The Most Important Wealth Secret You'll Ever Learn

The Most Important Wealth Secret You'll Ever Learn 
By Chris Hunter,

What you are about to read flies in the face of everything your stockbroker or Wall Street adviser will tell you. 

It's about the closest thing to heresy you can get in the investing world... and the newsletter business. It's also a key insight if you want to stay wealthy over time. 

It is simply this: Stock picking alone won't help you hold on to wealth. 

Unless you are very lucky... or very, very talented... you will struggle to pick the right stocks at the right time ALL the time. You will make mistakes. You will mess things up. 

And unless you have the right discipline in place, sooner or later you will lose money. 

That discipline is called "asset allocation." That sounds technical. But it's really just about how you spread your wealth over different types of investments. 

This is backed by hard data. 

For instance, a well-known study in 2000 by Yale professor of finance Roger Ibbotson and Paul Kaplan of Morningstar showed that differences in asset allocation among mutual funds explained virtually all of the variance in their returns. 

Differences in stock picks made virtually no difference to the variance in portfolio returns. 

Common Sense Decisions
It's common sense, but you don't put 100% of your wealth in stocks in a savage bear market. 

And you don't invest 100% of your wealth in bonds in times of runaway inflation. 

This seems straightforward. But you'd be surprised how many investors skip over these fundamental decisions in the rush for the latest "hot stock." 

This is nearly always a bad idea. 

Before you even think about picking which individual stocks to own, you have three decisions to make. These are the three most important decisions you make as an investor. 

1) Which assets to hold in your portfolio 

2) In what proportions to hold them 

3) When to change those proportions 

Get these three decisions right, and long-term wealth creation and preservation will follow. Get them wrong, and you are unlikely to hold on to what you've worked hard to earn and save. 

So what makes for a good asset allocation? 

Today, I'd like to share with you what we've learned so far at Bill's family wealth advisory service, Bonner & Partners Family Office... where our goal is long-term wealth preservation. 

7 Rules of Successful Asset Allocation
1) It will have a cash buffer – Having cash on board makes it easier to deal with a major downturn and the losses that come with it. Remember, you want to make sure you are not forced into dumping your investments in times of market stress. 

The more cash you hold, the more of a buffer you have. Having cash on board also allows you to go bargain hunting when investments go on sale. In times of crisis, having enough cash to buy beaten-down assets is essential. 

2) It will be an inflation beater – Your asset allocation must allow you to stay ahead of consumer price inflation. There is little use in putting together a portfolio that gets eaten away by inflation. 

This is especially important given the sky-high deficits most advanced economies are running and the widespread money printing central banks are engaging in. We may not see a lot of inflation show up now. But that doesn't mean it won't show up in the future. 

3) It will be able to withstand currency depreciation – This is particularly important if you are internationally mobile, as many Bonner & Partners Family Office members are. 

There is no point in making big portfolio gains in a currency that is losing value. Or for that matter, leaving a portfolio vulnerable to the collapse of a currency (something that is now being talked about openly in the case of the euro). 

4) It will be properly diversified – A prudent long-term portfolio will contain a mix of asset classes that reduce risk. It will also be well diversified within asset classes. 

For example, the money you have in stocks should be diversified across sectors and geographies. Having all your stock market investments in Japanese nuclear stocks, for example, is a bad idea, even if you have only 10% of your total wealth invested in stocks. 

5) It will take advantage of the "bargain counter" – The individual assets you own should only be bought when they are selling at what we like to call the "bargain counter." 

If you buy when an asset is expensive you expose your portfolio to the risk of a large capital loss. Buying assets when they are selling at a discount to their estimated fair value increases your margin of safety. 

6) It will follow sensible "position sizing" rules – Position sizing answers the question "How much should I own?" 

The answer to this question varies. But as a general rule, never put more than 3% of your overall capital at risk on one stock position. This is one of the most effective ways of reducing the risk of a ruinous loss to your portfolio. 

7) It will contain plenty of "off market" assets – "Off market" assets are assets that don't trade on a public exchange... things such as real estate, gems and stakes in private business ventures. 

Putting all your money at risk in the financial markets (whether in stock markets, commodity markets, bond markets or currency markets) is too much of a risk. 

For instance, owning a quality house... bought at a good value and soundly financed... is an excellent way of reducing overall portfolio risk. If you go about it right, you should own the home outright by retirement. 

Owning a home debt free is one of the best protectors against financial crisis that there is. Owning a private business or investing in one is another great way to earn high returns on your capital. 

The Icing and the Cake
Asset allocation is how serious investors think about investing. 

At Bonner & Partners Family Office we call the returns you get from your asset allocation decisions "beta." 

Beta is the result you get from getting the big trend right. 

Once you've got your beta right, it's time to look at boosting those returns. We call this "alpha." Alpha is what you get by choosing the individual investments (stocks, bonds, etc.) best positioned to profit from the big trends. 

Beta is the cake. Alpha is the icing on the cake. 

The most important wealth secret you'll ever learn is understanding this relationship... and always starting with the cake first. 

Most investors get this backward. And they suffer as a result. 

Source: Early To Rise

Follow us on Twitter: @blacklioncm

One of the All-Time Great Investment Secrets

One of the All-Time Great Investment Secrets An Interview with Brian Hunt Wednesday, July 9, 2014

Today's DailyWealth covers one of the greatest investment secrets in the world. You won't hear about it in the mainstream media… and very few people want to publicize this idea… but it's one of the safest, easiest ways to make great investments. In the interview below, S&A Editor in Chief Brian Hunt reveals all the details behind this powerful investment secret… including the reason nobody wants to talk about it… Stansberry & Associates: You often say one of the great investment secrets – a source of giant investment returns – comes down to "investing in habits."  What's the story here? How can it lead people to great investments?  Brian Hunt: One of the truly great investment secrets is the idea of owning companies that sell habit-forming, or even addictive, products. I'm talking about things like soda, fast food, candy, cigarettes, and alcohol.  I often tell people that if they only knew this secret of investing, they could ignore just about everything else. It's that powerful.  Although it can lead to gigantic investment returns, it's not a popular idea. The Wall Street Journal isn't going to run a regular column about this idea. Mainstream magazines aren't going to run monthly features on it. Many folks are just not comfortable with owning businesses that sell habit-forming products. And if they are comfortable owning them, they are often very uneasy about publicizing it. It's not a popular topic at dinner parties or cocktail receptions.  S&A: Let's talk about some real life examples.  Hunt: Sure.  If you look at the list of the 20 best-performing S&P 500 stocks from 1957 through 2003 that kept their general corporate structure intact, you'll note many of them sold habit-forming products. It jumps right out at you.  For example, Phillip Morris is at the top of the list. It was the top-performing S&P 500 stock from 1957 to 2003. It sold cigarettes, which contain addictive nicotine.  Coca-Cola and Pepsi Co. are on the list. They sold soda… which is a sugar delivery vehicle. Hershey Foods and Tootsie Roll are on the list. They sold chocolate and sugar. Wrigley is on the list. It sold sugary gum, like Big Red and Juicy Fruit. People love to get a little sugar rush. It's habit forming… even addictive.  Many drug companies are on the list. These names include Abbott Labs, Bristol-Myers Squibb, Merck, Wyeth, Schering-Plough, and Pfizer. People get accustomed to taking certain drugs. Much of the time, those drugs are useful, although sometimes they are not. I'm not saying they are good or bad… I'm simply pointing out that people get extremely accustomed, even addicted, to taking them.  Fortune Brands, which was called American Brands for a while, is on the list. It sold cigarettes and alcohol.  You can make the case that certain fast foods are addictive as well. Food chemists load fast food with stuff that makes people want more. This is part of the reason McDonald's has been such a corporate success. McDonald's returned an average of 13% a year for three decades. Few businesses can achieve that kind of sustained performance.  The businesses I just mentioned produced more than 13% annual gains for decades. Those returns are extraordinarily rare in the stock market. You won't find anything better. Most companies can't sustain 13% annual returns for more than five years. The businesses I just mentioned sustained those returns for decades. And the reason why they did so well is simple.  When people form a habit around a product, it goes a long way toward ensuring repeat business. People get used to certain brands and they grow resistant to switching. Also, when people get used to a product and the brand surrounding it, they are more likely to continue buying the product even if the price increases a little. Both of these habits help companies sustain sales growth and healthy profit margins. That's good for shareholders.  It's also important to know that when these companies hit upon the right recipes or the right mix of whatever it takes to make good products, they don't have to make large, ongoing investments in the business. They don't have to spend tons of money on further research and development. Once Coca-Cola hit upon Coke, it didn't have to change it. The same goes for Budweiser and Hershey and Tootsie Roll.  When you develop a product that people love and develop habits around, you don't tinker with it. You don't have to spend a lot of money on new research and development. You don't have to buy expensive high-tech equipment. This means a larger percentage of revenues can be sent to shareholders. This leads to big dividends and share price gains. When a business get into that position, my friend Porter Stansberry says it is "capital efficient."  These sellers of branded, habit-forming consumer goods, by the way, are the kinds Warren Buffett, the greatest investor in history, always looks to buy.  S&A: How about a few recent examples of this idea working?  Hunt: The coffee chain Starbucks is a great one. It's one of the great success stories of American business.  Starbucks coffee was traditionally higher in caffeine than other brands. This helped it become more addictive. From 1995 to 2006, Starbucks advanced more than 2,000%. Starbucks was very good at selling a habit-forming product, and shareholders made a fortune.  Sam Adams is another good modern-day example. The makers of Sam Adams did a great job of producing quality beers associated with a strong brand. The name "Sam Adams" is associated with quality beer all over America.  From 2003 to 2013, shares in the maker of Sam Adams, Boston Beer, gained more than 1,000%. It's been a tremendous stock market winner. And the driver of those gains is a habit-forming product.  S&A: What are some of the other benefits of this strategy?  Hunt: The idea of owning businesses that sell simple, habit-forming products is great for folks who don't follow changing technologies.  It shows you don't have to try to pick winners from the complicated world of high-tech. You can make a fortune in "low tech" companies. It's very unlikely that enjoying a beer after work will become obsolete.  I like the predictability of owning robust, reliable businesses like McDonald's and Coca-Cola. I know it's very likely that folks will keep eating burgers and drinking soda.  I don't like the idea of buying a stock only to see it fall 30% in a few days because its fad product is going out of style… or because the cancer drug it bet the company on got rejected by government regulators.  Owning quality businesses that sell habit-forming products is a safe, sleep-at-night way to build wealth in common stocks.  S&A: How about another benefit?  Hunt: This strategy is also ideal for investing in high-growth emerging markets like China and India.  Combined, China and India have about 10 times the population of the United States. Many of those people are at the level of economic development of 1950s America… and they are getting a little richer every year. It's an incredible trend.  To invest in the trend, I don't want to try and guess what websites will become popular… or what retailer will become fashionable. That's a very difficult game. Those business landscapes will shift and change rapidly.  On the other hand, I'm very confident those folks in India and China who are getting a little richer every year will want to enjoy the same habit-forming products Americans have enjoyed for decades. They will want to consume more branded soda, cigarettes, beer, liquor, and processed foods. So, owning international businesses that serve those growing markets makes a lot of sense.  S&A: Can you provide some guidance on the right time to buy these companies?  Hunt: One way is to buy the biggest and best companies, like Coca-Cola or Hershey.  In order to buy them at a bargain price, it's best to buy them after a bear market or a major market correction. For example, many good sellers of habit-forming products fell 25%-50% during the 2008 market crash. After the crash was a great time to buy them.  You can also get bargain prices when a good company gets hit by what Warren Buffett calls a "one-time huge, but solvable, problem."  What Buffett means here is that even great companies make mistakes along their way to greatness. When these mistakes occur, investors often overreact and dump their shares. When you see a great company like Hershey or Coke suffer a major share-price selloff, I recommend viewing it as a potential buying opportunity.  Another option is to try and pick the next big success story. Who's the next Boston Beer or Starbucks? If you can get in early, the gains can be extraordinary.  But remember, that's a much riskier path. When Boston Beer began nationwide distribution, there was no guarantee enough Americans – accustomed to mass-produced lager like Miller Lite – would pay premium prices for a higher-quality "craft" brew.  And remember in 1997, a year after it went public at $30 a share, Boston Beer was trading for $9 a share. Probably not a lot of shareholders held on through the darkest days to enjoy the big gains.  If you want to try to profit from the next big success story, my advice is to keep your position sizes small so you can withstand the big swings in share price. Also, if your stock doesn't become the next big success story, at least you won't lose much.  S&A: Any final thoughts?  Hunt: It's worth addressing something that always comes up when this idea is discussed. People like to talk about whether it's right or wrong.  I'm not making a statement on whether owning these companies is right or wrong or socially responsible. Deciding to own businesses like these is up to the individual.  I'm just pointing out what works. I'm pointing out that selling habit-forming products often makes for a great business. It has been a proven strategy for decades… and it will continue to be for decades more. Human nature is what it is.  There are two basic keys to successful long-term investing in common stocks. One is to learn how to identify great businesses that you can own for years and years. The other is to make sure you pay good prices for your ownership stakes in those businesses. Knowing the powerful secret of "investing in habits" is a great help with the first part of the strategy.  If investors know this secret, they can make sure to monitor these types of stocks, look to buy them at good prices, and hold them for long periods of time. It's a proven wealth-generating idea that's rooted in common sense.  S&A: Thanks for your time.  Hunt: My pleasure. Source: Daily Wealth Follow us on Twitter: @blacklioncm

How to Start Out in Stocks – Here at Record Highs

How to Start Out in Stocks – Here at Record Highs By Dr. Steve Sjuggerud Tuesday, December 31, 2013

I just received a fantastic letter from "Pastor Mark" – a new subscriber… Pastor Mark's fear is the "right" fear to have right now… He is worried about buying in at this point, after the U.S. stock market has run up so much and is sitting at record highs. Boiling it down, he says, "I don't really want to buy into some of the positions that have already run up so much." He asked me to share "some practical insight, guidance, or suggestions on the best way to enter the positions and what positions might want to be avoided if entering in at this stage of the game." Pastor Mark says he's new to investing. Fortunately, he's been "doing a lot of research and reading," which is clear from his letter. And he says he's "ready to jump in, albeit with fear and trepidation." Pastor Mark, you are not alone in your worries… I am certain thousands of other folks are thinking the same things you are right now. Let me focus my answers on how to start out buying now, especially with stocks at new highs… 1) You can ALWAYS find reasons NOT to invest… the hard part is overcoming those reasons.  This is one of the most important concepts you can possibly learn…  In December of 2010 in DailyWealth, I wrote: There's ALWAYS a reason NOT to invest. It's incredibly easy NOT to invest. It's much more difficult to puff your chest out, hold your head high, set your fears aside, and put your money to work. You can always come up with an excuse to NOT put your money to work. In that essay, I said, "Nobody will fault you for not investing. Meanwhile, you won't make any money."  I highly recommend you go back and read that DailyWealth…  You will never be a massively successful investor unless you understand this concept and learn to overcome it.  Having said that… when stocks are at new highs:  2) You must play good defense, first and foremost.  Before putting new money to work, the first question you must answer is, how much money are you willing to lose? I am serious…  Most people are thinking about how much money they could potentially make, or how much they've missed out on. But you can't control either of those. But you do have some control over how much you are willing to lose…  For example, you could use "trailing stops" and/or stop losses. If you have $50,000 in savings, and you are not willing to lose more than $5,000 of that, then you must use 10% "stop losses" across the board. This is even more crucial after a huge run-up in stock prices. (You can read more about trailing stops and other stop losses right here.)  3) Don't worry about how much stocks have gone up… worry about what you are getting for your money.  There's no denying that U.S. stocks have gone up – a lot. But with bonds paying you next-to-nothing, and your savings account paying you even less, U.S. stocks are still a good value compared with all other financial investments. If you are worried about buying them here, read No. 1 on this list again.  4) Be willing to look beyond U.S. stocks.  I believe European stocks and emerging markets are better values than the U.S. stocks today.  You may wonder why I keep buying U.S. stocks when I think these other countries are better deals.  I think being fully diversified across all of these sectors is the way to go. We have made money sticking with the trend in U.S. stocks, and we haven't made as much in Europe and emerging markets, but we know the value is there. Our eggs are spread out over a few baskets.  One crucial fact here… Typically, when the U.S. sneezes, the rest of the world catches a cold. What that means is foreign stocks will likely fall if U.S. stocks fall. Don't think that because you're buying cheaper stocks outside the U.S. that you are safer.  In my opinion, foreign stocks have more upside potential from here, so I want to own them. But they are certainly not immune from downside risk.  So, to invest at new highs, at minimum, you must:  1) Learn to overcome your objections.  2) Play good defense.  3) Don't worry about how much something is up… worry about what you're getting for your money.  4) Be willing to look beyond U.S. stocks.  All of these are difficult to do… You can understand these concepts rationally. But emotionally, something happens inside that makes them difficult to implement.  In addition to these few thoughts for how to buy when stocks are at new highs, I highly recommend you go back and read my 10 rules for successful investors.  Pastor Mark, I can't give you all of the answers neatly in one little DailyWealth. Hopefully today's essay gives you some of the insights – and the confidence – to do what's right for you…  Good investing,  Steve Source:  Daily Wealth Follow us on Twitter: @blacklioncm

This Is How the Fed Steals from You... and Gives to the Very Rich

This Is How the Fed Steals from You... and Gives to the Very Rich By Porter Stansberry Wednesday, December 18, 2013

On December 23, just five days from now, we "celebrate" 100 years of a currency system controlled by a select few private corporations. In 1913, a bill passed through a poorly attended Senate session… and was rushed to the White House, where Woodrow Wilson signed it into law that same night.  It established the Federal Reserve… which is not technically owned by the federal government, nor does it have any actual reserves.  Today, the Federal Reserve is a fixture in our economy. It controls the quantity and frequency of currency issued by the United States. Take a dollar bill out of your wallet and notice what it says on the top, "Federal Reserve Note." That currency is what we use to transact business in our lives. It is also what we get paid in when we work hard or take risks.  The Federal Reserve enjoys a great reputation. Every few months, the chairman visits Congress. He gives a speech on the condition of the nation's economy. Markets wait patiently for his statements and hang on his every word when the Fed issues policies. (This afternoon, you'll see the chairman's latest pronouncement.)  When it comes to the Fed, people assume that the experts are handling things. They forget that the Fed is a cartel, and the purpose of forming a cartel is to protect its members…  The Fed primarily relies on two tools to drive its monetary policy. First, it can adjust the "federal-funds rate," which is the short-term rate banks pay to borrow funds from each other overnight. Nearly all interest rates – mortgages, corporate debt, etc. – are linked either explicitly or implicitly to the federal-funds rate. So when the Fed lowers rates, the cost of borrowing drops for everyone. When rates are low, folks build more cars, buy bigger houses, and start new businesses.  The Fed can also manipulate the economy by purchasing or selling Treasury bonds. The Fed has to create new money to pay for Treasury purchases. And conversely, when the Fed sells these bonds, it essentially takes currency out of the system.  Recently, the Fed has been buying Treasury debt like crazy… about $85 billion worth a month. To fund these purchases, it is creating vast sums of money out of thin air. The Fed doesn't like the phrase "creating vast sums of money out of thin air"… It sounds reckless and irresponsible. "Quantitative easing" has a much more academic ring to it. But don't be fooled… When the Fed announces quantitative easing, it's about to print money out of thin air and drop it on the economy.  Money for nothing might sound like a good idea. But both of the Fed "tools" are inflationary. They make every one of your dollars less valuable…  When the Fed lowers interest rates, it is essentially bribing people to spend more money. When more people have more money to spend on the same goods and services… they will inevitably bid prices higher.  This is what happened with the recent housing crisis. With rates low, banks were encouraged to lend at a record pace. Suddenly, everyone could borrow money for record-low rates and buy "more house." Real estate prices soared around the entire country. Of course, we later learned the banks had been loaning to folks who couldn't repay. The inevitable slew of defaults drove home prices down and sent our country into a deep recession.  Since December 2008, the Fed's nominal interest rate has effectively been 0%. Since the Fed can't lower nominal interest rates below zero, the only tool it has left to manipulate the currency is "quantitative easing." So for the past several years, the Fed has been printing money in an effort to "ease" our way to prosperity.  Has it worked? As we explained in October, quantitative easing has been a godsend for some:  [Federal Reserve Chairman Ben] Bernanke permitted and encouraged the largest housing bubble in history. Its inevitable collapse allowed me to buy rental real estate paying yields in excess of 20% and trophy properties in Miami Beach for prices last seen 15 years ago… And for the very, very rich… Bernanke did even more, God bless him. Bernanke dropped real interest rates well into negative territory. That allowed the world's wealthiest capitalists – like renowned investor Warren Buffett and Stephen Schwartzman, head of the private-equity firm Blackstone Group – access to unprecedented amounts of capital at rates of interest that literally paid them to borrow. They did the only logical thing… they responded with a wave of leveraged buyouts that dwarfed every other private-capital cycle in history… This was a massive aggregation of wealth. Almost none of these deals would have been possible without Ben Bernanke's policies… Yes, for rich people all around the world, Ben has been a living saint. Thank you, Ben! We couldn't have done it without you! None of us ever thought we'd be quite this rich… or end up owning all of those incredible assets. Newly printed Fed money tends to find its way into the pockets of those who need it least…  The same thing is happening with businesses. People like to debate whether quantitative easing has helped small businesses. But it has clearly helped the "too big to fail" banks get even bigger. Last month,Forbes made a list of 29 banks that were "too big to fail." And topping the list… JPMorgan, the namesake bank of the man who helped drive the Federal Reserve's creation 100 years ago.  Along with Citigroup, Goldman Sachs, and other big banks, JPMorgan is one of the Fed's "primary dealers." These dealers act as the Fed's agent at Treasury auctions and in other markets. Under the current system, once the dealers buy the government bonds, they sell them to the Fed – for a slight profit, of course.  Not only do they profit from every Treasury bill the Fed purchases… but many people believe that their "seat at the table" offers the Fed's primary dealers insights into – and even influence over – our nation's monetary policies. The Fed has become a cartel with membership privileges.  Quantitative easing has re-inflated the entire banking system. The chart below tracks the balance sheets of the Federal Reserve. Notice that assets (the black line) have ballooned from around $900 billion to nearly $4 trillion.  Meanwhile, JPMorgan has seen its assets grow from $1.6 trillion in 2007 to $2.5 trillion today. That is 58% in just a little more than five years. It has also seen earnings per share (the gray line) grow by 43% over the same period.  Meanwhile, Federal Reserve manipulation of the dollar has undermined the lives of millions of Americans. It has driven down the standard of living for the average American in two key ways. First, the average household is earning less money at a time when prices are increasing.  Second, it's nearly impossible for people to protect the value of any extra cash they can save. The cash that is left in bank accounts will buy less next year than it does today.  The Fed has set interest rates so low, it's impossible to earn a decent return. Remember, all interest rates are tied – either directly or indirectly – to rates set by the Fed. This is great for the banks that own the Fed. They get to borrow for 0% and lend to the rest of us at 4% or 5%. But it's terrible if you're trying to hang onto your savings for retirement 15 or 20 years down the road.  In short, the Federal Reserve has changed the markets. It has also changed how we invest. There are considerations today that we would never have imagined 20 years ago. It is no longer enough to study business cycles and company fundamentals. We have to consider the unintended consequences of quantitative easing…  Tomorrow, I'll show you the results of a study we just conducted on what will happen when the Federal Reserve begins to rein in its quantitative-easing bond-buying policies. This is what people refer to as "tapering."  We looked at how the Fed's previous exits from the bond market have influenced every sector of the stock market – and how "tapering" could affect our recommended stocks.  Specifically, we studied more than 2,000 stocks across 39 industry segments. We spent dozens of hours on this analysis (which we've seen nowhere else, by the way).  We found there wasn't a single sector of the stock market that had gone up, on average, during the last three Federal Reserve "taper" periods.  But we did find a "window" of opportunity. I'll show you exactly where in my next essay…  Regards,  Porter Stansberry Source: Daily Wealth Follow us on Twitter: @blacklioncm

An Easy Guide to Shareholder Letters: Look for These 3 Things

An Easy Guide to Shareholder Letters: Look for These 3 Things By Dan Ferris, editor, The 12% Letter Wednesday, November 27, 2013

It was an unusual research project… Not one in 1,000 investment advisors or newsletter writers would ever consider it. Over the last month, my research partner and I read every shareholder letter issued by companies in the S&P 500 index. I got the idea from billionaire super investor Warren Buffett. A couple years ago, Buffett talked about a one-page fax he got from the CEO of a potential acquisition: The quality of the business, he said, "jumped off the page." During our project, we found a few shareholder letters that were that good… And if you study what I'm about to teach you, you, too, will be able to identify companies that "jump off the page" as wonderful investments you'd like to own one day. You won't have to pick stocks anymore. They'll pick you! And it's easier than you think… I found three valuable types of insight in the best shareholder letters…  1.   How the company spends the excess cash it earns.   2.   How to keep the company accountable and measure its success.   3.   How the CEO describes the company and what makes its approach to the industry different and better than other competitors. The first and most important insight a great shareholder letter will give you is about the company's approach to cash…  It's great to own a piece of a profitable company… but if the management team squanders the profits, they'll destroy shareholder value instead of preserving and growing it.  Take Wall Street mega-bank JPMorgan Chase (JPM), for example. It is the only S&P 500 company that says growing its dividend is the most important thing it does with excess cash… even more important than growing the business!  Here's the relevant passage from the 2012 annual shareholder letter by CEO Jamie Dimon.  Our fortress balance sheet… provides us with excess capital to invest, and we always are thinking way ahead about the best ways to deploy it. As we have said in the past, after steadily increasing dividends, our favorite deployment is in growing our businesses. After investing in the growth of our businesses, we look at other ways to use the remaining excess capital. One use we consider is buying back stock – but only at a price we think is good for shareholders. The priorities for investing excess cash couldn't be clearer. First, JPMorgan will grow the dividend. Second, it will consider ways to grow the business. Third, it will look to spend cash in other ways, including buying back its stock.  When you find the companies that allocate excess capital wisely – like JPMorgan has – well, I can't stress enough how highly valuable that is to you as an investor. It's like knowing who's going to win an Olympic gold medal before the event begins.  Second, great business leaders want to be held accountable. They want to give you, the shareholder, an objective benchmark for measuring their success.  Consider 3M (MMM), a conglomerate that produces everything from Post-It notes to welding goggles.  Its shareholder letter provides investors with a crystal-clear set of financial benchmarks they can refer to in the future, to make sure management is performing well.  Here's what 3M Chairman and CEO Inge Thulin said in the 2012 shareholder letter:  Finally, we set out financial goals for the next five years. We now have targets that are both realistic and aggressive, and that provide a real possibility of upside. The five-year goals are as follows: •   Grow earnings per share 9-11 percent per year, on average •   Grow organic sales 4-6 percent per year, on average •   Maintain return on invested capital above 20 percent •   Free cash flow conversion of 100 percent Shareholders can note these objective benchmarks and know in five years if management is performing up to speed or not.  Most shareholder letters don't do this. They aren't crystal clear about how to gauge success because they fear they won't measure up. But great managements believe in what they're doing. They want to be held to an objective standard.  Humans are ego-driven. They want recognition. But they like their recognition to come with as little effort and commitment as possible. So it takes a special kind of person to draw a line in the sand and let the world know that's the point from which his future progress will be measured.  There's one more big idea you'll find in many good shareholder letters. Simply put, you want a manager who can explain the industry he's in and what makes his company's approach to it different and better… For example, here's a clear explanation of how and why apartment REIT Equity Residential (EQR) changed its business…  Approximately ten years ago, we made a monumental shift in our company's investment strategy away from two- and three-story walk-up garden apartment properties with surface parking in suburban locations across the 50 largest cities in the country, towards higher density, urban properties in a handful of gateway cities in the northeast and West coast… We also wanted to invest where the construction of new housing would likely continue to be constrained, such that demand would exceed the supply of all forms of housing. Letters like this – that explain the company and the industry in plain English – provide a free, high-quality (and sometimes entertaining) financial education that will take very little of your time.  Those are just three examples of several great shareholder letters we read during our project. We found 79 that show the companies are dedicated to paying out their excess cash to shareholders… keeping themselves accountable… and explaining their business and industry in plain language.  Of course, there are great companies that don't have great shareholder letters. But it's hard to find the opposite – a really great shareholder letter that isn't written by a great CEO of a great business.  I've never heard about anyone undertaking a project like we did… But I believe in those kinds of "manual" methods of stock screening. It's easy for computerized screening tools to miss things an experienced human being carefully poring over the same data would find.  To be a great investor, you have to be willing to look at the stock market in ways most other people don't.  Reading the shareholder letters of the companies you invest in is invaluable when it comes to understanding the business, the industry, and what you can expect from your management team. Especially when you find one that's sending the right message in a clear, credible way.  Good investing,  Dan Ferris Source: Daily Wealth Follow us on Twitter: @blacklioncm