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Executive Summary May 22, 2015

The Economy

Oil prices are on the rise again, but the economy is continuing to feel the impact of the late-2014/early 2015 oil price plunge, with reports coming in quite mixed since our last newsletter.

On the positive side, housing starts surged in April, rising more than 20%, according to the Census Bureau, putting them about 9% above year-ago levels. Permit issuance for new construction jumped more than 10%, and is about 6% above where it stood a year ago.

The April jobs report was also released since our last newsletter, and the data was strong. The private sector added 213,000 jobs during the month, the Labor Department said, with total nonfarm payrolls rising by 223,000. Average hourly wages ticked higher by about 0.1%. The unemployment rate dipped slightly to 5.4%, while the broader "U-6" rate (which unlike the headline number takes into account those working part-time who want full-time work, and discouraged workers who have given up looking for a job) fell to 10.8%.

On the negative side, industrial production fell for the fifth straight month, declining 0.3% in April, according to a new Federal Reserve report. March's loss was, however, revised to 0.3% from initial estimates of 0.6%. But just as in March, the big driver of the decline was utility output, which tends to be seasonally driven. It fell 1.3%. Manufacturing output was flat, with March's gain revised to 0.3% (from 0.1%). Mining output dropped 0.8% in April, with a sharp decline in oil and gas drilling continuing to be the big issue.

After a big increase in March, retail sales were flat in April, according to a new report from the Census Bureau. That's just 0.7% higher than they were in the year-ago period, one of the worst year-over-year increases we've seen in a long time.

On the earnings front, the news remains mixed. With close to 450 of the S&P 500 companies having reported first-quarter earnings, 71% had beaten earnings estimates, but only 45% had beaten sales estimates, according to FactSet.

Gas prices continue to rebound. A gallon of regular unleaded on average cost $2.73 as of May 21, up from $2.46 a month earlier, according to AAA. That's still 25% below where it was a year ago.

Since our last newsletter, the S&P 500 returned 2.1%, while the Hot List returned 1.2%. So far in 2015, the portfolio has returned 13.1% vs. 3.5% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 265.7% vs. the S&P's 113.0% gain.

Portfolio Update

For the most part, it's been another good fortnight for the Hot List. As of mid-day trading on Thursday, 8 of the portfolio's 10 holdings were in the black since our last newsletter.

The biggest winner was real estate operations firm Jones Lang LaSalle, which was up more than 5%. JLL announced that it is purchasing Wilson Retail Group, a leading, independent retail brokerage and capital markets firm in Southern California. JLL said the move will enable it to provide a broader range of brokerage and investment sales services to retailers and investors in a core urban gateway. The transaction closed for an undisclosed sum.

Other solid performers included Chart Industries, Amtrust Financial, ePlus, and Sanderson Farms, which all had gained between 3.4% and 3.8%. Amtrust shares had fallen a bit after its May 5 earnings announcement, despite the fact that it beat earnings estimates, but are now rebounding nicely.

While there were only two losers in the portfolio over the past fortnight, they were significant. World Acceptance was a big laggard, losing 9.9%. Universal Insurance Holdings was the other losing position, falling 4.5%.

As for World Acceptance's plunge, shares started falling around the time the firm announced it had postponed a planned private offering of $250 million in senior notes because "terms could be more favorable in the future." Sounds inconspicuous, so why the 10% tumble? Well, there was some speculation that there may have been more to the postponement than that, with some wondering whether WRLD was having trouble raising capital. It's unclear, but that may have been behind the stock's decline.

Overall, it continues to be a strong year for the Hot List. In two weeks, we will rebalance the portfolio, and check back in on how the current holdings are faring.

Editor-in-Chief: John Reese

Guru Spotlight: Joel Greenblatt

Anyone who has ever put cash in the market knows that making money in stocks is hard. But what a lot of investors don't realize is that while it is difficult, it doesn't have to be complicated. You don't need incomprehensible, esoteric formulas and you don't need to spend every waking hour analyzing stocks -- Joel Greenblatt has proved that.

Back in 2005, Greenblatt created a stir in the investment world with the publication of The Little Book that Beats The Market, a concise, easy-to-understand bestseller that showed how investors could produce outstanding long-term returns using his "Magic Formula" -- a purely quantitative approach had just two variables: return on capital and earnings yield.

Greenblatt's back-testing found that focusing on stocks that rated highly in those areas would have produced a remarkable 30.8 percent return from 1988 through 2004, more than doubling the S&P 500's 12.4 percent return during that period. Greenblatt also posted impressive numbers in his money management experience, with his hedge fund, Gotham Capital, producing returns of 40 percent per year over a span of more than two decades.

Written in an extremely layperson-friendly manner, Greenblatt's "Little Book" -- it's only 176 pages long and small enough to fit in your jacket pocket -- broke investing down into terms even an elementary schooler could understand. In fact, Greenblatt said he wrote the book as a way to teach his five children how to make money for themselves. Using several simple analogies, he explains a variety of stock market principles. One of these he often returns to involves Jason, a sixth-grade classmate of Greenblatt's youngest son who makes a bundle selling gum to fellow students. Greenblatt uses Jason's business as a jumping off point to explain issues like supply, demand, taxation, and rates of return.

In reality, the "Magic Formula" is less about magic than it is about simple, common sense investment theory. As Greenblatt explains, the two-step formula is designed to buy stock in good companies at bargain prices -- something that other great value investors, like Warren Buffett, Benjamin Graham, and John Neff also did. The return on capital variable accomplishes the first part of that goal (buying good companies), because it looks at how much profit a firm is generating using its capital. The earnings yield variable, meanwhile, accomplishes the second part of the task -- buying those good companies' stocks on the cheap. The earnings yield is similar to the inverse of the price/earnings ratio; stocks with high earnings yields are taking in a relatively high amount of earnings compared to the price of their stock.

The Details

To choose stocks, Greenblatt simply ranked all stocks by return on capital, with the best being number 1, the second number 2, and so forth. Then, he ranked them in the same way by earnings yield. He then added up the two rankings, and invested in the stocks with the lowest combined numerical ranking.

The slightly unconventional ways in which Greenblatt calculates earnings yield and return on capital also involve some good common sense -- and are particularly interesting given the recent credit crisis. For example, in figuring out the capital part of the return on capital variable and the earnings part of the earnings yield variable, he doesn't use simple earnings; instead, he uses earnings before interest and taxation. The reason: These parts of the equations should see how well a company's underlying business is doing, and taxes and debt payments can obscure that picture.

In addition, in figuring earnings yield, Greenblatt divides EBIT not by the total price of a company's stock, but instead by enterprise value -- which includes not only the total price of the firm's stock, but also its debt. This give the investor an idea of what kind of yield they could expect if buying the entire firm -- including both its assets and its debts. In the past few months, we've seen how misleading conventionally derived P/E ratios and earnings yields could be, since earnings had been propped up by the use of huge amounts of debt. Greenblatt's earnings yield calculation is a way to find stocks that are producing a good earnings yield that isn't contingent on a high debt load.

In my Greenblatt model, I calculate return on capital and earnings yield in the same ways that Greenblatt lays out in his book.

We added the Greenblatt portfolio to our site in January of 2009, but have been tracking its performance internally for several years before that. So far, the model has been a strong performer, with some big ups and downs. Since we began tracking our 10-stock Greenblatt-based portfolio in late 2005, the S&P 500 has gained just 68%; the Greenblatt-based portfolio has gained 137.6% -- that's 9.6% annualized, vs. 5.6% annualized for the S&P (all performance data through May 20). The portfolio beat the market in 2006 and 2007, and then did what few funds have done: limit losses in what for stocks was a terrible 2008, and handily beat the market in the 2009 rebound. It fell 26.3% in '08 -- not good, but much better than the S&P 500's 38.5% loss -- and surged 63.1% in 2009, vs. 23.5% for the S&P. After beating the market again in 2010, it struggled in 2011 and 2012. Those ups and downs are proof of what Greenblatt stresses: that the strategy won't beat the market every month or even every year, which is important to remember. In fact, during that stellar 17-year period he covered in his book, there were even times when it lagged the market for three straight years. But that, he says, is why it works over the long haul: Undisciplined investors bail on the strategy, allowing those who stick with it to pick up the exceptional bargains they leave behind.

Indeed, in 2013, the Greenblatt-based portfolio bounced back strong, returning more than 50%. Last year it struggled, losing 2.2%, but this year it's my best individual Guru Strategy performer, having gained 12.2%. Below is a look at its current holdings.

One note: Because of the way financial and utility companies are financed (i.e. with large amounts of debt), Greenblatt excludes them from his screening process, so I do the same. He also doesn't include foreign stocks, so I exclude those from my model as well.

Gilead Sciences (GILD)
Chicago Bridge & Iron Company (CBI)
Pilgrim's Pride Corp. (PPC)
AOL, Inc. (AOL)
King Digital Entertainment (KING)
H&R Block Inc. (HRB)
GameStop Corp. (GME)
Discovery Communications Inc. (DISCA)
Murphy USA (MUSA)
Valero Energy Corp. (VLO)

News about Validea Hot List Stocks

Lannett Company, Inc. (LCI): Lannett announced that it has signed a definitive agreement to acquire privately-held Silarx Pharmaceuticals, Inc. and a related real estate entity. Silarx makes liquid pharmaceutical products, including generic prescription and over-the-counter products. It has received approval in the U.S. to market a generic version of Epivir, the patent on which expires in September 2018. Silarx also manufactures loratadine oral solution, the generic version of Claritin; citalopram oral solution, the generic version of Celexa; and fluoxetine oral solution, the generic version of Prozac. Lannett said the acquisition will provide it access to an FDA-approved manufacturing facility along with research and development expertise.

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   |   AFSI   |   UVE   |   SAFM   |   GTLS   |   TBI   |   PLUS   |   CACC   |   WRLD   |   LCI   |  

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.

Amtrust Financial Services, Inc., (AmTrust) is a provider of property and casualty insurance. The Company operates in four business segments: small commercial business, Specialty Risk and Extended Warranty, specialty program and personal lines reinsurance. Small Commercial Business segment provides workers' compensation to small businesses. The Company's Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages. The Company's Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance. The Company subsidiaries include: Technology Insurance Company, Inc. (TIC), Rochdale Insurance Company (RIC), AmTrust Insurance Company of Kansas, Inc. (AICK), AmTrust Lloyd's Insurance Company of Texas (ALIC), Oryx Insurance Brokerage, Inc. and TMI Solutions, LLC.

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.

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.

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.

TrueBlue, Inc., is a provider of temporary blue-collar staffing. The Company provides blue-collar staffing services to industries that include construction, manufacturing, transportation, aviation, waste, hospitality, retail, energy, and many more. The Company has a network of 757 branches in all 50 states, Puerto Rico and Canada. The Company operates as labor ready for general labor through Spartan Staffing for light industrial, CLP Resources for skilled trades, PlaneTechs for aviation and transportation mechanics and technicians, and Centerline Drivers for drivers. The Company's service lines include Providing blue-collar temporary labor services; serve customers who have a need for temporary staff to perform blue-collar tasks which do not require a permanent employee; build a temporary workforce through recruiting, screening and on-boarding. Temporary workers are dispatched to customers where they work under the supervision of its customers.

ePlus inc. (ePlus) along with its subsidiaries design, implement and provide provide leading information technology (IT) products and services, flexible leasing and financing solutions, and enterprise supply management to enable its customers to optimize their IT infrastructure and supply chain processes. They are focused primarily on specialized IT segments including data center infrastructure, networking, security, cloud and collaboration. Its solutions incorporate hardware and software products from multiple leading IT vendors, as well as third party services, maintenance and software assurance on the hardware and software products. The Company operates in two segments: technology segment and financing segment. Technology segment includes sales of information technology products, third-party software, third-party maintenance, advanced professional and managed services. Its financing segment consists of the financing of IT equipment, software.

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.

World Acceptance Corporation operates a small-loan consumer finance business in fourteen states and Mexico. The Company is engaged in the small-loan consumer finance business, offering short-term small loans, medium-term larger loans, related credit insurance and ancillary products and services to individuals. The Company offers standardized installment loans of between $300 and $4,000 through 1,271 offices in Alabama, Georgia, Illinois, Indiana, Kentucky, Louisiana, Mississippi, Missouri, New Mexico, Oklahoma, South Carolina, Texas, Tennessee, Wisconsin and Mexico as of March 31, 2014. The Company serves individuals with limited access to consumer credit from banks, credit unions, other consumer finance businesses and credit card lenders. In the United States offices, the Company also offers income tax return preparation services to its customers and others.

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.

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.


The names of individuals (i.e., the 'gurus') appearing in this report are for identification purposes of his methodology only, as derived by Validea.com from published sources, and are not intended to suggest or imply any affiliation with or endorsement or even agreement with this report personally by such gurus, or any knowledge or approval by such persons of the content of this report. All trademarks, service marks and tradenames appearing in this report are the property of their respective owners, and are likewise used for identification purposes only.

Validea is not registered as a securities broker-dealer or investment advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Validea is not responsible for trades executed by users of this site based on the information included herein. The information presented on this website does not represent a recommendation to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment. The information on this website is generic by nature and is not personalized to the specific situation of any individual. The user therefore bears complete responsibility for their own investment research and should seek the advice of a qualified investment professional prior to making any investment decisions.

Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. Past performance is not necessarily indicative of future results. Individual stocks mentioned throughout this web site may be holdings in the managed portfolios of Validea Capital Management, a separate asset management firm founded by Validea.com founder John Reese. Validea Capital Management, which is a separate legal entity and an SEC registered investment advisory firm, uses, in part, the strategies on the web site to select stocks for its clients.