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Executive Summary March 27, 2015

The Economy

While not as serious as it was in 2014, the economy seems to have a case of the winter blues for the second straight year. Recent data indicates that the US hit several economic speed bumps in February, some of which may have been at least partly due to terrible weather in various parts of the country.

New orders for nondefense capital goods spending excluding aircraft, which is considered a good gauge of business investment, fell 1.4% in February, for example, while January's surprise 0.6% gain was revised to a 0.1% loss. Overall, durable goods orders were down 1.4%.

Industrial production inched higher by 0.1% in February, according to a new Federal Reserve report. January's figure was revised lower, however, from a 0.2% increase to a 0.3% decline. For February, manufacturing output fell 0.2%, the Fed said, while mining output dropped 2.5%. Utility output, which tends to be seasonally driven, jumped 7.3%. Industrial production capacity utilization, which was near six-and-a-half year highs in November, fell for the third straight month, dipping 0.2%.

Retail sales declined sharply again in February, falling 0.6%, according to a new report from the Census Bureau. That's just 1.2% higher than they were in the year-ago period. As I noted last month, however, the recent retail sales declines have been led by sharp drop-offs in gasoline station sales. Given the growth in employment and wages recently, the declines may well be a case of consumers not yet spending the money they're saving at the pump, rather than a sign of any sort of economic trouble.

Speaking of job growth, on a positive note, new claims for unemployment moved slightly lower since our last newsletter, and are about 10% below year-ago levels. Continuing claims, the data for which lag new claims by a week, also declined and are about 14% below year-ago levels.

News from the housing market, meanwhile, was very mixed. On the bright side, new home sales jumped 7.8% in February, according to the Census Bureau. That put them nearly 26% above year-ago levels. Median sale prices were 2.6% above where they were a year ago.

Housing starts tumbled 17% in February, however, according to the Census Bureau, putting them about 4% below year-ago levels. But permit issuance for new construction rose 3%, and is about 8% above where it stood a year ago.

Oil prices have been up and down. That has moderated the rebound in gas prices. A gallon of regular unleaded on average cost $2.42 as of March 24, up 11 cents from a month earlier, according to AAA. That's more than 30% below where it was a year ago.

Since our last newsletter, the S&P 500 returned -0.5%, while the Hot List returned 1.3%. So far in 2015, the portfolio has returned 9.3% vs. -0.1% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 253.5% vs. the S&P's 105.5% gain.

Portfolio Update

It's been an up and down fortnight for the broader market, but overall the Hot List has faired pretty well, continuing its strong 2015 performance. As of early trading on Thursday, 6 of the portfolio's 10 holdings were in the black since our last newsletter.

Leading the way was SodaStream International, which was up nearly 11%. The catalyst for the move wasn't clear. SodaStream had been hit hard recently as earnings results showed declining US demand, so the recent gains may be a bounce-back as investors have realized they overreacted to the demand data. The turnaround also coincided with the firm's announcement of a new product, SodaStream Power, which provides touch-button automatic carbonation. It's unclear whether optimism about the new product was involved in the stock's rise, however.

Not far behind SodaStream was Sasol Limited, the South Africa-based energy and chemicals firm. Sasol had been hit hard in recent weeks after the oil price plunge led it to close down significant parts of its operations and change its dividend policy. But it's been on the rebound, with two likely catalysts. First, investors often overreact to bad news, so the recent gains have probably been a natural bounce-back as fears subside a bit. Second, Federal Reserve officials decreased their expectations for how high they will raise interest rates this year. While 15 of the 17 Fed officials said they still expect to raise the benchmark federal funds rate before year-end, most said they expect the rate to be 0.625% by the end of 2015, about half a percentage point lower than they forecast in December, The Wall Street Journal reported. The more-dovish-than-expected comments boosted emerging market equities -- investors have turned to EMs in a quest for yield amid the US's low-rate environment -- and Sasol likely benefited.

On the downside, generic pharmaceutical firm Lannett Company lost close to 6%. Lannett tumbled on March 25 amid a broader sell-off in biotech stocks and other recent market leaders. It wasn't clear exactly why leading stocks were hit so hard that day, though Investor's Business Daily cited the "prospect of rising interest rates in the U.S., weakness in the Chinese economy, the recent rebound in crude oil prices and continued problems in Europe" as possible factors.

Overall, however, it was another solid couple weeks for the Hot List. In two weeks, we'll rebalance the portfolio, and see if the Hot List is continuing its stellar 2015 performance as we move into the second quarter.

Editor-in-Chief: John Reese

Guru Spotlight: Peter Lynch

During the 13 years he headed Fidelity's Magellan fund, Peter Lynch became known for his ability to hone in on rapidly growing companies whose stocks were ready to pop. But while Lynch did indeed love his "fast-growers", he didn't disregard companies growing much more slowly. Lynch had room for them in his portfolio, too.

Because they were lacking in growth, however, "slow-growers" -- stocks of companies growing earnings per share at less than 10% a year over the long term -- had to offer something else for Lynch to take notice. That something else was dividends.

For slow-growers, Lynch wanted a high dividend yield, and the model I base on his approach requires dividend yield to be higher than the S&P 500 average and greater than 3 percent.

Lynch famously developed the PE-to-growth ratio as a way to value stocks, dividing a stock's P/E ratio by its long-term growth rate. His idea was that when a company was producing strong growth, you should be willing to pay a higher multiple for its earnings. For slow-growing stocks, he tweaked the ratio a bit. Since slow-growers often were large firms that paid out nice dividends, he adjusted the "G" portion of the PEG ratio to include dividend yield. For example, consider a stock that has a P/E ratio of 10, EPS growth of 8 percent, and a 4 percent dividend. To find the PEG, you'd divide the P/E (10) by the total of the growth rate and yield (8+4=12). That gives you 10/12 = 0.83 To Lynch, anything under 1.0 indicated that the stock was indeed a good value.

As he did for other stocks, Lynch looked at the inventory/sales ratios of slow-growers, which my Lynch-based model wants to be declining, and the debt/equity ratio, which should be below 80%. (For financial companies, it uses the equity/assets ratio and return on assets rates rather than the debt/equity ratio, since financials typically have to carry a lot of debt as a part of their business.)

The final part of the Lynch strategy includes two bonus categories that apply to all types of stocks: free cash flow/price ratio and net cash/price ratio. Lynch loved it when a stock had a free cash flow/price ratio greater than 35 percent, or a net cash/price ratio over 30 percent. (Lynch defined net cash as cash and marketable securities minus long term debt). Failing these tests doesn't hurt a stock, however, since these are only bonus criteria.

Lynch's slow-grower approach is a great example of the fact that you don't have to target high-growth dynamos to make money in the market. In fact, because so many investors are drawn to stories of explosive growth, oftentimes you can find some great buys among slower growing firms that are getting overlooked. But remember one word of caution Lynch mentioned in his One Up On Wall Street when it came to buying slow-growers: "If you do plan to buy a stock for its dividend, find out if the company is going to be able to pay during recessions and bad times. If a slow grower omits a dividend you're stuck with a difficult situation: a sluggish enterprise that has little going for it. A company with a 20- or 30-year record of regularly raising the dividend is your best bet." He says to avoid over-indebted high-dividend stocks (which my Lynch model should do), and adds that cyclical stocks are not always reliable dividend payers.

With all that in mind, here's a sampling of stocks that pass my Lynch-based model, have dividend yields of at least 3.5%, and have five-year annualized growth rates under 10%. (Note that the PEG ratios listed here are not dividend-yield-adjusted.)

Slow-Growing, High-Dividend Lynch-Based Model Picks (as of March 25)

News about Validea Hot List Stocks

Apple Inc. (AAPL): Apple is preparing a major overhaul of its digital music services that would let it compete directly with streaming services like Spotify, The New York Times reports. Apple is working with engineers and executives from Beats, which it acquired last year, to introduce its own subscription streaming service, the Times said, adding that Apple is also planning an enhanced iTunes Radio service "that may be tailored to listeners in regional markets, and, if Apple gets what it wants, more splashy new albums that will be on iTunes before they are available anywhere else, according to people briefed on the company's plans." According to several music executives, "Apple recently tried but failed to persuade record labels to agree to lower licensing costs that would have let Apple sell subscriptions to its streaming service for $8 a month -- a discount from the $10 that has become standard for services like Spotify, Rhapsody and Rdio," the Times said.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will rebalance the portfolio. If you have any questions, please feel free to contact us at hotlist@validea.com.

Current Portfolio

Detailed Stock Analysis

Disclaimer: The analysis is from Validea's selection and interpretation of content from the guru's book or published writings, and is not from nor endorsed by the guru. See Full Disclaimer

JLL   |   AAPL   |   LCI   |   UVE   |   SODA   |   GTLS   |   SAFM   |   SSL   |   CACC   |   ZUMZ   |  

Jones Lang LaSalle Incorporated (Jones Lang LaSalle), is a financial and professional services firm specializing in real estate. Jones Lang LaSalle has over 200 corporate offices worldwide and operations in more than 1,000 locations in 70 countries. The Company offers integrated real estate and investment management services on a local, regional and global basis to owner, occupier and investor clients. It delivers an array of Real Estate Services (RES) across its three geographic business segments: the Americas, Europe, Middle East and Africa (EMEA), and Asia Pacific. LaSalle Investment Management, a wholly owned member of the Jones Lang LaSalle group that consists of its fourth business segment, is a diversified real estate investment management company. In July 2014, Jones Lang LaSalle Inc acquired CLEO Construction Management (CLEO), a construction project management services firm that specializes in medical facilities.

Apple Inc. designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players and sells a variety of related software, services, peripherals, networking solutions and third-party digital content and applications. The Company's products and services include iPhone, iPad, Mac, iPod, Apple TV, a portfolio of consumer and professional software applications, the iOS and OS X operating systems, iCloud and a variety of accessory, service and support offerings. The Company offers a range of mobile communication and media devices, personal computing products and portable digital music players, as well as a variety of related software, services, peripherals, networking solutions and third-party hardware and software products. The Company's primary products include iPhone, iPad, Mac, iPod, iTunes, Mac App Store, iCloud, Operating System Software, Application Software and Other Application Software.

Lannett Company, Inc. develops, manufactures, packages, markets and distributes solid oral (tablets and capsules), extended release, topical and oral solution finished dosage forms of drugs. The Company also manufactures active pharmaceutical ingredients through its Cody Laboratories, Inc. (Cody Labs) subsidiary. The Company operates pharmaceutical manufacturing plants in Philadelphia, Pennsylvania and Cody, Wyoming. Customers of the Company's pharmaceutical products include generic pharmaceutical distributors, drug wholesalers, chain drug stores, private label distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups, Governmental entities and health maintenance organizations. The Company's products include Levothyroxine Sodium tablets, Digoxin tablets, Butalbital, Cocaine Topical Solution and Morphine Sulfate Oral Solution.

Universal Insurance Holdings, Inc. (UIH) is a vertically integrated insurance holding company. The Company's insurance products are offered to its customers through Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC), (collectively the Insurance Entities). Substantially all aspects of insurance underwriting, distribution and claims processing are covered through the Company's subsidiaries. Blue Atlantic Reinsurance Corporation (BARC), a wholly owned subsidiary of UIH, is a reinsurance intermediary broker. The Insurance Entities generate revenues primarily from the collection of premiums. Universal Risk Advisors, Inc. (URA), the Company's managing general agent, generates revenue through policy fee income and other administrative fees from the marketing of the Insurance Entities' insurance products through its distribution network of independent agents.

SodaStream International Ltd., formerly Soda-Club Holdings Ltd., along with its subsidiaries, is engaged in developing, manufacturing and marketing home beverage carbonation systems and related products. The Company's operational activities are managed by Soda-Club International BV (SCBV), wholly owned subsidiary of Soda-Club Enterprises N.V. (SCNV), whch is the wholly owned subsidiary of the Company. SodaStream manufactures home beverage carbonation systems, which enable consumers to transform ordinary tap water into carbonated soft drinks and sparkling water. The Company's products include soda makers, CO2 refills, flavors and carbonation bottles. In October 2011, the Company acquired CEM Industries S.R.L.

Chart Industries, Inc. is an independent global manufacturer of engineered equipment used in the production, storage and end-use of hydrocarbon and industrial gases. The Company supplies engineered equipment used throughout the global liquid gas supply chain. It operates in three segments: energy and chemicals (E&C), distribution and storage or (D&S), and biomedical. The E&C and D&S segments manufacture products used primarily in energy-related and general industrial applications, such as the separation, liquefaction, distribution and storage of hydrocarbon and industrial gases. Through its BioMedical segment, it supplies cryogenic and other equipment used in the storage and distribution of biological materials and oxygen, used primarily in the medical, biological research and animal breeding industries.

Sanderson Farms, Inc. is a poultry processing company which is engaged in the production, processing, marketing and distribution of fresh and frozen chicken and other prepared chicken items. In addition, the Company is engaged in the processing, marketing and distribution of prepared chicken through its wholly owned subsidiary, Sanderson Farms, Inc. (Foods Division). It produces a range of processed chicken products and prepared chicken items. It sells ice pack, chill pack, bulk pack and frozen chicken, in whole, cut-up and boneless form, under the Sanderson Farms brand name to retailers, distributors, and casual dining operators in the south-eastern, south-western, north-eastern and western United States and to customers who resell frozen chicken into export markets. During the fiscal year ended October 31, 2013 (fiscal 2013), it processed 452 million chickens, or over 3.0 billion dressed pounds.

Sasol Limited (Sasol) is an integrated energy and chemicals company. Sasol mines coal in South Africa and produce natural gas and condensate in Mozambique, oil in Gabon and shale gas in Canada. In South Africa it refines imported crude oil and retail liquid fuels. It has chemical manufacturing and marketing operations in South Africa, Europe, the Middle East, Asia and the Americas. It operates in four segments: South African energy cluster, International Energy Cluster, Chemical Cluster and Other businesses. Effective March 31, 2013, Sasol Olefins & Surfactants sold G.D. Portbury Ltd. On 16 August 2013, Sasol Investment Company (Pty) Limited, a wholly owned subsidiary of Sasol, entered into a definitive sale and share purchase agreement pursuant to which Main Street 1095 (Pty) Limited, completed the acquisition of 100% of the interest of SPI International (Pty) Limited (SPII). SPII is the indirect owner of a 50% interest in the Iranian joint venture, Arya Sasol Polymer Company.

Credit Acceptance Corporation is a provider of financing programs to automobile dealers that enable them to sell vehicles to consumers, regardless of their credit history. The Company's financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing; from repeat and referral sales generated by these same customers; and from sales to customers responding to advertisements. Credit Acceptance has two programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, it advances money to Dealer-Partners (referred to as a Dealer Loan) in exchange for the right to service the underlying Consumer Loans. Under the Purchase Program, Credit Acceptance buys the Consumer Loans from the Dealer-Partners (referred to as a Purchased Loan) and keeps all amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans.

Zumiez Inc. is a multi-channel specialty retailer of action sports related apparel, footwear, accessories and hardgoods, focusing on skateboarding, snowboarding, surfing, motocross and bicycle motocross for young men and women. The Company operates under the names Zumiez and Blue Tomato. The Company operates ecommerce Websites at www.zumiez.com and www.blue-tomato.com. Its apparel offerings include tops, bottoms, outerwear and accessories, such as caps, bags and backpacks, belts, jewelry and sunglasses. Zumiez's footwear offerings primarily consist of action sports related athletic shoes and sandals. Its equipment offerings, or hardgoods, include skateboards, snowboards and ancillary gear, such as boots and bindings. The Company sources its private label merchandise from primarily foreign manufacturers around the world.

Watch List

The Watch List contains the highest scoring stocks according to our guru consensus system that are not currently in the Hot List portfolio. We provide this list both for informational purposes and for investors who are not comfortable with a portfolio of ten stocks.


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