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Executive Summary February 28, 2014

The Economy

Weather, or not? When it comes to the economy, that's the big question on investors' minds right now -- that is, just how much of the weak recent economic data is a result of the dreadful winter weather, and how much is due to a deeper slowdown?

One area of weakness has been industrial production, which fell 0.3% in January, according to a Federal Reserve report. Manufacturing output fell 0.8% during the month, though the Fed report said that was at least partly due to severe weather. Mining output fell 0.9%, and utility output increased 4.1%, thanks to the cold temperatures. While the January data may have been skewed by weather, the Fed report also said that fourth-quarter industrial production increased less than previously estimated, rising at a 4.6% pace rather than the previously cited 6.2% figure.

Retail and food service sales, meanwhile, also declined, falling 0.4% in January. A big chunk of that was the result of a significant decline in auto sales, which would seem to jive with the bad-weather thesis. Compared to the same month a year ago, total retail and food service sales were up 3.0%.

Housing starts fell sharply in January, declining 16.0%, according to the Census Bureau. Again, it would stand to reason that the major snowfalls across many regions of the country impacted that. But permit issuance for new construction also declined, by 5.4%. Both permit issuance and housing starts are within 1% of their year ago levels.

The Census Bureau also said, however, that new home sales rose nearly 10% in January, reaching their highest level in more than five years. The median sales price was 3.4% above year ago levels. But, according to the National Association of Realtors, existing home sales fell 5.1% during the month, putting them 3.4% below their year ago pace. Sales prices for existing homes remains well ahead of their year ago pace, however, with January's median sales price 10.7% above January 2013's median price.

As for the jobs market, new claims for unemployment rose just slightly over the past two weeks. There are now about the same as they were a year ago. Continuing claims, the data for which lags new claims by one week, were also barely changed since our last newsletter. They are 4.3% below where they stood a year ago.

In the corporate sector, good news has been rolling in. With all but 29 of the S&P 500 companies reporting, analysts estimate earnings grew by 8.6% in the fourth quarter, according to Bloomberg, significantly higher than many had expected. About 70% of firms had beaten analysts' estimates, Bloomberg said.

Since our last newsletter, the S&P 500 returned 1.3%, while the Hot List returned 3.7%. So far in 2014, the portfolio has returned -5.4% vs. 0.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 244.1% vs. the S&P's 85.4% gain.

Portfolio Update

While the broader market has had a fairly uneventful fortnight, the Hot List has gained some ground on it, led by a couple of very big gainers.

Leading the way has been BofI Holding, the San Diego-based Internet banking small cap, which has surged 14% since our last newsletter (performance figures as of late morning on Feb. 27). The stock seems to still be carrying momentum from its Feb. 5 earnings announcement. It reported second fiscal quarter (ended December 31) net income of $13.2 million -- a record for the firm -- up 34.7% over net income of $9.8 million for the year-ago quarter. Earnings attributable to BofI's common stockholders were $13.1 million or $0.91 per diluted share, up 38.6% from $9.4 million ($0.70 per diluted share) for the year-ago quarter. Core earnings, which exclude the after-tax impact of gains and losses associated with the firm's securities portfolio, were up 36.8% to $13.8 million.

BofI's surge also may have been impacted by a Feb. 13 regulatory filing disclosing that Renaissance Technologies, the hedge fund founded by well known investor James Simons, has a 5.3% stake in the company.

The other Hot List holding making a big upward move has been HCI Group. The Florida property & casualty insurer was up nearly 10% since our last newsletter, with a few possible catalysts. HCI was upgraded from Market Perform to Market Outperform by JMP Securities, according to Street Insider. It also announced that it plans to voluntarily delist its 7% Series A, cumulative redeemable preferred shares from the NASDAQ Capital Market. It anticipates that will help result in enough preferred share conversions to common shares to push the number of preferred shareholders below the number necessary to maintain a listing on the NASDAQ Capital Market. Finally, and perhaps most likely, HCI may simply be experiencing a bounce-back after some rough sledding earlier this year, as investors realize the stock has been hit too hard.

Only one Hot List holding had a difficult fortnight -- Russian oil giant Lukoil. The stock was down 4.6%, likely a result of the ongoing turmoil in Ukraine. Russia supported Ukraine's deposed president, and it seems investors fear that oil and gas could become a tool used by both countries to exert their will over the other. The impact could be felt both because Russia is a major supplier of energy to the Ukraine, and because a chunk of its exports to Europe are transported through Ukraine. The situation seems to be shifting every day, and is one to keep an eye on.

Two weeks from now, at our regularly scheduled rebalancing, we'll see if Lukoil and the Hot List's other holdings will have what it takes to remain in the portfolio.

Editor-in-Chief: John Reese

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Guru Spotlight: Benjamin Graham

Today, many investors look to Warren Buffett for advice about the stock market and the economy. But before he became one of the world's richest men and greatest investors, there was someone whose investment advice Buffett himself cherished: Benjamin Graham. And Buffett was far from alone. Known as "The Father of Value Investing", Graham inspired a number of famous "sons" -- Mario Gabelli, John Neff, John Templeton, and, most famously, Buffett are all Graham disciples who went on to their own stock market greatness.

So, just who was Graham? Born in England in 1894 as Benjamin Grossbaum (his family later changed its surname to Graham during World War I, when German names were viewed with suspicion), Graham built his reputation -- and fortune -- by using an extremely conservative, low-risk approach to investing. To him, preserving one's original capital was every bit as important as netting big gains, and two factors from his early years may show why. The first was Graham's own family's fall from financial comfort to poverty not long after his father died when he was nine. The second involved his first major business venture, an investment firm he founded with Jerome Newman. Just three years after opening, the stock market crash of 1929 and the Great Depression arrived. Graham's clients, like just about everyone else, were hit hard, according to Graham biographer Janet Lowe, and Graham worked without compensation for five years until his clients' fortunes were fully restored.

Having lived through both his own family's financial troubles and the market crash, it's no surprise that the strategy Graham laid out in his classic book The Intelligent Investor was a conservative, loss-averse approach. To Graham, an investment wasn't something that could be turned into quick, easy profits; anything that offers such "easy" rewards also comes with substantial risk, and Graham abhorred risk. True "investment", he wrote, deals with the future "more as a hazard to be guarded against than as a source of profit through prophecy."

In terms of specifics, Graham's "Defensive Investor" approach limited risk in a number of ways, and my Graham-based model lays out several of those methods. For example, one key criterion is that a firm's current ratio -- that is, the ratio of its current assets to its current liabilities -- is at least two, showing that the firm is in good financial shape. The approach also targets financially sound firms by requiring that long-term debt not exceed net current assets. Two other criteria the Graham method uses to find low-risk plays: the price/earnings ratio and the price/book ratio. Graham wanted P/E ratios to be no greater than 15 (and, as another signal of his conservative style, he looked not only at trailing 12-month earnings but also at three-year average earnings, to ensure that one-year anomalies didn't skew the P/E ratio). For the price/book ratio, he used a more unusual standard: He believed that the P/E ratio multiplied by the P/B ratio should be no greater than 22.

My Graham-inspired strategy tends to find bargains across a variety of areas of the market, though right now it has a fairly high concentration in the energy sector. Here are the current holdings of the 10-stock Graham portfolio:

HollyFrontier Corp. (HFC)
National-Oilwell Varco (NOV)
Sears Hometown and Outlet Stores, Inc. (SHOS)
Coach, Inc. (COH)
AGCO Corporation (AGCO)
Sasol Limited (SSL)
Big Lots, Inc. (BIG)
The Buckle, Inc. (BKE)
Compania de Minas Buenaventura SAA (BVN)
Chevron Corporation (CVX)

Two types of stocks that you won't find in the Graham portfolio are technology and financial firms. Graham excluded tech stocks from his holdings because they were too risky, and, while they're not as risky today, I do the same. Financial stocks, meanwhile, aren't explicitly excluded from my Graham model. But because of the low-debt requirements in this strategy, it's nearly impossible for a financial firm to garner approval. Since I started tracking my Guru Strategies nearly 10 years ago, the performance of my Graham-based model has been rather remarkable. Even though the strategy Graham outlined is now more than 60 years old, it just keeps on working. Through Feb. 25, the 10-stock Graham-based portfolio was up 365.4% since its July 2003 inception, making it one of my best 10-stock performers. That's a 15.6% annualized return in a period in which the S&P 500 has gained just 5.9% per year. The model's strict balance sheet criteria helped it avoid big losers in 2008, as the portfolio lost less than half of what the broader market lost, and it rebounded big in 2009 and 2010, gaining 31.4% in '09 and 22.6% in '10. In 2011, it had its worst year, however, falling 19.0% while the broader market was flat. It rebounded nicely, though, gaining 33.8% in 2012 and 41.4% in 2013.

The 20-stock Graham-based portfolio I track has been even better. In fact, it's the best performer of any of my 10- or 20-stock portfolios, having returned 421.0% since its July 2003 inception -- that's 16.8% per year.

The Graham portfolios' long-term results are a great demonstration of how successful stock investing doesn't need to be incredibly complex or cutting-edge. You don't need fancy theories or gimmicks; you just need to focus on good companies whose stocks are selling at good values. Do that, and you should produce some strong results of your own.

News about Validea Hot List Stocks

Lukoil (LUKOY): The Russian firm has stopped oil supplies to the Odessa refinery in Ukraine, ITAR-TASS news agency reported on Feb. 26. Two days earlier, the refinery's director tendered resignation and its executive director and other top managers also walked out, according to ITAR-TASS. Russia's support of Ukraine's deposed president have led to tensions between the two countries -- on Feb. 25, Reuters said Ukraine's state oil and gas company slashed gas imports from Russia in February, and said Russian leaders had hinted that gas prices it charges Ukraine could rise.

HollyFrontier Corporation (HFC): HollyFrontier reported fourth quarter net income attributable to stockholders of $62.9 million or $0.31 per diluted share, down from $391.6 million or $1.92 per diluted share in the year ago period, thanks in large part to lower refining margins. For the full 2013 year, net income attributable to HollyFrontier stockholders was $735.8 million or $3.64 per diluted share, down from $1,727.2 million or $8.38 per diluted share in 2012. Fourth quarter revenues were about $4.8 billion, down from about $5.1 billion a year earlier. Full year revenues were about $20.2 billon, up slightly from $20.1 billion in 2012. The quarterly revenue and net income results both beat analysts expectations.

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

HCI   |   BOFI   |   AGCO   |   PRXL   |   HFC   |   TBI   |   CEO   |   LUKOY   |   USNA   |   ROST   |  

HCI Group Inc, formerly Homeowners Choice, Inc., is a holding company. The Company, through its subsidiaries, is engaged in the property and casualty insurance business. Through Homeowners Choice Property & Casualty Insurance Company, Inc. (HCPC) and subsidiaries, primarily Homeowners Choice Managers, Inc. (HCM), Southern Administration, Inc., Claddaugh Casualty Insurance Company, Ltd., and its subsidiary, HCPCI Holdings LLC, it provides property and casualty homeowners' insurance, condominium-owners' insurance and tenants' insurance to individuals owning property in Florida. Its subsidiaries also include TV Investment Holdings LLC, which owns and operates a marina facility located in Florida; Unthink Technologies Private Limited. During the year ended December 31, 2011, it organized TV Investment Holdings LLC, HCI Holdings LLC and HCI Technical Resources, Inc.

BofI Holding, Inc. is a holding company for BofI Federal Bank, a diversified financial services company. The Bank operate its bank from a single location in San Diego, California, serving approximately 40,000 retail deposit and loan customers across all 50 states. As of June 30, 2012, it had total assets of $2,386.8 million, loans of $1,799.7 million, mortgage-backed and other investment securities of $483.0 million, total deposits of $1,615.1 million and borrowings of $547.2 million. It distributes its deposit products through a range of retail distributions channels, and its deposits consist of demand, savings and time deposits accounts. It distributes its loan products through its retail, correspondent and wholesale channels, and the loans it retains are primarily first mortgages secured by single family real property and by multifamily real property.

AGCO Corporation (AGCO) is a manufacturer and distributor of agricultural equipment and related replacement parts globally. The Company sells a range of agricultural equipment, including tractors, combines, self-propelled sprayers, hay tools, forage equipment and implements. It also manufactures and distributes grain storage and handling equipment systems, as well as protein production systems. Its products are recognized in the agricultural equipment industry and are marketed under a range of brands, including Challenger, Fendt, Massey Ferguson and Valtra. The Company distributes its products through a combination of approximately 3,100 independent dealers and distributors in more than 140 countries. In September 2013, Grain Systems, Inc. (GSI), a global brand of the Company announced that it has purchased Johnson System Inc. (JSI), manufacturer of catwalks, towers and support structures based in Marshall, Michigan.

PAREXEL International Corporation (PAREXEL) is a biopharmaceutical services company, providing a range of expertise in clinical research, medical communications, consulting, and advanced technology products and services to the worldwide pharmaceutical, biotechnology, and medical device industries. It operates it three segments: Clinical Research Services (CRS), PAREXEL Consulting and Medical Communications Services (PCMS) and Perceptive Informatics, Inc. (Perceptive). The Company's product and service offerings include clinical trials management, observational studies and patient/disease registries, data management, biostatistical analysis, epidemiology, health economics / outcomes research, pharmacovigilance, medical communications, clinical pharmacology, patient recruitment, post-marketing surveillance. In May 2013, PAREXEL International Corp acquired the entire share capital of HERON Group Ltd.

HollyFrontier Corporation (HollyFrontier), formerly Holly Corporation, is a petroleum refiner, which produces light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. HollyFrontier operates in two segments: Refining and Holly Energy Partners, L.P. (HEP). The Refining segment includes the operations of its El Dorado, Tulsa, Navajo, Cheyenne and Woods Cross Refineries and NK Asphalt. The HEP segment involves all of the operations of HEP. As of December 31, 2011, it operated five refineries having a combined crude oil processing capacity of 443,000 barrels per day that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. The Company merged with Frontier Oil Corporation (Frontier), on July 1, 2011. On November 9, 2011, HEP acquired from the Company certain tankage, loading rack and crude receiving assets located at its El Dorado and Cheyenne Refineries.

TrueBlue, Inc. (TrueBlue) is a provider of temporary blue-collar staffing services. The Company has a network of 691 branches in all 50 states, Puerto Rico and Canada, which supply its customers with temporary workers. It operates as Labor Ready for general labor, Spartan Staffing for light industrial services, CLP Resources for skilled trades, PlaneTechs for aviation and diesel mechanics and technicians, and Centerline Drivers for dedicated and temporary drivers to the transportation and distribution industries. In June 2013, Trueblue Inc acquired the assets of Crowley Transportation Services. On September 30, 2013, the Company acquired The Work Connection (TWC).

CNOOC Limited is an investment holding company. The Company, along with its subsidiaries, is a producer of offshore crude oil and natural gas and an independent oil and gas exploration and production company. Its subsidiaries are engaged in exploration, development, production and sales of oil and natural gas. It has three segments: independent operations, operations under joint arrangement and trading business. The Company has four producing areas in offshore China, which include the Bohai Bay, Western South China Sea, Eastern South China Sea and East China Sea. It also has oil and gas assets in Indonesia, Iraq, Australia, Africa, North America and South America. As of December 31, 2012, its subsidiaries included CNOOC China Limited, CNOOC International Limited, China Offshore Oil (Singapore) International Pte Ltd and others.

NK Lukoil OAO (Neftyanaya Kompaniya LUKOIL OAO or NK LUKOIL OJSC) is a Russia-based integrated oil and gas company. The Company is engaged in the business of oil exploration, production, refining, marketing and distribution. It is an owner of refineries, gas processing, petrochemical plants and gas stations network located in Russia, Eastern and Western Europe, as well as Africa. The Company's petroleum products are sold in the Russian Federation, the Commonwealth of Independent States (CIS) countries, Eastern and Western Europe, Asia and the United States. NK Lukoil OAO operates through numerous subsidiaries and affiliated companies. In April 2013, the Company acquired a 100% of Samara-Nafta ZAO and completed acquisition of CJSC Kama-Oil. In June 2013, it sold a 99.57% stake in Lukoil Odes'kyi NPZ PAT. The Company's major shareholder is NKO ZAO NRD with a stake of 91.60%. In December 2013, it consolidated a 100% stake in ISAB Srl.

USANA Health Sciences, Inc. develops and manufactures science-based nutritional and personal care products. The Company has operations in 15 markets worldwide, where it distributes and sells its products by way of direct selling. The Company reports operations in two geographic regions: North America and Asia Pacific, which is further divided into three sub-regions; Southeast Asia/Pacific, Greater China, and North Asia. North America includes the United States, Canada, Mexico, and direct sales from the United States to the United Kingdom and the Netherlands. Southeast Asia/Pacific includes Australia, New Zealand, Singapore, Malaysia, and the Philippines; Greater China includes Hong Kong, Taiwan and China; and North Asia includes Japan and South Korea. The Company's customer base consists of two types of customers: Associates and Preferred Customers. As of December 31, 2011, the Company had 222,000 active Associates and 64,000 active Preferred Customers worldwide.

Ross Stores, Inc. is an off-price apparel and home fashion chain in the United States, with 1,091 locations in 33 states, the District of Columbia and Guam. The Company operates two brands of off-price retail apparel and home fashion stores: Ross Dress for Less (Ross) and dd's DISCOUNTS. It offers designer apparel, accessories, footwear, and home fashions for the entire family at everyday savings of 20% to 60% off department and specialty store regular prices. As of February 2, 2013, it operated 108 dd's DISCOUNTS stores in eight states. dd's DISCOUNTS features brand apparel, accessories, footwear, and home fashions for the entire family at everyday savings of 20% to 70% off moderate department and discount store regular prices.

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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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.