4.6% below the consensus, the downside is negligible.

News Corp., on the other hand, had quite the opposite story that Gannett had. The media titan experienced double-digit growth in all segments, but publishing. Consensus estimates for its EPS are that it will grow by 16.9% to $1.38 in 2012 and then by 21.7% and 22% more in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $1.57, the rough intrinsic value of the stock is $21.98. I find that it has less risk than Gannett given diversification, strong brand name, and solid fundamentals. Analysts currently rate both companies a "buy," but tend to prefer News Corp.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

DOL’s Borzi: Industry Backlash on Fee Rules Is Unfounded

Phyllis Borzi at congressional hearing in July 2011.

Phyllis Borzi, Assistant Secretary of Labor at the Employee Benefits Security Administration (EBSA), laid out on Monday EBSA’s regulatory agenda for the rest of the year and clarified one area that’s caused a “backlash” from retirement planning officials—the department’s position on the use of brokerage windows under fee disclosure rule 408(b)2.

While stating that she couldn’t predict the timing of EBSA’s release of its reproposed rule to amend the definition of fiduciary under the Employee Retirement Income Security Act (ERISA), Borzi restated comments she made to AdvisorOne in a recent interview that Labor will not be releasing a fiduciary rule that mirrors the one being crafted by the Securities and Exchange Commission (SEC). “I will not promise anybody there will be a single fiduciary standard,” Borzi told attendees at the Society of Professional Asset-Managers and Record Keepers (SPARK) Institute’s annual conference in Washington.

However, she added that compliance with EBSA’s fiduciary standard “won’t put you out of compliance with another [fiduciary] standard” such as the SEC’s.

Borzi also said the reproposed fiduciary rule will “make clear what types of investment counseling constitutes advice versus education,” and include a more “robust” economic analysis.

‘Backlash’ on Brokerage Windows

Borzi also noted the “backlash” that EBSA has received from the industry regarding its guidance on use of brokerage windows as part of EBSA’s fee disclosure rules 408(b)2 and 404a-5. The industry has complained that the department has ushered in a new requirement involving brokerage windows. But Borzi said during her comments that’s just not true.

The department, she said, has noticed an accelerating trend that has occurred due to rule 408(b)2: “There appears to be a notion that the best advice to give employers is if they want to avoid fiduciary duty they should provide an unlimited choice of investment options,” Borzi said. “People are advising [their plan sponsor] clients that the way to get around the 404c [participant] disclosure [rule] is to move to a brokerage window” that offers unlimited investment options.

In its recent Field Assistance Bulletin providing guidance to help plan administrators and service providers comply with the requirements of new rules, Borzi said the department was “trying to reiterate that a brokerage account or window is not a designated investment alternative (DIA); that’s not groundbreaking.” What the department is concerned about, she said, is disclosure.

She said the guidance reiterated another point, “again not new … that a plan fiduciary needs to prudently select and monitor service providers. So once you choose a service provider you can’t just walk away.”

Added Borzi: “You need to look at what people are actually selecting because you have to tell them what the fees are associated with that. It is entirely possible that many in the industry haven’t captured that information. But if you’re going to give people these kinds of choices and fulfill your fiduciary duty, you can’t just set it and forget it.” 408(b)2, which was published on Feb. 3 and becomes effective in July, requires, in part, that certain covered service providers furnish specified information to plan administrators so that they in turn can comply with their disclosure obligations to participants. As plan sponsors “get the information first” about the fees they pay, Borzi said, “there will be some sticker shock.” She added that the department is “not naive enough to think” that both fee-disclosure rules will be “smoothly implemented.”

Coming Out Soon: Lifetime Income Illustration, Target Date Fund Guidance

As part of its joint effort with the Treasury Department on how to best integrate lifetime income products into 401(k) and other types of employer sponsored retirement plans, Borzi said DOL is “optimistic” that it will soon seek comment on a “lifetime income illustration.”

The lifetime income illustration would be contained in the pension benefit statements and could show participants the amount of money they would receive per month—as an annuity defined-benefit like payment, not lump-sum cash-out—at retirement. EBSA is currently considering whether it should show an estimate of the monthly allotment based upon one’s current savings balance, or on a projected account total at retirement.

In collaboration with the SEC, Borzi said DOL also hopes to release soon a “simple guide” for fiduciaries on what to look for in a target date fund. “Ordinary people, which includes plan sponsors, don’t understand jargon,” she said. “We’ve spent hours trying to get this guidance into a form that people can understand.”

Quantitative Easing: The Real Reason the Fed May Go For QE3

Ben Bernanke has a secret.

And it's a secret that very likely terrifies him and his policymaking brethren at the U.S. Federal Reserve.

That secret has to do with his latest round of "quantitative easing," a liquidity-push known as "QE2."

What Bernanke & Co. don't want Americans to know is that painfully slow growth - or even a double-dip recession - isn't their greatest fear. Bernanke's greatest fear is that without this liquidity, one or more of the massive, already-bailed-out U.S. banks could stumble and once again undermine the global financial system.

And this time around, the outcome would be much, much uglier.

Raising QuestionsIf you think about it, the proof of what I'm saying is right in front of each of us. You just have to take a step back and look at it objectively.

Last Sunday, in an appearance on CBS News' "60 Minutes," Bernanke said he could raise interest rates in 15 minutes if inflation ever became a problem. Not to worry, there's no sign of inflation, at least according to him.

Well, there's no sign of deflation either, and thanks to Fed policies, interest rates are at historic lows. So why embark upon "Round Two" of quantitative easing (known as "QE2") and state on one of the nation's most-watched television news programs that additional rounds might follow?

I'm going to break the magician's code and tell you what the trick is and how it works.

Financial Sleight of HandThe "outward" trick the Fed is pulling off is adding massive liquidity to the U.S. banking system to tide the big banks over in case they face insolvency issues in the near future.

Remember, most of these big banks were in the "too-big-to-fail" category. That's why back in 2008-09 they got all that bailout money: Given their size and influence, the worry was that should one or more of these fail, the whole financial system could come crashing down.

But here's the problem. Since that time, many of those big banks have gotten bigger. And their risks have been steadily increasing: Many of them now face litigation, as well as the balance-sheet, credit and liquidity risks that could cause any one of them to fail - which could take the financial system down with them.

What the Fed is hiding under its cloak is the inside knowledge of:

• What the banks still have on their balance sheets in the way of so-called "toxic assets" - for starters, $2.4 trillion in mortgages and more than $1 trillion in mortgage-backed-securities.
• How the banks have been able to juggle accounting rules to make their books look better.
• How they've made their recent profitability look robust by moving loan-loss reserves back over into the revenue columns of their income statements - booking that as top-line growth.
• And the onslaught of litigation banks now face that could force them to mark down their assets at the same time that they will have to buy back tens of billions of dollars of non-performing mortgages they originated and securitized.

Banks are subject to "put-backs" or "buybacks" of the mortgages they place into securities if it can be proven that the quality of the mortgages weren't what they were represented to be when the securities contracts were originated. That's not hard to prove.

Regulators are very worried about the size of the put-back problem. In an attempt to assess the put-back risk faced by individual banks, the Fed has embarked on internal investigations.

When asked in recent testimony about the depth of the problem, Fed Governor Dan Tarullo, while not willing to quantify banks' put-back risk, termed it "substantial."�

Put-back risk is one key reason the Fed will be conducting another round of stress tests on the country's 19 biggest banks. Only this time they're keeping the results to themselves.

That's frightening.

But, that's only the beginning.

Toxic MessThe U.S. Securities and Exchange Commission (SEC) is investigating the banks for their part in falsely - if not fraudulently - spreading their toxic financial Kool-Aid around to other institutions.

Hints that a settlement was in the works last week quickly got squashed. Besides costing the banks penalties in settling charges, by settling and admitting any kind of guilt, they would be subject to lawsuits for decades to come. And since the litigation costs and the damages themselves could reach into the hundreds of billions of dollars, banks would have to set aside capital and reserves against future liabilities.

Now that this cat is out of the bag, it's doubtful that the SEC can let the banks off that easily.

• The bottom line here is that banks are facing years of possible litigation and massive potential losses - just as their revenue will be squeezed by the many reforms laid out in the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Additionally, new Basel III international capital standards are being imposed on banks, which will mean changes in how they classify the risk profile of various assets over time and how much capital will have to be held in reserve. (A recent report in The Financial Times suggested that U.S. banks - related to Basel III alone - face a $100 billion shortfall.)

And while all this is happening, the U.S. Treasury Department sold its Citigroup Inc. (NYSE: C) stake for a tidy little profit (thanks to the Fed's easy money-inflating equity prices) and banks are saying they're planning on raising dividend payouts in 2011.

The Ultimate ObjectiveIt's a high-stakes poker game. The Fed is bluffing and the banks are playing their hands - and will be big beneficiaries if the central bank pulls this off.

Just this Tuesday, at the Goldman Sachs Group Inc. (NYSE: GS) financial services conference in New York, Bank of America Corp. (NYSE: BAC) Chief Executive Officer Brian Moynihan said the big bank has fixed its balance sheet and is planning to raise its dividend next year.

And, Wells Fargo's CEO John Stumpf projected confidence about growing market share in 2011 and said the bank "was optimistic it can steal loan customers from community banks that are retrenching after overextending themselves before the downturn," according to an American Banker story on the meeting.

That brings us to the trick behind the trick. What QE2 and any subsequent quantitative easing actions (as well as the original quantitative easing move that was worth $1.7 trillion) really does is create a direct liquidity lifeline into the big banks.

The big banks got to stuff themselves with liquidity to enhance their capital ratios and balance sheets. And when that money had no place to go (it wasn't being lent out), it found its way into the stock and bond markets, giving them a very nice run.

But small U.S. community banks got nothing.

In fact, they got less than nothing.

Community banks got overly cautious regulators from the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corp. (FDIC). Those OCC and FDIC visits sucked the life out of the community banks because, after missing all the banking problems that led to the credit crisis in the first place, bank examiners are now erring on the other side of caution.

There's no question that things are bad at community banks. But while big banks reap the benefits of the Fed's direct triage efforts, community banks are being left for dead. That works out fine for the big U.S. banks. They want to grab market share, and can do so in a big way when these community workhorses are put out to pasture.

The difference between big banks and community banks comes down to economies of scale and size. Big banks want to serve big clients with big loans and capital markets services. They don't want little-guy loans, they're too small to be profitable relative to the allocation of resources.

Now, more than ever, that's especially true. With all the problems inherent in the securitization market, big banks aren't interested in small loans because they can't package them into big loans and offload them to investors.

It's going to be a long time before securitization of small loans from disparate originations makes sense again to investors.

Community banks could be facing planned extermination. Of course, the big banks will say that community banks did it to themselves. Without the necessary support to backstop their shaky balance sheets and with capital so difficult to raise because of their weak future prospects, community banks are in great jeopardy.

Since all real estate is "local" and job growth comes from small businesses, who better than community banks to take back the high ground of personal-relationship banking to serve local banking needs that can be better assessed by local bankers?

If we want to empower small businesses to take chances, they need a more-direct access to capital. Since that capital isn't coming from the big banks, we better take another look at whom quantitative easing is benefiting and whom it is hurting.

If the Fed really wanted to shore up community banks, it could backstop most of the "local" commercial real estate and local commercial and industrial loans at community banks with less than $100 billion in assets.

That would give the community banks room to breathe and money to lend to local small business start-ups. Some of the 18 million unemployed folks in America could sure use that kind of backstopping.

If you couldn't initially see the ultimate objective in the QE2 trick, you could be forgiven. But now you know. The fact is that banks are being made to look healthy by means of massive liquidity thrown at them. To foster that "illusion," the U.S. Treasury is cutting them free, and the banks themselves are talking about a future bright with dividends and buyouts.

But they're doing this without really knowing what their liabilities, capital requirements and future revenue will actually be.

And that says it all.

[Editor's Note: Shah Gilani, a retired hedge-fund manager and renowned financial-crisis expert, walks the walk. In a recent Money Morning expos�, Gilani warned that high-frequency traders (HFT) were artificially pumping up market-volume numbers, meaning stocks were extremely susceptible to a downdraft.

When that downdraft came, Gilani was ready - and so were subscribers to his new advisory service: The Capital Wave Forecast. The next morning, because of that market move, investors were up 186% on a short-term euro play, and more than 300% on a call-option play on the VIX volatility index.

Gilani shows investors the monster "capital waves" now forming, and carefully demonstrates how to profit from every one.

But he doesn't stop there. He's also the consummate risk manager. As the article above demonstrates, Gilani also makes sure to highlight the market pitfalls that can ruin years of careful investing and saving.

Take a moment to check out Gilani's capital-wave-investing strategy - and the profit opportunities that he's watching as a result. And take a look at some of his most-recent essays, which are available free of charge. Those essays can be accessed by clicking here.]

News and Related Story Links:

• CNNMoney.com: Bernanke on 60 Minutes
• CBSNews.com: Bernanke on 60 Minutes (Video).
  
• Money Morning News Archive: Stories by Shah Gilani
  
• The Wall Street Journal:
  Banks Could Face $120B In Mortgage 'Put-Back' Costs�JPMorgan
  
• Money Morning News Archive: Quantitative Easing
  
• Bank Investment Consultant:Regulators See Growing Threat from Put-Backs
  
• SEC.gov: Official Website
  
• Wall Street Journal:Banks in Talks to End Probe
  
• Money Morning News Analysis:
  By Yanking the Teeth Out of Dodd-Frank Act Ratings Rules, SEC Blunts Hope for Real Financial Reforms
  
• The Financial Times: U.S. Banks Face $100 billion Basel III Shortfall
  
• TheStreet.com: Bank of America Dividend Raises Likely
• American Banker: Bank CEOs More Upbeat on M&A and Dividend Increases
  

Leap Wireless Shares Jumped: What You Need to Know

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Leap Wireless (Nasdaq: LEAP  ) have leapt up by 15% today after Deutsche Bank analysts added the stock to its "Short-Term Buy" list.

So what: The analysts cite channel checks through Black Friday that show healthy signs for the prepaid wireless segment, although competition continues to heat up. Larger national carriers have been focusing more efforts on the prepaid segment lately, which could pose a potential threat to Leap.

Now what: Deutsche Bank is raising its estimate of fourth-quarter net voice additions from 175,000 to 225,000, and total net additions from 125,000 to 175,000. The analysts believe these estimates may be on the conservative side. Deutsche Bank highlighted two key growth drivers going forward: adding new national retail channels and encouraging fourth quarter channel checks through Black Friday. Overall, Deutsche Bank has Leap rated at hold with a $13 price target, implying that it thinks any bullishness may be short-lived.

Interested in more info on Leap Wireless? Add it to your watchlist by clicking here.

The Best 401(k) Funds from Vanguard

Watching your 401(k) balance in 2011 was a roller coaster ride. You probably saw it go up for a while at the beginning of the year, then take a steep dive down, then rise again before the year closed out.

Scanning the performance of Vanguard’s funds over the past year, you can understand the argument against mutual funds that invest in stocks. Of Vanguard�s open-end funds, Vanguard Long-Term Treasury (MUTF:VUSTX) was the best performer, returning an astounding 29.3% for 2011. Meanwhile, the Vanguard 500 Index fund (MUTF:VFINX) gained only 2%, and Vanguard Total Stock Market (MUTF:VTSAX) barely managed a 1% return.

You can be sure more volatility is in store for 2012. So, does that mean you should cash in your 401(k) and run for the hills — or at least plow your cash into other low-risk investments like U.S. Treasuries instead of stock funds?

No way!

I am steering investors into stock funds as part of their 401(k) holdings, and Vanguard has some of the best in the business. With more than 170 funds — which I cover every year in my annual Independent Guide to the Vanguard Funds — Vanguard has an almost overwhelming array of options. But I’d like to make that job easier for you by telling you up-front about the best Vanguard funds for your 401(k).

Strengthen Your Core with PRIMECAP or Wellington

Retirement accounts such as 401(k)s are inherently geared toward the long term. But good retirement planning doesn’t just mean saving money — it means making your portfolio grow. Even after you retire at 60 or 65, you could live another 30 years. Put another way, you could be spending almost one-third of your life in retirement. If your money doesn’t grow with your age, you could outlive it. That’s why my first choice among Vanguard funds for your 401(k) is a trio run by PRIMECAP Management: PRIMECAP (MUTF:VPMCX), PRIMECAP Core (MUTF:VPCCX) and Capital Opportunity (MUTF:VHCOX).

The problem is, outside of established 401(k) plans, these funds are closed to most new investors. But if they’re available to you, don’t hesitate to allocate a big chunk of your portfolio to them. The PRIMECAP team is a master of investing for “growth at a reasonable price,” or GARP. Their funds are the largest single component of my retirement and nonretirement accounts, as well as those of my wife and kids.

If the PRIMECAP funds aren�t an option, Vanguard Wellington (MUTF:VWELX) is your next best bet for a solid portfolio core. This fund is the industry’s original balanced fund, putting up strong returns since its inception in 1929 with a portfolio split between about 60% to 70% in high-quality blue-chip stocks, and 30% to 40% in investment-grade government and corporate bonds. This fund alone could easily give you all the bond exposure you need. And in 2011, Wellington�s balanced approach paid off, with a healthy return of 3.9% vs. only 2% for the S&P 500.

The best part about Wellington is its fantastic management team. Ed Bousa took the lead for the fund’s equity portfolio in 2003 with nary a change in the fund’s strong and consistent gait, and very minor changes to the underlying portfolio. Buying only about 100 stocks, he gives shareholders his best ideas — undiluted. Meanwhile, John Keogh handles the fixed-income investments.

Bonus: By investing through your 401(k), you can avoid the $3,000 minimum initial investment required for IRAs and taxable accounts.

    

Mid-Caps Are the Sweet Spot

Now that you have a strong core, you’ll want to put about 40% of your 401(k) money into mid-cap funds. My favorite for this role at Vanguard is Vanguard Selected Value (MUTF:VASVX) fund. The fund’s primary managers, Jim Barrow and Mark Giambrone, are quintessential value guys looking for stocks selling below the market’s multiples and yet generating a decent yield. Barrow always has said he’s happy being paid a dividend while waiting for his companies’ shares to take off. And Barrow has a good chunk of his own dough in Selected Value, a nice vote of confidence.

If your plan doesn’t hold Selected Value, you could ask for it, or use an index duo as an alternative: Vanguard Mid-Cap Growth Index (MUTF:VMGIX) and Vanguard Mid-Cap Value Index (MUTF:VMVIX).

Why not just buy Vanguard Mid-Cap Index (MUTF:VIMSX) instead? Splitting your money between the growth and value funds gives you the flexibility to shift your weighting depending on market conditions.

At the moment, you’d want to overweight the growth side of the ledger. The value index has a hefty weighting to financials, which still are under a regulatory cloud, while the growth index is heavier in tech, which could gain momentum as the economy improves.

Best Vanguard International Funds

In 2011, as the European debt crisis came to the fore, holding international stocks hurt. Every one of Vanguard’s international funds lost money, with the best performer (which diluted its foreign stock stake with hefty domestic holdings) being Total World Stock (MUTF:VTWSX), down 7.9%.

So why hold international stocks at all? In the emerging markets, stock market declines are at odds with economic expansion. And don’t forget, when markets take a tumble, that’s also when good managers find the best values.

Which brings us to my next pair of favorite funds. Vanguard has some stellar choices for international investment, and Vanguard International Growth (MUTF:VWIGX) is one of my favorites. There’s a good chance it’s available in your 401(k).

Overseen by three management teams, International Growth still demonstrates strong concentration with only about 180 stocks and 18% of the portfolio in the top 10. Plus, the managers aren’t afraid to commit money to emerging markets, which you might not find in many broad international funds.

Even so, I still think you�ll want to put some money directly into this next fund: Vanguard Emerging Markets Index (MUTF:VEIEX). Why emerging markets? Globally, these countries are showing increased economic firepower, hungry consumers and the ability to take advantage of newly aggressive importers, exporters, manufacturers and entrepreneurs. Emerging Markets Index will give you access to several of these economies, including one of the most powerful investment markets out there — China — with about 18% of its assets there.

In addition, Emerging Markets has investments in Brazil (about 15%), Korea (16%) and Taiwan (10%). In the long term, I think these economies offer great growth opportunities and, at current prices, we’re buying in almost 20% cheaper than we could have a year ago.

Short-Term Bonds for Safety

With a balanced fund like Wellington as your core, you really don’t need another bond fund in your 401(k). But otherwise, it’s worth putting about 10% of your 401(k) money in Vanguard Short-Term Investment-Grade Bond Fund (MUTF:VFSTX).

This fund invests at least 80% of its assets in “investment-grade” or better short- and intermediate-term bonds. It makes a great cash substitute for a long-term portfolio. While it lost about 7.6% in the credit crunch of 2008, it completely recovered in only six months. And while the stock market rocked back and forth in 2011, and money market funds had to be subsidized to stay afloat, VFSTX put up a nice 1.9% return with one-third less volatility than the overall bond market.

Vanguard’s Intermediate-Term Investment-Grade Bond Fund (MUTF:VFICX) also is a good choice, but it will be a bit more volatile when interest rates begin to rise. That said, over the long haul, intermediate-term bonds tend to provide 80% of long bonds’ total return with about half the risk.

Connecting the Dots

Whether you use PRIMECAP (best option) or Wellington (a strong alternative) as your core, you’ll be in good hands with some of the best institutional investors in the business. Round out your equity holdings with either Selected Value, or a combination of Vanguard Mid-Cap Growth Index and Vanguard Mid-Cap Value Index, adjusting your weightings as market conditions warrant.

From there, head overseas with about 10% to 15% in International Growth and Emerging Markets.

Finally, put 10% of your 401(k) money in Vanguard Short-Term Investment-Grade Bond Fund or Vanguard Intermediate-Term Investment-Grade Bond Fund. Remember, this is only if your core is pure equity funds. If you’re using a balanced fund like Wellington, which already has a large allocation to bonds, you won’t need additional fixed-income funds.

For specific breakdowns, please see the table below. Even if some of the funds aren’t available to you, you can use it as a guide to building a strong, diversified retirement portfolio.

Remember, it’s your retirement. So make sure your 401(k) plan is designed to help you, not your benefits manager.

Portfolios for Long-Term Growth Investors

Fund	Focus	Allocation
Using Wellington as your core
Wellington	Balanced (60% stock/40% bond)	40%
Mid-Cap Growth Index	Stock — mid-cap growth	30%
Mid-Cap Value Index	Stock — mid-cap value	15%
International Growth	Foreign stock — large	10%
Emerging Markets Index	Foreign stock — emerging	5%
TOTAL		100%
Using PRIMECAP-run funds as your core
PRIMECAP/PRIMECAP Core/ Capital Opportunity	Stock — Growth at a reasonable price	44%
Selected Value	Stock — mid-cap value	25%
International Growth	Foreign stock — large	10%
Short-Term Investment-Grade Bond	Short corporate bonds	8%
Intermediate-Term Investment-Grade Bond	Intermediate corporate bonds	8%
Emerging Markets Index	Foreign stock — emerging	5%
TOTAL		100%

Dan Wiener is the editor of The Independent Adviser for Vanguard Investors. A five-time winner of the Specialized Information Publishers Foundation Editorial Excellence Award, Wiener is the founder of the Fund Family Shareholder Association and chief executive officer of Adviser Investments, a Newton, Mass., investment advisory firm.

Two Bullish, Optionable Stocks With Recent Insider Action

Here are two stocks with recent insider transactions that look healthy for a nice bullish run in 2012. They are also optionable for those traders that are also interested in option strategies along side buying the stock directly.

Energy Transfer Equity (ETE), through its direct and indirect investments in the limited partner and general partner interests in Energy Transfer Partners, L.P., engages in midstream, intrastate, and interstate transportation of natural gas, as well as in storage of natural gas in the United States. The company's Intrastate Transportation and Storage segment engages in the ownership and operation of natural gas transportation pipelines and natural gas storage facilities. As of December 31, 2009, it owned and operated approximately 7,800 miles of natural gas transportation pipelines and 3 natural gas storage facilities. This segment sells natural gas to electric utilities, independent power plants, local distribution companies, industrial end-users, and other marketing companies on the Houston pipeline system.

Presently trading at $40.38, analysts have pegged ETE at a median target price of $47.00 so it has a lot of growth in 2012. December saw a huge transition of stock accumulated in a "general partnership" private transaction. It is just about this time that ETE broke through a very well defined resistance level and continues in a bullish direction.

ETE appears ripe for an investor to buy the stock after initial research. There is room for an 18% gain before upper resistance is again challenged. An option investment here looks very inviting for those investors that like using option strategies. A debit spread here allows low risk but the possibility of high returns. Look at buying a July 45 2012 call option and selling a 50 in the same month.

International Speedway Corp (ISCA), together with its subsidiaries, promotes motor sports themed entertainment activities in the United States. The company's motor sports themed event operations consist of racing events at its motor sports entertainment facilities. Its motor sports entertainment facilities promoted approximately 100 stock car, open wheel, sports car, truck, motorcycle, and other racing events.

International Speedway also involves in souvenir merchandising operations; food and beverage concession operations; provision of catering services in suites and chalets; creation of motor sports-related programming content, including national satellite radio service; usage of its track facilities for testing for teams, driving schools, riding experiences, car shows, auto fairs, concerts and settings for television commercials, print advertisements, and motion pictures; and rents show cars for promotional events.

Presently trading at $25.77, analysts have a high target of $31.00 for ISCA, so 2012 could be a very profitable year for this sports-oriented company! On October 11, Officers and Beneficial owners of the corporation bought shares at $21.15 and at that point, the stock found a solid foundation and has developed a nice bullish up trend since then.

For investors, it looks like investing either long term in the stock or buying call options straight up would be a wise investment. The March 2012 30 call options (presently priced at $0.40) would make a good investment as the stock continues to rise. The price is good, and offers a great resale strategy at a point in the future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Politics Pose Greatest Threat to Economic Growth

As of the present moment in time, the U.S. economy is expected to grow only about 2 percent this year and 2.3 percent next year. Since the International Monetary Fund (IMF) reported their annual outlooks in April, both figures above have already dropped by 0.1 percent.

Despite cutting the global growth forecast, the IMF is actually keeping their latest outlook in mind from an optimistic viewpoint; anticipating U.S. officials to be more proactive in agreeing upon and acting on fiscal policy changes that will be able to keep our economy afloat and that euro governments will follow through with some proposals that will reform and stabilize the currency union.

If politicians in both America and Europe neglect to focus on the big picture of our global economy and get lost in some of the more trite political details, we'll have some big burdens to bear in the next few years with the bulk of the problem beginning after policy changes scheduled to go into effect January 1, 2013.

Quicker action and longer-term planning are two key factors our leaders must hone in on when combating the fiscal crises at hand.

From CNNMoney.

"The most immediate risk is still that delayed or insufficient policy action will further escalate the euro area crisis," the IMF report states.

…

The other main threat to global economic growth is in the United States, according to the IMF. 

"In the short term, the main risk relates to the possibility of excessive fiscal tightening in the United States, given recent political gridlock," the report states.

If lawmakers do not raise the federal government's $16.394 trillion debt ceiling, the IMF warns that further financial blunders will ensue and consumer and small business confidence will take a nosedive.

Some hurdles in proposed legislation included the end of the Bush-era tax cuts, middle class protection from the Alternative Minimum Tax, and over 50 “temporary” tax breaks for some individuals and businesses.

Many experts believe the massive spending cuts and tax increases will only further debilitate any hope for the potential of achieving sustained economic growth, or any growth at all for that matter.

The fact that this is an election year has even more conservative experts concerned with the financial crisis...

To understand more about the fear behind the looming “fiscal-cliff storm” watch this CNN Money video, explaining why lawmakers in Washington D.C. really need to get it together before January 1 in order to avert an even deeper recession.

 

SS&C Technologies Comes Public At $15; Stock Inches Higher

SS&C Technologies (SSNC), which provides software to the financial services sector, came public this morning with an offering of 10.725 million shares at $15 each. The deal includes 8,225,000 shares fro the company and 2.5 million from selling holders.

This is the company’s second stint as a public company; SS&C went public the first time in 1986, and then was take private by the Carlyle Group in 2005.

SSNC today is up 81 cents, or 5.4%, to $15.81.

Earlier: Meru Networks Prices IPO Of 4.39M Shrs At $15; Top Of Range; Stock Jumps (Updated)

Netflix in 2015

Don't be jealous, but I'll be taking a time machine I just got for a few test drives over the next few days.

I have the destination locked on 2015, and I'll check out a few of the companies that intrigue me the most. What are they up to? Are they trading higher or lower? Can you suspend reality long enough for a completely fictional though entirely possible snapshot of the future?

My first stop this time: Netflix (Nasdaq: NFLX  ) .

Yes, the Netflix you loved in 2010 and loathed in 2011 is every inch an independent company in 2015. Buyout rumors still come and go, but CEO Reed Hastings has no plans of cashing out.

Yes, Hastings is still CEO. What did you think?

Crawling through 2012
After back-to-back weeks of strong gains to kick off 2012 -- leaving you where you are today -- I wish I could tell you that Netflix's fourth quarter was the blowout quarter to silence the bears.

It wasn't. Netflix continued to bleed subscribers through the fourth quarter. The average-revenue-per-subscriber spike that bulls were initially hoping for after last summer's rate increase failed to materialize, as couch potatoes continued to downgrade their plans, often choosing between streaming and DVDs.

Things got better after that. They had to.

Subscribers -- on a global basis -- began growing again by the first quarter. Netflix turned heads when domestic subscribers inched higher during the second quarter of 2012. Where were they going to go?

Netflix did get some new competition in 2012, but it didn't come from the usual suspects. Blockbuster actually retreated in scope through 2012. Redbox and FiOS did live up to the streaming speculation, but neither company was willing to bankroll the premium content to match Netflix at its price point. Amazon.com (Nasdaq: AMZN  ) is the one current competitor that gained traction early in 2012, but when shareholders and analysts grew more concerned with the company's deteriorating margins in promoting the Kindle and its digital initiatives, CEO Jeff Bezos scaled back on that front.

Tech giants attack
So who are Netflix's biggest threats come 2015? Believe it or not it's Apple (Nasdaq: AAPL  ) and Google (Nasdaq: GOOG  ) .

Apple didn't roll out a Netflix killer when its iTV -- Apple's full-blown smart television (yes, it acquired the trademark) -- rolled out in the fall of 2012. The rumored Web-based pay TV service also failed to materialize right away. Studios and cable networks were reluctant to arm cord cutters with the scissors that would eat into their juicy cable and satellite television revenue.

Apple's bar-raising flat screen revolutionized the way we interact with our TVs, relying on seamless access to iTunes for piecemeal streaming video rentals that ultimately led to the cord cutting the pay TV industry was trying to avoid.

It's the end of the fat cable bill as you know it -- and you feel fine.

Google's push came in 2013, realizing that it couldn't let Apple have all of the fun. In a move to fortify its then-fledgling Google TV platform, Google rolled out an unlimited streaming service that blended licensed Hollywood content with free and premium YouTube content (yes, there's premium YouTube content in 2013).

Parting shots from the future
You may be wondering whether Netflix is still dishing out optical discs in 2015. It is. There will never be a streaming service that offers every title. Netflix never came through with its Qwikster era promise to begin offering video games on disc, though it did team up with a popular cloud-based gaming company in 2014 to offer bundled pricing for both services.

Netflix's global subscriber count is closing in on 30 million in 2015. Subscriber growth has been steady, but clearly not explosive. The real driver at Netflix from 2013 to 2015 has come primarily from accelerating average revenue per user. Once Netflix began offering new releases as piecemeal streams in the latter half of 2012 -- taking advantage of its massive base of tethered users to push the content that studios wouldn't dare license under the unlimited model -- customers learned to rely more on Netflix than DVD rental chains or video on demand for fresh content.

Netflix is still not close to its summertime highs of 2011, though it has handily beaten the market since 2012. It may seem like cheating given my time-traveling contraption, but I'm sticking to my bullish CAPScall on Netflix in Motley Fool CAPS.

Come back tomorrow for another trek out to 2015.

Motley Fool's top stock for 2012 isn't Netflix. If you want to find out what it is, a special report reveals all. It's entirely free, but will only be available for a limited time so check it out now.

Commonwealth Financial to Raise Payouts, Cut Ticket Charges

The annual Chairman’s Retreat at Commonwealth Financial Network gathers together the biggest producers who are independent financial advisors at the Waltham, Mass. and San Diego-based independent broker-dealer for several days of intense educational and networking events in Boston.

The attendees, who this year included advisors new to Commonwealth like Alex Armstrong and David Young and Commonwealth veterans like Tom Bartholomew, Debra Brede and Carrie Coghill, are veterans who bring a healthy dose of skepticism when it comes to the financial services business. But those same big producers broke out into spontaneous applause Jan. 31 when Commonwealth Financial’s CEO, Wayne Bloom (left), announced pricing and payout changes effective April 1, 2011 to Commonwealth’s fee-based asset management platform, known as Preferred Portfolio Services, or PPS.

Prefacing the announcement by reporting that over 70% of Commonwealth’s revenue is recurring revenue—“not all fees, but that’s where we’re headed”—Bloom said that in the second quarter the firm would reduce ticket charges and increase payouts. Noting that the change will mark the eighth time since 1996 that Commonwealth would make such a move, Bloom said that for advisors with more than $25 million in fee-based assets, equity and ETF ticket charges would drop from $16 to $7.95. The applause came when Bloom stated that “going forward, neither you nor I will be disadvantaged over ticket price charges.”

As for payouts, the increases for Commonwealth reps will increase to 94% from 92% on assets of more than $50 million to $100 million; to 96% from 94% on assets from $200 to $250 million, and to 98% from 95% for those advisors with more than $500 million. Bloom added that "these payouts are linear, right back to dollar one."

Hatteras Meets Expectations But A Dividend Reduction May Be Forthcoming

On Tuesday, February 14, 2012, Hatteras Financial (HTS), an agency mortgage REIT, reported its results for the fourth quarter and full year for 2011. During Q4 2011, the Company earned net income of $70.6 million, or $0.92 per share, compared to net income of $79.0 million, or $1.04 per share during Q3 3011. The results are in line with Wall Street expectations.

Hatteras also reported net interest margin decreased to 1.56% from 1.64% in the prior quarter. Their portfolio's weighted average coupon was 3.46% during Q4 of 2011, compared to 3.54% during Q3. The annualized yield declined to 2.60% in Q4 2011, compared to 2.72% in Q3 2011.

See a recent chart for HTS:

The Company's repo debt-to-shareholders' equity leverage ratio was 7.8x, a slight decrease from 7.9x the prior quarter. Book value increased 2.89 percent to $27.08 per share.

Hatteras buys agency mortgages that are backed by federal agencies. Other well-known agency mREITs include American Capital Agency Corp (AGNC) and Annaly Financial (NLY). Index ETFs for mREITs include the FTSE NAREIT Mortgage REITs Index ETF (REM) and the Market Vectors Mortgage REIT Income ETF (MORT), though both of these ETFs also hold mREITs that invest in non-agency backed securities.

On Monday, February 6, 2012, American Capital Agency reported net Q4 income of $208.7 million, or $0.99 per share, compared to $1.39 per share during Q3 of 2011. Following their announcement of earnings, AGNC also announced a dividend policy cut, lowering the quarterly payout to $1.25 from 1.40 per share. This was the first time in two and half years that AGNC cut or changed its quarterly dividend.

On Tuesday, February 7, 2012, Annaly reported net Q4 income of 54 cents per share, compared to 60 cents for the same quarter in 2010 and 65 cents for Q3 of 2011. Wall Street expectations were for earnings to be slightly higher.

Annaly and Hatteras have not yet reported dividend policy for the upcoming dividend, but has both reduced payouts in 2011. Hatteras cut its dividend 10% last quarter, from $1 to .90 cents. Previously, HTS maintained a $1 dividend for four quarters. Hatteras' last dividend works out to a 13.7 percent annualized yield.

It is possible that Hatteras will maintain its present dividend policy, but a forthcoming dividend reduction could be on the horizon. Given potential further spread tightening and the reduction in quarterly EPS, as much as a five to fifteen percent dividend reduction could be on the table. Last year, Hatteras announced its first dividend of the year on March 8, 2011, with an ex-dividend date of March 16, and a pay date of April 22, 2011.

Rising interest rates could reduce the value of RMBSs, because their value must decline to a rate where their yield will meet the new, higher rate. Such potential future declines will be multiplied by the leverage used by the holder. Last quarter, though, decreasing rates helped inrease HTS' book value.

If interest rates do increase, or when they do, many investors may then flee the mREIT industry. Nonetheless, U.S. Treasuries and agency debt performed well in the past year and so far in 2012.

Disclosure: I am long NLY.

Ford reinstates dividend after 5-year hiatus

NEW YORK (CNNMoney) -- In another signal of its comeback, Ford Motor reinstated its dividend Thursday, its first payout to common shareholders in five years.

Ford, (F, Fortune 500) the only major U.S. automaker to avoid a federal bailout and bankruptcy reorganization in 2009, has been the most profitable of the U.S. Big Three for several years. But it held off on the payments until now as it tried to address its balance sheet.

The company's debt is still considered to be junk bonds by the rating agencies, despite recent improvement.

Ford will pay 5 cents a share to shareholders of record of its Class B and common stock on Jan. 31, 2012. Payments will be made in March. Ford last paid a dividend in 2006.

"We have made tremendous progress in reducing debt and generating consistent positive earnings and cash flow," said Bill Ford, the company's executive chairman, in a statement. "We are pleased to reinstate a quarterly dividend, as it is an important sign of our progress in building a profitably growing company and our confidence in the future."

Ford will become the only U.S. automaker paying a dividend. GM (GM, Fortune 500) has yet to pay one since its initial public offering a year ago. Shares of Chrysler Group are still privately held, split between Italian automaker Fiat and a union-controlled trust fund for retirees' health care expenses.

Ford earned net income of $1.6 billion in the third quarter and $6.6 billion so far in 2011. But the lack of dividend, coupled with uncertainty about the strength of the U.S. economic recovery, has worked against Ford shares, which are down 35% year to date.

Shares of Ford, which had been down 3% just before the announcement, wiped out most of that loss on the dividend announcement. 

Is FedEx the Right Stock to Retire With?

Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.

It doesn't seem like so long ago that when it absolutely, positively had to be there overnight, FedEx (NYSE: FDX  ) was pretty much the only delivery choice you had. But with the rise of online shopping and the overall global economy, FedEx now finds itself part of a huge business -- one with lots of competition. Can FedEx stay ahead of the pack? Below, we'll look at how the company does on our 10-point scale.

The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.

Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.

When scrutinizing a stock, retirees should look for:

• Size. Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
• Consistency. While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
• Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
• Valuation. No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
• Dividends. Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.

With those factors in mind, let's take a closer look at FedEx.

Factor	What We Want to See	Actual	Pass or Fail?
Size	Market cap > $10 billion	$26.1 billion	Pass
Consistency	Revenue growth > 0% in at least four of five past years	4 years	Pass
�	Free cash flow growth > 0% in at least four of past five years	1 year	Fail
Stock stability	Beta < 0.9	1.25	Fail
�	Worst loss in past five years no greater than 20%	(27.7%)	Fail
Valuation	Normalized P/E < 18	16.45	Pass
Dividends	Current yield > 2%	0.6%	Fail
�	5-year dividend growth > 10%	8%	Fail
�	Streak of dividend increases >= 10 years	10 years	Pass
�	Payout ratio < 75%	10%	Pass
�	�	�	�
�	Total score	�	5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

With only five points, FedEx lacks some of the reassuring characteristics that conservative investors prefer to see from their stocks. Despite solid results on the bottom line, the delivery company has had less dependable free cash flow and doesn't pay the dividends that many retirees depend on.

FedEx has refined its delivery business into a highly profitable machine. As fellow Fool Sean Williams observed last month, FedEx beats rival United Parcel Service (NYSE: UPS  ) on a wide variety of financial measures, producing greater revenue growth over the past decade while sporting valuations based on book value, cash flow, and earnings that are far less than UPS can deliver.

In a slow economy, though, FedEx faces other threats. Airlines like Delta Air Lines (NYSE: DAL  ) and United Continental (NYSE: UAL  ) depend on cargo shipments to make ends meet, yet a tough economy means that profits across the board are getting squeezed, leading FedEx to rein in its full-year earnings outlook when it released its most recent quarterly results in September.

But one bright spot may come from the holiday season. Reports indicate that truckers' fuel purchases during the third quarter fell sharply, suggesting fewer shipments via trucking companies like Swift Transportation (NYSE: SWFT  ) and J.B. Hunt (Nasdaq: JBHT  ) . But if that means that companies are reducing inventory in advance of the holidays, then more shoppers than usual may need quick-shipping options -- shipping that FedEx is in the best position to deliver.

The biggest problem for retirees and other conservative investors is FedEx's insignificant dividend. Although proponents argue that its low payout ratio gives FedEx more flexibility to direct capital to where it will benefit shareholders most, a 10-year history of raising dividends annually is a good start to what will hopefully become a more lucrative proposition for investors. Despite the stock's shortcomings, many retirement investors may want to turn to FedEx for the long haul.

Keep searching
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.

Add FedEx to My Watchlist, which will aggregate our Foolish analysis on it and all your other stocks.

If you want to retire rich, you need to be confident that you've got the basics of your investment strategy down pat. See if you're on track by following the "13 Steps to Investing Foolishly."

Indexes End Rocky Week Higher

It was a difficult week for investors, because they spent the first three days of it waiting for the last two days to happen. With European leaders traveling to Brussels on Thursday to try to hammer out “the deal that will save the world,” trading swung this way and that on rumors and innuendos. And then, when a deal finally came, it was a little anticlimactic.

On Friday, 26 out of 27 of the countries in the E.U. agreed on the framework for a deal to add 200 billion Euros to an IMF fund and impose strict budget limits. Great Britain took a pass on the agreement, and three of the countries said they need to consult their parliaments. It wuill take months to hammer of the details of the pact, and it could probably still fall apart in whole or in part.

But clearly the deal gave the market some relief. The Dow rose 200 points, and the S&P was up %. In addition, the Chicago Board Options Exchange Market Volatility Index (VIX) fell 14%. Banks rose on the day, with Citigroup (C) up 3.7%.

With so much anxiety about macroeconomic factors roiling the market in recent weeks, it seemed like the market would either soar or plunge on news our of Europe. Instead, the market has made incremental progress in the past few weeks, and appears to be reacting to a gradual consensus in Europe, and more and more evidence of improvements in the U.S. economy. For instance, weekly jobless claims fell to 381000, their lowest level since February, according to a report that came out Thursday.

For the week, the Dow rose 165 points, or 1.4%, to close at 12,184. The S&P rose 10.9 points, or 0.9%, to 1,255.2.� The Dow is up 5.2% this year, but the S&P is down 0.2%.

Pressure Mounts On Apple As Amazon Releases New Tablet

Amazon.com (AMZN) is set to release a tablet computer into a strange market. The tablet industry is still clearly dominated by Apple's (AAPL) iPad, but it is also crowded by a steady stream of competitors using the Google (GOOG) Android open source operating system. While these tablets have met with little success, pricing trends and inevitable entrances from Amazon and Microsoft will continue to make the space more competitive than it appears based on historical unit sales.

Amazon Gambling With House Money

1. If reports are true, Amazon developed a new 7-inch tablet computer and they are set to show it off this Wednesday. Amazon is one of the stock market's hottest stocks right now. Their pricey valuation is largely based on the stunning revenue growth of its domestic and international online retail presence. With intensifying fears of a global slowdown, investors are increasingly desperate for sales growth and they are valuing the AMZN's stock accordingly. The stock has a trailing P/E of 101.39, a forward P/E of 71.60 and a price/sales of 2.59 despite reporting profit margins of only 2.58% in the last 12 months. This rich valuation is a major source of strength. It gives Amazon cushion from shareholder scrutiny and valuable currency for potential acquisitions. With rumored interest in Hulu, Netflix Inc (NFLX) and other high growth companies, the sky is the limit for the former book retailer.

As such, Amazon.com does not need a huge success here to maintain its stock valuation - at least not in the short-term. While NFLX's recent struggles clearly illustrate the market's quick trigger when it comes to high valuation stocks, we should remember that the heart of the AMZN valuation is centered on the fact that the company provides almost equal exposure to domestic and international markets and that its online retail presence is growing significantly faster than Internet retail as a whole. This domination and success gives AMZN leeway when it comes to developing new products like the Kindle tablet. Unlike other tablet entrants, Amazon had the freedom to wait until they had a finished product. In addition, if the product is not a success, they have the leeway to go back to the drawing board to improve the tablet for the future. Make no mistake about it, this is an enviable position and this trait makes them dangerous to Apple and other tablet makers.

Pressure Mounts for Apple Inc.

We have been and continue to be bullish of Apple's stock. The company's stock offers a rare instance where a growing market leader trades at cheap valuations. But still, all companies should be aware of investment risks and for Apple, the risks are increasingly worrisome.

1. Struggling economy could reduce demand. The computer company's products have defied the gravity of worsening consumer economics, but are we finally witnessing the end of Apple's retail exceptionalism? Recent unconfirmed reports from JP Morgan point to a 25% cut in Apple's orders to vendors. First, this story is totally unconfirmed and could very well be merely a sign of poor investigative work or maybe a transition to new vendors, but still the story raises interesting concerns. The real economy has been a struggle for other retailers, maybe Apple is suffering from the same headwinds.

2. The last couple of years have provided fond memories for Apple. During this time, companies like Research In Motion (RIMM), Hewlett Packard (HPQ) and Dell Corp (DELL) tried to sell inferior tablets for the same price as the iPad. As such, it was not a big surprise to see competitors come and go. But recent events suggest that the strategy may be changing. Hewlett-Packard created the biggest frenzy in recent consumer electronics history by liquidating its Touchpad tablets for $99 and $149, which was well below manufacturing costs. The pricing created sell-outs around the world and left people scrambling around the Internet looking for excess supply. As we highlighted in our article, Hewlett-Packard's Accidental Genius, there is a silver lining to the Touchpad's failure but also an interesting precedent for the industry. Amazon's new tablet is expected to price at $250. While it is only a 7" tablet, the pricing could still undermine the iPad and ultimately drive down Apple's profit margins.

3. Competitors continue to come out of the woodwork. Amazon's entrance into the tablet market has not been a big surprise. And to be truthful, there have been so many iPad failed iPad competitors introduced in the last two years that I don't blame Apple bulls for brushing aside the short term risks of competition. But Amazon is a serious competitor and Microsoft will be another serious and persistent competitor in the next 12 months as it begins to bear fruit from its Nokia (NOK) relationship. While previous tablets may have been rushed to the market, these two deep pocketed companies have taken their time to refine their offerings and as a result, they are last, but certainly not least.

Summary

If everything that we have heard about the upcoming Kindle tablet is true (upgraded Android front end, 7-inch touch screen, $250 price), we think AMZN will have another big product success. While its stock price upside may be somewhat limited by its already rich valuations, we think investors should also pay close attention to Apple. In addition to the Amazon tablet, Apple faces a growing number of risks.

Disclosure: I am long AAPL.

FINRA Alternative: New SRO With ‘Bona Fide’ Fiduciary Standard for RIAs

When the Securities and Exchange Commission (SEC) released its Dodd-Frank-mandated “Study on Enhancing Investment Adviser Examinations,” in January, it acknowledged that there currently wasn’t enough firepower at the agency to supervise the growing number of registered investment advisor (RIAs) adequately. It proposed three options for overseeing RIA firms:

Authorize the Commission to impose user fees on SEC-registered investment advisers to fund their examinations by OCIE;  

Authorize one or more SROs to examine, subject to SEC oversight, all SEC registered investment advisers; or

Authorize FINRA to examine dual registrants for compliance with the Advisers Act

While some RIA and industry groups have been vocal in support of the SEC getting the funding it needs to supervise RIAs itself, until today there has been little in the way of an alternative to FINRA, the broker-dealer (BD) self-regulator, stepping forward to grab the reins.

But early Wednesday, The Business Law Society (BLS), a group of law students at the University of Mississippi School of Law (Ole Miss), stepped forward with a proposed SRO for RIAs.

The Oxford, Mississippi-based organization is dubbed “Self-Regulatory Organization for Independent Investment Advisers (SROIIA)–that’s pronounced “sir-oy-uh,” the group says. The group was created by law students Timothy Collins and D. Tyler Roberts under the tutelage of the University’s Mercer Bullard (left), associate professor of law, founder of Fund Democracy and senior advisor at PlanCorp. Bullard is also on the SEC’s Investment Advisory Committee.

On a conference call on Wednesday, it was apparent that the group clearly is at the beginning of a long road to becoming an actual alternative to the giant FINRA.  "First, Congress would have to amend the Advisers Act to authorize the creation of an SRO, then the SEC would have to approve an applicant," Bullard says via email. The new group is only looking to be the SRO for the 10% of RIAs that are independent RIAs, not those that are affiliated with BDs.

SROIIA's founders don't know how much the group would charge members to join the SRO, how many people it would would need on staff to examine RIAs once every year, or whether the examiners would be law students or RIA professionals or some kind of team.

The SEC routinely examines advisors only once every 11 years, according their RIA Oversight study. But SROIIA’s goal is oversight of RIAs by an RIA-based group that would, in addition to enforcing the Advisers Act, be proactive and preventative, instead of “coming in [to an RIA firm] with an army of examiners and leaving behind a deficiency letter,” says Bullard.

A 'Bona Fide' Fiduciary Standard

The group emphasizes that they would hold RIAs to a bona fide fiduciary standard rather than broker-dealer ‘best interest’ or suitability standard.” The SEC has recommended in a separate study that brokers who provide advice also be held to a fiduciary standard “no less stringent” than the fiduciary standard in the Investment Advisers Act of 1940, but Bullard is concerned that a broker’s “fiduciary “ standard would be less strict than the one RIAs must abide by. Yet, FINRA says it would like to be the SRO for all RAS—not only the ones that are affiliated with broker-dealers (BDs).

Bullard has said that unless funding is increased for the SEC, they will not be able to be the regulator for RIAs.

The release states these goals for the potential new SRO:

SROIIA will be tailored to the specific needs of independent investment advisors. The BLS will explore operational and policy approaches for SROIIA, including:

• Higher Standard of Conduct: Bona fide fiduciary standard rather than broker-dealer “best interest” or suitability standard.
• Inspections: 100% adviser-inspection rate based on regular, small-touch, tailored interactions rather than one-size-fits-all, bi-annual examinations.
• Compliance: Active compliance assistance program rather than “deficiency” based evaluations.
• Conflicts of Interest: Prohibitions of selected practices (e.g., principal transactions, revenue sharing).
• Client-Centered Testing: Qualifications standards based on bona fide fiduciary standard and financial planning competence not limited to securities-related advice.

The organization is talking to potential “strategic partners” like fi360 and Strategic Ethos, Roberts says.

Stirring the Pot

With the severe budget constraints on the SEC, nobody can say exactly when they will decide on which of the oversight options to push forward. But Blaine Aikin, CEO of fi360, which provides training in fiduciary best practices and the fiduciary process, pointed out in an exclusive interview with AdvisorOne that there had “better be someone ready to step up. We can't wait until we get a clear picture of what is going to happen,” with a potential SRO, or the default might be FINRA—a choice that would be very unpopular with RIAs. Aikin is a member of The Committee for the Fiduciary Standard, as is this editor.

“At Fi360 we believe that a self-funded SEC is the best way to go [for RIA oversight] and that is our hope,” says Aikin. “But [Bullard] might be right that this is not going to happen. Bullard has said that the FINRA ‘fiduciary’ standard would be lower and he’s probably right about that.”

“I applaud Messrs. Collins and Roberts. Their dedication to an “authentic” fiduciary standard is clear and vital for investors. That SROIIA appears to be the ‘first to market’ SRO alternative is a crisp reminder about leadership in tumultuous times,” Knut Rostad, chairman of The Committee for the Fiduciary Standard, told AdvisorOne. Rostad is also regulatory and compliance officer at Rembert Pendleton Jackson Investment Advisors. See "Video: Exclusive—Knut Rostad on Whether a Fiduciary Standard for Brokers Will Rebuild Investor Confidence."

 

See related Articles about the SEC's studies on SRO and Fiduciary issues:

8 Surprising Findings in the fi360-AdvisorOne Fiduciary Survey

The Fiduciary Study:

SEC and the Fiduciary Study: The Process, Part I

SEC and the Fiduciary Study, Part II: Politics and the Fiduciary Standard

SEC and the Fiduciary Study, Part III: Where Do We Go From Here?

SEC Tells Congress It Will Proceed With Uniform Fiduciary Standard for Brokers, Advisors

Reaction to SEC’s Fiduciary Study Is Entwined With Politics

House Democrats Call for More Funding for SEC

The SRO Study:

In SRO Report to Congress, SEC Offers Lawmakers Options for Advisor Oversight

In Unusual Move, SEC Commissioner Elisse Walter Dissents on SRO Study

SEC SRO Study Projects High Growth Rate for Large RIAs

Monday Apple Rumors: iPad 3? Not This Year

Here are your Apple news items and rumors for Monday:

No iPad 3 Until After Christmas: Looks like spring 2012 will bring just as many disgruntled holiday Apple (NASDAQ:AAPL) iPad shoppers as spring 2011 did. Speaking with All Things Digital in a Monday report, J.P.Morgan analyst Mark Moskowitz tried to kill off persistent rumors that a third iPad model would hit stores this holiday. Moskowitz said his research indicates the iPad 2 will continue to be the only iPad model sold throughout the rest of 2011. Prototypes of a third-generation iPad are out there, though, the analyst said. Past rumors have said the iPad 3 will include a higher-resolution screen, putting it on par with the Retina Display in current models of the iPhone.

Samsung Plans to Sue Pants Off Apple Over iPhone 5: Apple hasn’t even officially announced the iPhone 5 yet, and it already is the target of the latest litigation in an ongoing legal war between Apple and Samsung (PINK:SSNLF). A Sunday report in The Korea Times (via Apple Insider) said Samsung is preparing to block the sale of the new iPhone in Korea as soon as it’s announced on the grounds that — surprise, surprise! — it violates patents held by Samsung. A senior executive at Samsung said, “For as long as Apple does not drop mobile telecommunications functions, it would be impossible for it to sell its i-branded products without using our patents.” The only recourse remaining for either company is to make smartphones that are entirely different shapes and sizes. Would consumers cotton to a triangular smartphone? Probably not.

Apple Online Retail Spreads Across the World: Eastern European nations anxious for the opportunity to purchase both an iPad and an Apple Protection Plan online are watching their wishes come true. Apple finally has opened for business online in Hungary, Poland and the Czech Republic, according to a Monday report at 9 to 5 Mac. Not only that, but Apple’s online operation has extended to the myriad city-states that make up the United Arab Emirates, as well. That’s a prospective 65 million new customers online for Apple.

As of this writing, Anthony John Agnello did not own a position in any of the stocks named here. Follow him on Twitter at�@ajohnagnello�and�become a fan of�InvestorPlace on Facebook.

Top Stocks For 6/14/2012-1

National Health Partners, Inc. (NHPR)

Driving ever increasing health costs is more, more, more. Health spending. It rose 4% in 2009 to an all time record of 17.6% of gross domestic product. We are far above every other nation in health spending but don’t have the longevity to show for it. Health costs are by far the biggest threat to the nation’s fiscal health in the long run.

National Health Partners, Inc. is a national healthcare savings organization that provides discount healthcare membership programs to uninsured and underinsured people through a national healthcare savings network called “CARExpress.” CARExpress is one of the largest networks of hospitals, doctors, dentists, pharmacists and other healthcare providers in the country and is comprised of over 1,000,000 medical professionals that belong to such PPOs as CareMark and Aetna.

The reason why new health care technologies are so expensive is because consumers aren’t involved in buying them. The typical American gets insurance either from his employer or from the government. In both cases the consumer is several times removed from the price and value of a particular health technology. He doesn’t pay for the product or service (his insurer does); and he doesn’t pay for his insurance (his employer or the taxpayer does). This allows everyone to game the system at someone else’s expense.

The company’s primary target customer group is the 47 million Americans who have no health insurance of any kind. The company’s secondary target customer group includes the millions of Americans who lack complete health insurance coverage. The company is headquartered in Horsham, Pennsylvania.

National Health Partners, Inc. recently announced that it has signed a new agreement with a major marketing company that will significantly enhance the growth of its CARExpress membership base.

According to the Company, this deal, in combination with the previous partnership with Xpress Healthcare, will enable the company to build its membership base exponentially, initially generating in excess of an additional 2,000 new members per month. The new campaign is set to launch within the next few weeks and will provide a material positive impact on the company’s 2nd quarter sales.

National Health Partners anticipate that this new marketing agreement will provide a major impact on their overall sales not only for the 2nd quarter, but more importantly for the year. They look forward to building on the profits that they anticipate generating in 2011 that will be driven by substantial growth in sales of their CARExpress health discount programs. The combination of their substantial growth with their low price-to-equity ratio should reflect itself in the price of their stock over the coming months.

For more information about National Health Partners, Inc visit its website www.nationalhealthpartners.com

Cytori Therapeutics, Inc. (Nasdaq:CYTX) will host a webcast to discuss its first quarter financial results and provide an update on its product development pipeline on Thursday, May 5, 2011 at 5:00 PM Eastern Time. Prior to the webcast at approximately 4:05 PM Eastern Time on May 5, Cytori will post a shareholder letter to its Investor Relations homepage, which will review Cytori’s first quarter performance, provide an update on commercialization activities and discuss recent developments. The webcast will be available both live and by replay two hours after the call on the Company’s website, under “Webcasts” on the Investor Relations page (http://ir.cytoritx.com).

Cytori Therapeutics, Inc. engages in the development, manufacture, and sale of medical technologies to enable the practice of regenerative medicine. Regenerative medicines focus on repairing or restoring lost or damaged tissue and cell function.

Rosetta Resources, Inc. (Nasdaq:ROSE) announced that it will hold its First Quarter 2011 Conference Call on Monday, May 9, 2011. The call will be hosted by Randy L. Limbacher, Rosetta’s Chairman, Chief Executive Officer and President, and will cover the Company’s 2011 first quarter financial and operating results as well as an updated outlook. The conference call will broadcast live over the internet. Rosetta Resources Inc. 1st Quarter 2011 Conference Call on Monday, May 9, 2011 at 10:00 a.m. Central, 11:00 a.m. Eastern, http://www.rosettaresources.com.

Rosetta Resources Inc., an independent oil and gas company, together with its subsidiaries, engages in the acquisition, exploration, development, and production of oil and gas properties in the United States.

Oncothyreon Inc. (Nasdaq:ONTY) announced that it will conduct a conference call to discuss its first quarter 2011 financial results and provide a review of its pipeline of products in development on Friday, May 6, 2011 at 1:30 p.m. Eastern time. To participate in the call by telephone, please dial (877) 280-7291 (United States) or (707) 287-9361 (International). In addition, the call will be webcast live and can be accessed on the “Events” page of the “News & Events” section of Oncothyreon’s website at www.oncothyreon.com. An archive of the webcast will be available after completion of the discussion and will be posted on the Oncothyreon website.

Oncothyreon Inc., a clinical-stage biopharmaceutical company, focuses primarily on the development of therapeutic products for the treatment of cancer.

On gay marriage, some brands take a stand

In an unconventional move, a number of high-profile business executives have come out on the issue of gay marriage.

Amazon.com founder Jeff Bezos is the latest to say "I do," to supporting same-sex unions. On Friday, Washington United for Marriage � a coalition that seeks to uphold a civil union law that passed in Washington � announced that Bezos and his wife MacKenzie will donate $2.5 million to its cause.

Microsoft founder Bill Gates and CEO Steve Ballmer have each also donated $100,000 to the effort to keep gay marriage legal. Ken Powell, CEO of food behemoth General Mills, has publicly spoken out against Minnesota's proposed amendment that would ban gay marriage. And Paul Singer, founder of financial firm Elliott Management, recently contributed $150,000 to Freedom to Marry, which fights for gay marriage across the nation.

In an opposite corner is Chick-fil-A President and Chief Operating Officer Dan Cathy, who recently told the Baptist Press that Chick-fil-A is "very much supportive of the family � the biblical definition of the family unit."

Cathy's perceived anti-gay marriage statements renewed the nation's debate on this hot-button topic, with not only government officials, college students, gay rights advocates and fast food customers weighing in, but the CEO of the Jim Henson Company vocalizing her opinions as well.

The company, which had a licensing agreement with Chick-fil-A, said it will not partner with them on any future endeavors.

"Lisa Henson, our CEO, is personally a strong supporter of gay marriage and has directed us to donate the payment we received from Chick-Fil-A to (the Gay & Lesbian Alliance Against Defamation)," it said a statement.

Politicians weigh in

In the case of Chick-fil-A, it's not just executives weighing in. Politicians are getting involved as well.

On Thursday night, San Francisco Mayor Edwin Lee tweeted that he is "very disappointed (Chick-fil-A) doesn't share San Francisco's values & strong commitment to equality for everyone."

Boston Mayor Thomas Menino and Chicago Mayor Rahm Emanuel also have criticized the private company.

Yet there are also many who support Chick-fil-A and Cathy.

For example, former presidential candidate Mike Huckabee says he's "incensed" by the negative feedback, and in turn has deemed Aug. 1 "Chick fil-A Appreciation Day." He's asking consumers to support the chain by eating there.

Chick-fil-A didn't respond directly when asked by USA TODAY for a comment on Cathy's statements, but issued its own statement that said in part: "The Chick-fil-A culture and service tradition in our restaurants is to treat every person with honor, dignity and respect � regardless of their belief, race, creed, sexual orientation or gender."

Impact on brand

In the Baptist Press interview, Cathy said his stance against non-traditional marriage "might not be popular with everyone, but thank the Lord, we live in a country where we can share our values and operate on biblical principles."

And while companies and their employees are free to openly share their feelings on highly polarizing matters such as gay marriage, such statements from top executives can affect the brand image, say marketing experts.

"Usually companies stay away from anything contentious," says Allen Adamson, managing director at branding firm Landor Associates and author of BrandSimple: How the Best Brands Keep it Simple and Succeed. "They want the focus and attention on their products and services."

As for Chick-fil-A, its reputation took a hit on the YouGov BrandIndex, which tracks consumer sentiment on 1,100 brands on a daily basis.

Before Cathy's statements, it ranked high with consumers. As the controversy expanded, the company's brand health has deteriorated.

In turn, that will likely affect sales, says BrandIndex Managing Director Ted Marzilli.

"Some consumers might be very supportive of the brand or (Cathy's) position, but when we look at overall consumers � this is going to have an impact," he says.

Gay marriage is a "political hot potato," he says, and executives "should be careful about dipping into the political waters. They should realize that when they are speaking to the press � even when it is a niche audience � they are speaking about the brand."

When General Mills' pro same-sex marriage sentiments were heard, demonstrators took to turning in boxes of Old El Paso taco shells, cans of Green Giant corn and other company products.

Janet Bezdicek, a suburban Minnesota mother of five, said she took General Mills Cheerios off of her shopping list.

"We're talking about a definition of something that's been upheld for centuries," she said. "To be challenged by a corporation, that's not appropriate."

Controversial decisions

Earlier this year J.C. Penney also felt backlash when it hired openly gay personality Ellen DeGeneres as its spokesperson early this year.

But despite criticism from conservative activist groups, the retailers stood by its decision and even took it as step further by featuring same-sex parents in its promotions.

"J.C. Penney really showed us a turning point," says Michael Wilke, senior U.S. consultant for gay marketing firm Out Now. "Not only did they stand squarely behind (DeGeneres) in a public way, but then they took the unprecedented step of coming out with those Mother's Day and Father's Day same-sex ads that they put in their catalogs."

Words go viral

Adding more pressure to the corporate office is this reality: Any executive statement or action that is remotely controversial can spread to millions in seconds via social media.

"Everything is connected and everyone sees everything," says Adamson. "In today's media landscape, there is a magnifying glass. Anything you say or do is prime time."

Even before the Cathy controversy, Chick-fil-A saw how negative news could quickly disseminate.

Chick-fil-A � which has used the ad slogan "Eat Mor Chikin" since 1995 � tried to stop a small business owner's trademark application for "Eat More Kale," a catch-phrase he had printed on shirts and stickers since 2001.

Thousands quickly rallied to support that owner, Bo Muller-Moore, after word got out and spread via social media streams.

For its part, Chick-fil-A is using social media to get its messages out as well. It didn't directly address the company stance on gay marriage, but last week it let its Facebook fans know that they are going to try to step out of the spotlight on the issue.

"Going forward, our intent is to leave the policy debate over same-sex marriage to the government and political arena," it said in that statement.

Contributing: Catalina Camia, the Associated Press

Diversification: Failure Or Free Lunch During Market Turbulence?

Since Markowitz, portfolio diversification is one of the most recommended and well known investment strategies among the financial industry.

In general, diversification is an investment strategy which should reduce risk within a portfolio by investing in different securities. If a price of a security does not move in the same direction like other stocks within the portfolio, a price decrease in that stock can be offset by a price increase in a different stock. For that reason, the volatility (risk) of the entire portfolio is limited although the expected returns of each security and thus the expected return of the portfolio remain unchanged.

However, diversification is only suitable to reduce/eliminate unsystematic risk (company specific risks like losing the market leadership, lack of innovation etc.) while the systematic risk (changes in the macroeconomics factors) remains predominant and cannot be diversify away. For example, the European dept crisis is a good example of a systematic risk that affects the stock market while the lack of innovation by Research in Motion would be a good example for an unsystematic risk that an investor could face. Therefore the goal of diversification is to minimize the risks for which an investor is not expecting to be rewarded.

It is a widespread belief that correlation tends to increase among different asset classes (stocks, commodities etc.) during turbulent market conditions and that implies a reduction in the benefits arising from portfolio diversification. This is exactly the time when an investor depends on these benefits the most, to keep his portfolio stable.

Diversification can be considered at a number of levels. While diversification among different asset classes has attracted a lot of research, the focus of this article is on diversification within equities or to be more precise, within the entire stocks among the Dow Jones Industrial Average (DIA).

We investigate, if the correlations among stocks within the Dow Jones Industrial Average are increasing during the time they are facing turbulences.

The mathematical background for diversification is well known. When investors diversify among stocks that are not perfectly correlated (having a correlation coefficient "ρ" less than +1) the volatility of the portfolio will be less than the weighted sum of the volatilities of the individual securities. All other things being equal, the lower the correlation between the different stocks the greater the diversification benefits will be.

Table 1 contains following data:

• The degree of correlation coefficient between each stock and an equally weighted index, where all stocks within the Dow Jones Industrial Average are given the same weights (Correlation To Average).
• The average correlation coefficient between each stock when they are facing a down-turn (only those periods have been taken into account, where this particular stock has been in a draw down (Average Drawdown Correlation)).
• The degree of correlation coefficient between each stock and the Dow Jones Industrial Average (Correlation To DJIA),

Click to enlarge.

Not surprisingly, stocks that show a high degree of correlation between them and the Dow Jones Industrial Average are also highly correlated to an equally weighted index, where all stocks within the Dow Jones Industrial Average are given the same weights. More importantly, their correlation coefficient tends to be higher in times other stocks within the DJIA are face a peak to valley event.

If we have a closer look at those five stocks that have the highest correlation coefficient, we can see that on average those stocks go down in more than 50 percent of the time, if any of all the other stocks within the Dow decreases. So in total, those stocks will decrease the benefits of diversification, especially in times of market turbulences.

The case is different, if we focus only on the top 5 stocks, in terms of a low correlation coefficient (green area). On average, those stocks tend to have an extremely low correlation coefficient in times other stocks are facing difficulties. In total, they fell in almost less than 45 percent of the time if any of all the other stocks within the DJI had decreased. So those stocks are increasing the benefits of diversification and therefore they minimize the risk within a portfolio significantly.

To prove those numbers, we have constructed two different portfolios:

• Top 5 Stocks Portfolio: an permanently equally weighted portfolio with the best stocks in terms of low average drawdown correlation
• Bottom 5 Stocks Portfolio: an permanently equally weighted portfolio with the worst stocks in terms of low average drawdown correlation
• For both, there is no allowance for transaction costs or brokerage fees

Table 2 presents the results of our back tests from 2001/06/15 until 2012/06/01 on the two portfolios described previously. The first and second column tests the proposed Top 5- and Bottom 5 Stocks portfolio. The third column represents a buy and hold strategy on the Dow Jones Industrial Average.

The Top 5 Portfolio has an annualized return of 5.5% while a buy and hold has only generated an annualized rate of return of 1.2%. More importantly, on a risk-adjusted basis (Sharpe Ratio), the Top 5 Portfolio is strongly outperforming the buy and hold.

If we have a closer look on the diversification benefits (reducing risk during turbulent market conditions), we can see that those stocks that have the lowest average draw down correlation, have also shown significant lower draw-downs in the past. The maximum draw down for the Top 5 Portfolio was only 37.9 percent compared to 70.1 percent for the Bottom 5 Portfolio. In total, the Top 5 Portfolio was reaching a new high after 716 days compared to 1115 days for the Bottom 5 Portfolio. The Dow Jones Industrial Average is still trading below its high from 2007.

The bottom line: Diversification does not eliminate systematic risk. No investment strategy does. However, a well diversified stock portfolio reduces the risk within a portfolio significantly. Even in times the market faces turbulent conditions, diversification helps to reduce draw-downs considerably. In our study we have found no proof that stocks have a higher correlation coefficient to other stocks in times they facing draw downs. In general, diversification is not just about investing money in different kind of stocks; it's about the idea of investing in low-correlated securities, able to utilize the full benefits from this well proven strategy. The basic principle is working as long as investors do understand what diversification is all about.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.