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Executive Summary September 4, 2009

The Economy

While the market has taken a break from its nearly six-month rise, several pieces of very positive economic data have emerged since our last newsletter.

Foremost among those encouraging data points may have been the Institute for Supply Management's latest manufacturing index reading, which showed that the U.S. manufacturing sector expanded in August -- the first time it has done so in more than a year-and-a-half.

In another sign that the recession might finally be over, new factory orders jumped 1.3% in July, the Commerce Department reported, marking the fourth straight month orders have increased. The housing market also featured another encouraging trend, with pending home sales increasing in July for the sixth straight month -- the first time that has happened since the National Association of Realtors began tracking the index in 2001. The Realtor group's pending home sales index is now at its highest level since June 2007, and its existing home sales index is also showing signs that we may have hit a bottom in the housing market. The existing sales index rose in July for the fourth straight month, posting the biggest increase it has made in its 10-year history. It was also the first month in which the index was higher, year-over-year, since late 2005.

The bad news is that, while economic production and home-buying are on the rise, unemployment doesn't yet seem to be abating. Unemployment claims fell slightly in the week ending August 29, but the prior week's claim totals were readjusted upward by about the same amount. And, while ISM's manufacturing index showed an expansion in August, the group also said the manufacturing sector likely won't be adding a significant number of jobs in the short term. It appears the recent uptick in production is due to increased productivity, not hirings -- the Labor Department reported this week that productivity increased more than initially thought in the second quarter, with the 6.6% gain the highest jump in productivity in almost six years.

While the economic reports were, on the whole, fairly strong over the past fortnight, the market scuffled. And a big reason why was the financial sector. The FDIC reported last week that the number of banks on its "problem" list rose to 416 in the second quarter, up more than 30% from end-of-first-quarter levels. It was the highest that figure had been in 15 years. That news -- and, according to the Associated Press, rumors that a major bank might be on the verge of failure -- held the market back, with the S&P 500 falling 0.4%, while the Hot List fell 2.2%. For the year, the portfolio remains well ahead of the index, having gained 29.1% vs. the S&P's 11.1% increase. And since its inception more than six years ago, the Hot List is up 111.7% while the S&P is up 0.3%.

Big Changes

The Hot List is making a major shake-up this week. It's selling off six of its holdings, including five of the six stocks it added last month. Those five stocks -- Allegiant Travel Company (ALGT), Astec Industries (ASTE), Lloyd's Banking Group (LYG), Marathon Oil (MRO), and Sociedad Quimica y Minera de Chile (SQM) -- have all lost ground since joining the portfolio. Another of the departing stocks -- Fuqi International (FUQI) -- has been a standout, however, gaining about 56% since the Hot List picked it up back in mid-June.

Joining the portfolio this month are a wide variety of companies, including a financial (Tower Group); a clothing retailer (Aeropostale); an aerospace & defense firm (General Dynamics); a Chinese I/T services provider (VanceInfo Technologies); and an oil services company (World Fuel Services).

While those additions mean the portfolio is quite diversified, spanning five sectors and even more industries, one area it is continuing to find a good number of values in is energy stocks. In addition to World Fuel Services, the portfolio's holdovers include Chevron and Frontier Oil Corporation.

A driving force in the portfolio continues to be Jos. A. Bank Clothiers. The men's retailer surged another 20% these past two weeks as it reported strong earnings, and is now up more than 90% since the portfolio snatched it up in late February.

A Contrarian's View

With stocks cooling over the past few weeks, some are wondering whether the market has the juice to push forward. And, to be sure, there are legitimate concerns moving forward about both the economy and the stock market. Skyrocketing government debts, corporate and consumer deleveraging, the threat of major inflation that top strategists like Warren Buffett and John Paulson have been warning about -- these are all issues that are weighing heavily on investors now.

Can the economy and market overcome these challenges? I believe they can. As something of a contrarian at heart, I feel that the economy -- an incredibly complex machine -- often acts contrary to our reasonable expectations. For instance, many people think that the U.S.'s massive trade deficits hurt the economy and portend bad news for the stock market. But the reality is that over the decades that economists have been following the trade deficits, the stock market hasn't cared much about those deficits; the economy has had good times and bad times, and they have not correlated with the trade deficit.

In the same way, while it's reasonable to think that a fast-growing national debt will quash the growth in the economy and be a drag on the stock market, decades of history don't support that notion. In fact, you could make a case for the opposite being true in the past -- that massive increases in government debt actually provided fuel to the economy and to the stock market. To be fair, this surge in government debt is different from many past instances in that most of this debt is not being used to purchase things and stimulate the economy, but instead to shore up financial companies' balance sheets. Nevertheless, in the end I think the huge buildup of debt will not by itself weigh down the stock market.

But what about inflation? Given all of the money pumped into the global economy in the past year, it seems likely we're headed for a period of at least moderate inflation, and conventional wisdom seems to hold that inflationary climates make bad times for stocks.

Well, in this case, conventional wisdom may again be misleading. In fact, a study performed by two Harvard economists, John Campbell and Tuomo Vuolteenaho, found that from 1927 to 2002, earnings and inflation tended to move up and down together -- meaning that stocks appear to actually be a good hedge against inflation. "When inflation is high and rising, companies are able to raise prices and hence fatten their bottom line," MarketWatch's Mark Hulbert explained in highlighting the study. "By the same token, when inflation is low, firms' pricing power is correspondingly low." This is similar to what David Dreman, one of the gurus upon whose writings I base my strategies, found.

There are other fears out there in the market as well -- fears of the impact of tax hikes, entitlement programs that could run out of money, and massive healthcare changes. But in the end I think all of those will turn out to be overblown. Federal tax hikes represent a 1% -5% increase, but won't start for a couple years. Fears of entitlement programs going bankrupt, meanwhile, have been a recurring problem for decades, not something new. And we've all seen in recent weeks that there is huge resistance to major healthcare reforms among the American public and members of Congress; if health reform does come, it likely will be gradually phased in.

Now, all of this is not to say that the coming years will be all sunshine and roses for the market and the U.S. economy. There no doubt will be tough times and tough choices for the American public, and investors. But the market and economy are resilient animals; they've made it through wars, depressions, crises of confidence, and much more. I'm confident that they'll make their way through the current issues dogging them, and, as they do, those who've bet against stocks will end up missing out.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 6 stocks leave our portfolio. These include: Astec Industries, Inc. (ASTE), Sociedad Quimica Y Minera (Adr) (SQM), Lloyds Banking Group Plc (Adr) (LYG), Marathon Oil Corporation (MRO), Allegiant Travel Company (ALGT) and Fuqi International, Inc. (FUQI).

The Keepers

4 stocks remain in the portfolio. They are: Jos. A. Bank Clothiers, Inc. (JOSB), Frontier Oil Corporation (FTO), Chevron Corporation (CVX) and Capella Education Company (CPLA).

The Newbies

We are adding 6 stocks to the portfolio. These include: General Dynamics Corporation (GD), Sturm, Ruger & Company (RGR), World Fuel Services Corporation (INT), Aeropostale, Inc. (ARO), Tower Group, Inc. (TWGP) and Vanceinfo Technologies Inc. (VIT).

Portfolio Changes

Newcomers to the Validea Hot List

Aeropostale (ARO): This mall-based clothing retailer targets youngsters age 14 to age 17 through more than 900 stores in 49 states, Puerto Rico, and Canada. Its new P.S. from Aeropostale stores also are aimed at 7- to 12-year-old youngsters. In the past year, the $2.6 billion market cap firm has raked in more than $2 billion in sales. Aeropostale has an impeccable earnings history, upping earnings per share in every year of the past decade. It's at it again this year, with EPS and sales rising in each quarter so far in 2009.

Aeropostale gets approval from three of my Guru Strategies, those I base on the approaches of Peter Lynch, Warren Buffett, and James O'Shaughnessy. Check the "Detailed Stock Analysis" section below to find out why.

General Dynamics Corporation (GD): This Virginia-based firm is one of the U.S.'s largest aerospace & defense firms, making battle tanks and assault vehicles, armaments and munitions, battleships and nuclear submarines, and military information technology systems. It has a $22.4 billion market cap, and $31.4 billion in trailing 12-month sales.

General Dynamics is one of the highest rated stocks in the market right now according to my strategies. It gets approval from four of my models, including those based on the approaches of Peter Lynch, Warren Buffett, Joel Greenblatt, and Kenneth Fisher. See the "Detailed Stock Analysis" section below to learn why.

Tower Group, Inc. (TWGP): Based in New York City, this small-cap ($954 million) offers specialized property and casualty insurance to businesses and individuals. It's upped EPS in seven straight years, and over the past year has taken in more than $720 million in sales.

Tower gets approval from my Peter Lynch-, Martin Zweig-, and James O'Shaughnessy-based strategies. The "Detailed Stock Analysis" section below explains why.

VanceInfo Technologies (VIT): Based in Beijing, this I/T service provider was the first Chinese software development outsourcer listed on the New York Stock Exchange. It provides service to firms in technology, telecommunications, financial services, manufacturing, and retail & distribution arenas. It's a small-cap ($506 million market cap), but its 2008 revenues ranked number one among Chinese-based offshore software development service providers for the North American and European markets, according to International Data Corporation.

VanceInfo gets very good "some interest" scores from two of my toughest growth stock models, my Martin Zweig-based approach and my Motley Fool-based method. To see why, check out the "Detailed Stock Analysis" section below.

World Fuel Services Corp. (INT): Based in Miami, World Fuel provides fuel and services to aircraft, petroleum distributors, and ships at more than 2,500 locations around the world. It has 43 offices in 23 countries across five different continents. Its market cap is about $1.3 billion, and it has brought in almost $13 billion in sales over the past 12 months.

World Fuel is making its third appearance in the Hot List this year. It gets approval from my Peter Lynch- and James O'Shaughnessy-based approaches. To see why those strategies like the stock, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Jos. A. Bank Clothiers (JOSB): Bank hit a 52-week high after reporting a 40% gain in profit in its second quarter, the Associated Press reported Wednesday. Bank posted earnings of 68 cents per share, topping analysts' estimates of 54 cents per share.

Aeropostale (ARO): Aeropostale said that same-store sales rose 9% in August, exceeding the 7.1% rise analysts expected, the Associated Press reported Thursday. For the four-week period ended Aug. 29, total sales rose 16%, and are up 20% for the year, AP reported, adding that Aeropostale upped its third-quarter earnings guidance.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will examine one of my individual Guru Strategies in greater depth. 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

JOSB   |   TWGP   |   INT   |   RGR   |   VIT   |   GD   |   FTO   |   CPLA   |   ARO   |   CVX   |  

Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, retailer and direct marketer (through stores, catalog and Internet) of men's tailored and casual clothing and accessories. It sells all of its products exclusively under the Jos. A. Bank label through its 460 retail stores (as of January 31, 2009, which includes seven outlet stores and 12 franchise stores) located throughout 42 states and the District of Columbia in the United States, as well as through the Company's nationwide catalog and Internet (www.josbank.com) operations. Its products are targeted at the male career professional and emphasize the Jos. A. Bank brand of tailored and casual clothing and accessories. The Company's products, which range from the original Jos. A. Bank Executive collection to the more luxurious Jos. A. Bank Signature collection to the exclusive Jos. A. Bank Signature Gold collection. Jos. A. Bank operates through two segments: Stores and Direct Marketing.

Tower Group, Inc. (Tower), through its subsidiaries, is engaged in offering a range of specialized property and casualty insurance products and services to businesses and to individuals primarily in the Northeast, Florida, Texas and California. The Company provide coverage for many different market segments, including nonstandard risks that do not fit the underwriting criteria of standard risk carriers due to factors, such as type of business, location and premium per policy. It provides on both an admitted and excess and surplus lines basis, commercial lines products comprised of commercial package, general liability, workers' compensation, commercial auto and commercial umbrella policies to businesses such as residential and commercial buildings, retail and wholesale stores, food service and restaurants, artisan contractors and garage automotive services. The Company also provide personal lines products that insure homes and dwellings, as well as personal automobiles.

World Fuel Services Corporation is engaged in the marketing and sale of marine, aviation and land fuel products and related services on a worldwide basis. The Company operates in three segments: marine, aviation and land. In its marine segment it offers fuel and related services to maritime customers, including international container and tanker fleets, commercial cruise lines and time-charter operators. In its aviation segment, it offers fuel and related services to major commercial airlines, second and third-tier airlines, cargo carriers, regional and low-cost carriers, corporate fleets, fractional operators, private aircraft, military fleets. In its land segment, it offers fuel and related services to petroleum distributors operating in the land transportation market. In June 2008, it acquired certain assets of Texor Petroleum Company, Inc. In April 2009, the Company acquired the Henty Oil Group of Companies.

Sturm, Ruger & Company, Inc. is principally engaged in the design, manufacture and sale of firearms to domestic customers. The Company's design and manufacturing operations are located in the United States and substantially all product content is domestic. The Company offers products in four industry product categories: rifles, shotguns, pistols and revolvers. Its firearms are sold through a select number of independent wholesale distributors, principally to the commercial sporting market. The Company manufactures and sells investment castings made from steel alloys for both outside customers and internal use in the firearms segment. Approximately 96% of the Company's total sales for the year ended December 31, 2008, were from the firearms segment, and approximately 4% were from investment castings.

VanceInfo Technologies Inc. is an information technology (IT) service provider and one of the offshore software development companies in China. The Company's range of IT services includes research and development services (R&D services), enterprise solutions, application development and maintenance (ADM), quality assurance and testing, as well as globalization and localization. It provides these services primarily to corporations headquartered in the United States, Europe, Japan and China, targeting industries, such as technology, telecommunications, financial services, manufacturing, retail and distribution. The Company operates a range of offshore development centers in China (CDCs). Its major clients include Microsoft, IBM, Huawei, TIBCO, and a European mobile handset manufacturer. In July 2009, the Company acquired the operating subsidiaries of TP Corporation Limited (TP), a provider of customer relationship management (CRM) solutions and call center services.

General Dynamics Corporation (General Dynamics) offers a portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; shipbuilding design and construction, and information systems, technologies and services. The Company focuses on delivering products and services to military, federal government, commercial and international customers. General Dynamics operates through four business groups: Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. On December 19, 2008, the Company acquired AxleTech International (AxleTech), a manufacturer and supplier of axles, suspensions, brakes and aftermarket parts for heavy-payload vehicles for a variety of military and commercial customers. On November 5, 2008, it acquired Jet Aviation of Zurich, Switzerland. On July 23, 2008, it acquired HSI Electric, Inc. (HSI), a marine and industrial electrical company. On July 22, 2008, the Company acquired ViPS, Inc. (ViPS).

Frontier Oil Corporation (Frontier) is an independent energy company engaged in crude oil refining and the wholesale marketing of refined petroleum products. The Company operates refineries (the Refineries) in Cheyenne, Wyoming and El Dorado, Kansas with a total annual average crude oil capacity of approximately 182,000 barrels per day (bpd). Frontier's Cheyenne Refinery has a permitted crude oil capacity of 52,000 bpd on a 12-month average. The Company markets its refined products primarily in the eastern slope of the Rocky Mountain region, which encompasses eastern Colorado (including the Denver metropolitan area), eastern Wyoming and western Nebraska (the Eastern Slope). The Cheyenne Refinery has a coking unit, which allows the refinery to process amounts of heavy crude oil for use as a feedstock. During the year ended December 31, 2008, heavy crude oil constituted approximately 76% of the Cheyenne Refinery's total crude oil charge.

Capella Education Company, is an online postsecondary education services company. Through its wholly owned subsidiary, Capella University (the University), the Company offers a variety of bachelor's, master's and doctoral degree programs primarily delivered to working adults. At December 31, 2008, Capella Education Company offered over 1,020 online courses and 22 academic programs with 111 specializations to approximately 26,800 learners. The Company also offers certificate programs, which consist of a series of courses focused on a particular area of study. In addition, Capella Education Company offers academic services, such as advising, writing and research services; administrative services, such as online class registration and transcript requests; library services; financial aid counseling and career counseling services.

Aeropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. The Company designs, markets and sells its own brand of merchandise principally targeting 14 to 17 year-old young women and young men. The Company also sells Aeropostale merchandise through its e-commerce Website, www.aeropostale.com. As of January 31, 2009, it operated 914 stores, consisting of 874 Aeropostale stores in 48 states and Puerto Rico, 29 Aeropostale stores in Canada, and 11 Jimmy'Z stores in 10 states. The Company locates its stores primarily in shopping malls, outlet centers and, to a much lesser degree, lifestyle and off-mall shopping centers. The Company has developed a new retail store concept called P.S. from Aeropostale, which will offer casual clothing and accessories focusing on elementary school children between the ages of seven and 12. It offers a focused collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, outerwear and accessories.

Chevron Corporation (Chevron) manages its investments in subsidiaries and affiliates, and provides administrative, financial, management and technology support to the United States and International subsidiaries that engage in fully integrated petroleum operations, chemicals operations, mining operations of coal and other minerals, power generation and energy services. Exploration and production (upstream) operations consist of exploring for, developing and producing crude oil and natural gas, and also marketing natural gas. Refining, marketing and transportation (downstream) operations relate to refining crude oil into finished petroleum products; marketing crude oil and the many products derived from petroleum, and transporting crude oil, natural gas and petroleum products by pipeline, marine vessel, motor equipment and rail car. In April 2009, Reliance Industries Limited bought back Chevron Corporation's 5% stake in Reliance Petroleum Limited.

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.

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