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Editor's note: Over the past three years, investors in the popular emerging-market stock Petrobras have been killed. They've lost over 50% of their money. How could such a popular company lose so badly? DailyWealth Editor in Chief Brian Hunt answers the question with a classic educational essay he wrote in 2013. We hope you always keep this lesson in mind...

A Timeless Lesson on Investing With the Government

By Brian Hunt, Editor in Chief, Stansberry Research
Friday, October 31, 2014

Sometime in the past decade, Americans who should know better embraced a horrible investment idea...
 
If you've ever bought a stock because an investment guru told you it was "state owned" and backed by the government, chances are good you fell for a common mistake... And chances are good you lost money on the deal.
 
In today's essay, I'll show you why this is the case... and why you should always be leery of investing with "state owned" companies.
 
To drive the point home, we'll look at a poster child of "state owned" investing – Brazil's oil firm, Petrobras. It's a popular stock among investment advisors and fund managers. If you watch a financial television program about "investing around the globe," you'll probably hear someone gushing about Petrobras and its "state owned" status. After all, how could you go wrong partnering up with the national government?
 
Answer: very easily.
 
Below is a three-year chart of Petrobras. It tracks shares from early 2010 through 2012. They've plummeted from $47 per share to $17… a loss of 64%. This horrific performance was produced in a rising oil price environment. During the same period, other "Big Oil" companies like ExxonMobil and Chevron registered gains. (Note: See our "Market Notes" section below for an updated look at Petrobras versus ExxonMobil.)
 

How could the "experts" be so wrong about Petrobras? How could investors in a big "state backed" company get killed while investors in regular oil companies did well? It's easy to explain. But we have to leave investment "La La Land" and remember how things work in the real world...
 
Remember how your average government agency works (or doesn't work). The bureaucrats running government agencies are not incentivized to produce profits. They are not incentivized to improve the long-term value of a business. Bureaucrats are incentivized to spend their entire budgets and grow larger. This allows them to acquire more power... and bigger budgets for next year... which allows them to acquire more power and bigger budgets for the year after that.
 
Compare this to an entrepreneur who has his own money on the line. He's going to do his best to keep costs down, instead of intentionally blowing his budget. He's going to do his best to hire only employees he needs... rather than hire as many people as possible. He's going to keep a close eye on his cash flow, or he'll go broke.
 
Most smart people know this is the difference between government and business. But when it comes to investment, even "small government" republicans and libertarians lose their minds and line up to buy shares in inefficiently managed, state-owned companies. It defies belief. They'd be better off partnering up with a crack addict.
 
As for Petrobras, the company has phenomenal assets. It controls some of the biggest untapped oilfields on the planet. But they are offshore oilfields. Developing them will cost enormous amounts of money. That's why the company has trumpeted its planned $200 billion-plus capital-spending plans. It's believed to be the biggest corporate-expenditure program in the world.
 
This absurdly large amount of spending will be overseen by bureaucrats. Take a guess on how that will turn out. While you're forming your guess, remember that if an entrepreneur opened a lemonade stand, he would work by himself and turn a profit. If a government opened a lemonade stand, it would have a dozen employees and go broke in three months.
 
Don't get me wrong: I'm not saying you should never buy shares in a state-owned company. They can work out as trades. Also, I'm not saying all government is bad. I'm not saying government employees are horrible people. Save your hate mail.
 
But just remember what happens with most every government agency or program. They are not run for a profit. They are not incentivized to keep costs down. They are incentivized to grow bloated and inefficient.
 
The next time you're considering "partnering up with a government" – and buying a state-owned company – remember how government works.
 
You'll probably do better with a lemonade stand.
 
Regards,
 
Brian Hunt




Further Reading:

Find more of Brian's timeless investment advice right here:
 
The Easiest Way to Protect Yourself From the Next Financial Disaster
"Could another crisis cause the value of the U.S. dollar to collapse? Could the stock market suffer another epic decline? Fortunately, I don't need to know the answer to these questions... and neither do you."
 
One of the All-Time Great Investment Secrets
"Very few people want to publicize this idea... but it's one of the safest, easiest ways to make great investments."

Market Notes


FOR THE GOVERNMENT OR FOR PROFIT?

In today's essay, we heap abuse on the idea of owning "for the state" businesses instead of "for profit" businesses. The chart below shows this idea at work.
 
We've written that you're better off partnering with a crack addict than with your average group of government stooges. We're much more interested in well-managed companies that focus on returning cash to shareholders.
 
Regular readers know we consider Petrobras as a classic "for the government" company. We consider ExxonMobil to be one of the world's best managed oil companies.
 
To see our idea at work, see the performance of ExxonMobil (blue line) versus the performance of Petrobras (black line) over the past two years. ExxonMobil has climbed... while Petrobras has plummeted. For the government or for profit? We'll take for profit!
 

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