My wife Jo and I recently had dinner with two coup

first_imgMy wife Jo and I recently had dinner with two couples, good friends who also happen to be Miller’s Money Forever premium subscribers. They spoke enthusiastically about the in-depth research behind our portfolio picks and asked how our newsletter business really works. Well, I sure can’t take all of the credit. The Money Forever portfolio is really the brainchild of our senior research analyst, Vedran Vuk, and his team. I can’t help but brag about Vedran’s work, so I’m breaking a cardinal rule – just this once – and sharing one of his recommendations from our October 2012 edition. In the days before online brokerage firms, most of us traded stocks through a full-service broker like EF Hutton or Morgan Stanley. They justified their fees – often 10-30 times higher than the online brokerage firms’ fees – by promoting themselves as full-service research organizations offering custom investment advice. Personally, I saw a big gap between what they advertised and the help clients actually received. I rarely received anything better than a one-page summary, the sort I could easily find today on any online brokerage’s website. It was “squawk box” research. Every morning the “squawk box” on each broker’s desk would light up just before the market opened, with some analyst in New York telling them to push the hot stock of the day. These firms also did more rigorous research, but you had to have a huge account to access that data. These days, investment newsletters fill the research gap. For every monthly issue and special report, Vedran and his team start with a general idea of what they are looking for, and with the help of some very sophisticated computer programs they shrink the list to a few short-list candidates to research more extensively. In many cases, they will call up a prospective company and ask for further explanation of the data and reports they’ve provided. They easily spend a week or more before honing in on a pick that’s appropriate for our subscribers. At that point, Vedran begins his write-up – a thorough explanation of why his team chose the investment written in plain English. It truly is hands-on research. After I explained this process, my dinner guests asked a pointed question: “Isn’t that pretty expensive?” Yes indeed, it is very expensive. Research newsletters basically divide the cost of research among thousands of subscribers, making high-quality research available to the average investor. I have been investing for close to 40 years now, and I have never seen anywhere else the sort of in-depth research high-quality newsletters provide. Then our dinner guests nailed me. They said there was a huge disconnect between trying to describe the research to potential subscribers and what they, as subscribers, read every month. It sounded like this: “Miller, you are a good wordsmith, but until we read Vedran’s write-ups we could not imagine the kind of in-depth analysis you were talking about.” When they suggested that I make one of these write-ups available to all of our readers, I had to explain a cardinal rule: the minute you provide something for free that your paid subscribers purchased, you’re going to have a lot of angry paid subscribers. After a quiet pause, one of our friends spoke up: “As a person who’s plunked down his credit card to buy your service, I encourage you to make a one-time exception. I want you to have a huge subscriber base so you can keep your top-notch team without the pressure to raise prices.” They all agreed. I was quite surprised. At that point, I went back to our team. They all agreed that if I explained what I was doing and why – with particular emphasis that it is a one-time event – we’d be OK. With that said, I still want to ask our paid subscribers to please forgive me. The write-up we selected is one of many we publish every month. Instead of reading my description of what real research is all about, you can see for yourself. I think you will find, as I did, that this kind of quality research is not regularly available to most investors… certainly not for free. OK, you asked for it… Well, at least two well-meaning friends and premium subscribers did, anyway!Lorillard, Inc. (LO)By Vedran Vuk The fact that Lorillard doesn’t immediately ring a bell is half the reason the company excites us. The firm has managed to produce growing profits year after year without drawing the limelight. For decades, it has remained under the radar. Actually, if you consider that the company is among the oldest publicly traded US firms, beginning its business in 1760, you might say that it’s been under the radar for centuries. So what does Lorillard do? If the picture didn’t give it away, it’s the third-largest tobacco company in the United States. While the headlines always focus on Phillip Morris and RJ Reynolds, Lorillard has been happy to stay out of the spotlight while slowly but surely growing its market share. Since 2006, the company’s market share has grown from 9.6% of the domestic tobacco market to 14.3% in 2012. The firm’s main brand, Newport, makes up 88% of company’s sales and 36.2% of the menthol-cigarette market. While Newport is the flagship brand, the company also has rapid growth in its discount brand, Maverick, which along with a few other minor brands – Kent, True, Old Gold, and Newport non-menthol – make up the other 12% of sales. Part of what makes this company so attractive is that the business is so simple. This isn’t a company working on rocket-science technology or pushing 50 different productions in 30 different countries. Instead, it has two solid businesses in the US: its menthol cigarettes and its discount brands. Furthermore, the company’s expenditures aren’t complicated either. Lorillard has some warehouses in Virginia where the tobacco dries and a factory in North Carolina which rolls the cigarettes and ships them out. As a result, we don’t have to worry about massive capital outlays in the future. So, how does Lorillard fit in its competitive landscape, and how does this industry still make sense in an environment of dwindling smokers and constantly rising prices? The industry’s challenges can been seen as both a threat and an opportunity. As the industry changes, the most adaptable companies will prosper. When everything was going smoothly, Phillip Morris and RJ Reynolds dominated the industry. However, they are less adaptable to the new environment. Although they’re still profitable, their brands are losing domestic share in this new paradigm. According to Morningstar’s research, since 2007 Altria Group (Phillip Morris) has lost sales of 40 billion cigarettes in volume, and RJ Reynolds has lost a volume of 25 billion cigarettes. That’s no surprise, as the industry as a whole has been declining by 3.6% per year since 2001. However, Lorillard has not experienced those same declines. From 2007 to 2011, the company’s volume grew from 36.6 billion cigarettes to 40.7 billion – exactly when the other big players were losing volume. Furthermore, discount brands have done an amazing job in the new environment. They’ve grown from less than 2% of the market in 1998 to 13.9% in 2011. As a result, the Maverick brand has leaped from a volume of 2.1 billion cigarettes in 2007 to 5.9 billion in 2011 – that’s an astounding 181% jump! Last year, the brand continued to move forward with a 16% growth rate. As mentioned earlier, higher prices are challenges for some brands and opportunities for others. So as a premium brand, why is Newport doing so well while big names like Marlboro and Camel are losing share to discount cigarettes? That’s where my expertise as a financial professional ends and my experience as a decade-long former smoker begins. What I’m about to tell you isn’t written in the annual report, but every smoker knows that it’s true. While Newport smokers don’t make up a large majority of total smokers, they are extremely loyal to their brand – maybe more so than any other brand out there. And this isn’t the case without reason. Newport is a very strong and uniquely flavored menthol cigarette. There really isn’t a good substitute for them on market. If a Newport smoker wants to go on a budget, he doesn’t have any menthol alternatives which come close to the flavor. Furthermore, just from my opinion, cheap menthol cigarettes taste awful. Among regular cigarettes, the discount brands can be rough too, but among menthols, it’s basically an unspeakable horror to smoke through a discount pack. As a result, Newport smokers have a harder time substituting discount brands than Marlboro or Camel smokers. When I was a smoker, the loyalty of Newport smokers would shock me. When one of them would run out of cigarettes, they would often turn down a free cigarette if it wasn’t a Newport. This wouldn’t happen all the time, but I never saw the same behavior with almost any other brand. When I explained this all to Dennis, he came back at me with a great analogy to explain Lorillard’s position. Marlboro and Camel are the Coca-Cola of the cigarette world. People prefer them, but if their budget gets really squeezed, they can live with Big K cola or Sam’s Club cola. Newport smokers are like Dr. Pepper lovers. Yes, it’s technically also a soda like Coke, but it’s a very unique flavor. As a result, Dr. Pepper fans are sometimes intensely loyal to their brand. They don’t have many good substitutes. A Big K cola or even a Coke is not really a substitute for a Dr. Pepper. In a way, Coke and Dr. Pepper compete in similar but separate markets. Besides the growth in market share, the brand loyalty, and the low capital expenditures, a few more factors drew us to Lorillard. The company has very stable operating margins of 52%, giving it a strong economic moat. Since the company doesn’t really need a lot of cash to operate, it promises to pay out 70-75% of earnings every quarter to shareholders. At its current income and stock price of $114, that’s a yield of 5.2%. And since the customers aren’t going away overnight, you can expect the company to make similar earnings quarter after quarter. If Lorillard continues growing at its current rate, we estimate its value will reach $144 – that’s not a lot of meat on the bone, but enough to make it worth our while. We also valued the company using a model which values just the stream of dividends and ignores all the other factors of the company – it came out to a very high value of $105. Think about it… just the dividends of this company are nearly worth the current price of $114. Putting aside all the other features of Lorillard, it still looks like a good deal. That’s very rare for any company. Despite all the things going for Lorillard, we’re putting it in the moderate risk category. As with any company, there’s always a down side. Our main concern is the regulatory environment for cigarettes – in particular for menthol cigarettes. We’re not that concerned about regulations and higher prices in general. As we mentioned beforehand, Lorillard is well placed to deal with those issues – that’s one of the reasons we like it. While regulations on tobacco will get tighter, no one is going to prohibit smoking altogether. What makes us cautious is the possibility of regulation or outright prohibition of menthol cigarettes. If menthol cigarettes were banned, this would pretty much be a nuclear scenario for Lorillard, which gets 88% of revenues from menthols. There are government agencies out there that want to get rid of menthols. In 2009, the FDA managed to ban flavored cigarettes, so this caution isn’t completely unrealistic. Lorillard is a great company which will continue to grow while providing a very generous dividend. However, it does have the slight chance of that nuclear event happening. That said, put Lorillard in your portfolio, enjoy the growth, take in the dividends, but don’t invest so much that a single government regulation could seriously damage or cripple your financial health.And Now, Back to Dennis There is nothing I can add to Vedran’s write-up except to say that he does this month after month. More than one reader has taken the time to drop us a note and comment on how lucky we are to have him on our team. Vedran’s analysis certainly highlights the difference between real research and the kind of one-page write-up that full service brokers provided years ago. We want our subscribers to receive more than just stock tips; we want them to thoroughly understand the reasons behind our recommendations. I should also mention that Lorillard was added to our portfolio in October with a 20% stop loss. I asked Vedran to bring us up to date on how it is doing, and here’s what he had to say: Since recommending Lorillard (LO) on October 15, 2012, we’re up 1% on the stock. It’s not a lot, but the stock is doing its job of being very defensive. It hasn’t skyrocketed through the ceiling, but we also haven’t lost a single wink of sleep from owning it. And that’s part of the benefit here. Since putting Lorillard in our portfolio, we’ve gone through the nail-biting, rollercoaster ride of the fiscal cliff as well as the presidential election before it. Over that time period, Lorillard stood firm. During the height of those momentary panics, the lowest our stock got was down 3%. At its highest, Lorillard reached just under 7%. And in the mean time, the company has paid us its first monster dividend of $1.55. Sometimes, the value of a stock isn’t a 30% overnight price increase – which can just as quickly disappear. It’s the company’s ability to withstand shaky markets – and Lorillard managed to do just that. If this stock does nothing more than pay out our 5.4% dividend yield and add a couple more points in capital appreciation by the year’s end, we’ll be happy. One more thing: if you’re going to purchase shares of Lorillard, there will be a stock split in a matter of days. So don’t be shocked if the stock price looks very different from today’s numbers. The underlying value is still the same. If Vedran’s Lollilard write-up has piqued your interest, I urge you to take advantage of our 90-day, no-risk trial if you haven’t done so already. Click here to learn more.On the Lighter Side It was a busy weekend in the sports world. The NFL is now down to the final eight teams headed to the Super Bowl, and the NHL appears to have settled its lockout so hockey fans will soon have something to cheer about. I find it difficult to understand how the NHL can continue to have work stoppages and expect its fan base to grow. You would think both sides could get together and resolve their differences before the season starts. —- A few subscribers have asked if we have any type of compensation arrangement with EverBank or any other firm I’ve mentioned. I’m happy to share that we receive no compensation from any of the firms I mention, nor would I accept any. We take pride in serving only one master, our subscribers. That’s as it should be! And finally… Our friend Terry D. sent us a poem on January. I think many of us men can relate to its message as well.A January Poem’Twas the month after Christmas, and all through the house Nothing would fit me, not even a blouse. The cookies I’d nibbled, the eggnog I’d taste At the holiday parties had gone to my waist. When I got on the scale there arose such a number! When I walked to the store (less a walk than a lumber), I’d remember the marvelous meals I’d prepared, The gravies and sauces and beef nicely rared. The wine and the rum balls, the bread and the cheese, And the way that I’d not said, “No thank you, please.” As I dressed myself in my husband’s old shirt And prepared once again to do battle with dirt, I said to myself, as I only can, “You can’t spend a winter disguised as a man!” So away with the last of the sour cream dip. Get rid of the fruitcake, every cracker, and chip. Every last bit of food that I like must be banished Till all the additional ounces have vanished. I won’t have a cookie, not even a lick. I’ll want only to chew on a long celery stick. I won’t have hot biscuits, or corn bread or pie. I’ll munch on a carrot and quietly cry. I’m hungry, I’m lonesome, and life is a bore, But isn’t that just what January’s for? Unable to giggle, no longer a riot. Happy New Year to all and to all a good diet. Until next week…last_img

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