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Executive Summary October 1, 2010

The Economy

Since our last newsletter, the National Bureau of Economic Research -- the group responsible for officially determining the beginnings and ends of U.S. recessions -- has confirmed what many already suspected: that the "Great Recession" ended in the middle of last year -- June 2009, to be exact. And, 15 months removed from the longest post-World War II recession, the economy is continuing to plug along, though lately it's been doing so in unspectacular fashion.

Positive news does continue to come from the manufacturing sector, with the Institute for Supply Management's Chicago branch reporting a significant September jump in its business barometer. The index, which has now indicated that the manufacturing sector has been expanding for 12 straight months, was driven higher by sharp gains in production and new orders. It also saw gains in employment for the fourth straight month (on a seasonally-adjusted basis), though the gains weren't as great as they'd been in the previous three months.

ISM's national manufacturing report is due out today, and it will be interesting to see if it reflects the same type of gains seen in the Chicago report, both for manufacturing activity and employment conditions.

In terms of the broader labor market, new claims for unemployment fell by a greater-than-expected 3.4% in the most recent week (ending Sept. 25), the Labor Department reported. But that simply reversed an identical increase in new claims recorded the prior week.

Continuing claims also fell. As always, however, these week-to-week changes by no means offer a comprehensive picture of the employment situation; weekly fluctuations and the fact that the initial figures will get revised in coming weeks make it difficult to draw conclusions from the weekly changes. Stepping back a bit, however, the numbers do give a general sense of the overall picture -- they show that claims are well below where they were a year ago, but still well above levels associated with a healthy labor market.

The housing market, meanwhile, is transitioning into a post-tax-credit environment. The National Association of Realtors' latest data shows that existing home sales rose 7.6% in August vs. July. But the figure is 19% below where it stood a year ago, when the government's homebuyer tax credit was in place.

The market is now working through the glut of foreclosed homes across the U.S. New data from RealtyTrac shows that almost a quarter of all homes sold in the second quarter were foreclosures. There's still a long way to go, however; RealtyTrac estimates it will take about three years to work through the inventory of distressed properties at the current pace.

While the housing and job markets are struggling, another market -- M&A -- is surging. Merger & acquisition activity for the third quarter was the highest in two years, according to Bloomberg. Companies have tons of cash on their balance sheets, and with interest rates low and financing costs down, it appears firms are putting their money to work. Deals or potential deals involving big players like Intel Corp. and Sanofi-Aventis have helped restore some confidence to the markets in recent weeks.

Bernanke to Set Sail with "QE2"?

Speaking of confidence, the Federal Reserve's latest statement on the economy was lacking just that. Ben Bernanke's Federal Open Market Committee said in a Sept. 21 statement that it sees indications that "the pace of recovery in output and employment has slowed in recent months. "The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term."

The underwhelming assessment has, however, actually seemed to help the market. That's because the second part of the FOMC's statement indicated that, because of the slowing of the recovery, the Fed is getting ready to give the economy another jolt. In addition to saying it would likely keep the key federal funds rate exceptionally low for an extended period, the Fed said it "will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate."

That talk of "additional accommodation" has many investors thinking that another round of quantitative easing is coming -- and they are taking that as a bullish sign. Since our last newsletter, the S&P has returned 1.5%, while the Hot List has returned 3.5%. For the year, the portfolio stands at -0.4% vs. 2.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 140.1% vs. the S&P's 14.1% gain.

All Shapes and Sizes

As part of its regular monthly rebalancing, the Hot List is selling two stocks and replacing them with two others that now score higher on my Guru Strategies.

The departing stocks were both winners. Discount clothing retailer Ross Stores was up about 9% (as of yesterday's close) since joining the portfolio on Aug. 6; the S&P 500 was barely in the black over the same period. Also leaving the portfolio: pawn broker Cash America International, which was up about 7%. It also had joined the portfolio on Aug. 6.

The newcomers are about as different a pair as you can find. The first is Research in Motion, the Canadian tech giant that makes the BlackBerry smartphone. The second: L&L Energy, a small coal mining firm that, while based in Seattle, does its business in China.

So, on the one hand, we have a $25 billion company which is from perhaps the flashiest sector -- technology -- and which makes one of the flashiest products -- the BlackBerry -- out there. It's a company that most investors know well; its name is constantly popping up in daily market reports because it is seen as a bellwether for the tech sector. But while it's been growing profits and revenues at a solid pace over the past year, it hasn't been good enough for investors -- shares are down about 30% over the past year.

L&L, meanwhile, is a $245 million firm that comes from a drab industry and produces an ancient, dull product -- coal. On top of that, it does its business half a world away from where RIM is headquartered. Many investors probably haven't even heard of it -- it has no analysts following it. Its shares are also headed in the opposite direction as those of Research in Motion -- they've surged some 50% in the past year and 15-fold since late March 2009 as profits and revenues have soared. Likely because of its anonymity, the stock trades for just six times trailing 12-month earnings, however, and a reasonable 1.6 times trailing 12-month sales.

I mention the stark contrast not just because it's an interesting tidbit. I think it also helps prove a broader point about investing -- namely that good values come in an array of different shapes and sizes. That's why, unlike funds that key in only on certain types of stocks (say, mid-cap value), we let the Hot List roam the entire market to find the best values.

And, whether you are roaming the entire market or looking at a more focused area, the key to finding value is focusing on the numbers -- not the headlines, not what a co-worker tells you about the stock, not what a TV pundit says about it. That's what the gurus upon whom I base my investment strategies knew so well.

Take the great Warren Buffett. While he's called the "Oracle" of Omaha, Buffett isn't blessed with any sixth sense about which way the market or individual stocks will go. How has he been so successful, then? His son Peter was once asked that. Here's what he had to say: "I think it's because he's removed emotion from his decision-making. He is not colored by anything he thinks somebody else is doing, somebody else might want, some feeling he has about something that might not be rational. Ultimately, it's because he is clear and unemotional, dispassionate about his relationship to those numbers on the page and the information he's taking in."

Recently, a new study was unveiled that backs up the notion that keeping emotion at bay is key to successful investing. Performed by The Brandes Institute, the study looked at how value stocks (which it defined as those with lower price/earnings ratios, using projected earnings for the next year) and "glamour" stocks (those with higher forward-looking P/Es) fared after both beating and missing earnings expectations. What it found was intriguing: "Prices rose for value stocks when they exceeded (or beat) earnings forecasts and, perhaps counterintuitively, when they missed expectations," the study states. More popular glamour stocks, on the other hand, produced lower returns whether they beat or missed expectations. And, the trend held up regardless of whether the firm's business was improving or declining.

What does that mean? It's an indication that value stocks tend to outperform other stocks not because they are riskier, as many believe; instead, they outperform because of behavioural biases that cause investors to put unrealistically high expectations on glamour stocks, and unrealistically low expectations on value stocks. "Over time," Brandes says, "as the influence of these biases weaken, security prices revert away from extreme levels." As that happens, the group concludes, "there are ample opportunities for investors who can remain rational and patient."

I couldn't agree more. Being rational and focusing on the numbers is a big reason the Hot List has fared so well over the long haul. It's what guided the portfolio to a stock like HealthSpring, which was being dogged by overhyped fears of the new healthcare bill's impact when the portfolio picked it up in mid-May. As fears began to subside, investors began to realize how much of a bargain HealthSpring had become, given the strength of its underlying business; since joining the portfolio, it's up about 50% while the broader market is essentially flat.

Right now, the numbers tell us that, despite the hit its shares have taken this year, Research in Motion is still running a strong business -- and that, while they have surged in the past year, L&L Energy's shares are still a bargain given the firm's strong growth.

To be sure, that's no guarantee that either stock will enjoy the kind of success HealthSpring has had while in the portfolio. But in the stock market, there are no sure things; you can't be right all the time, not even if you are Warren Buffett or Peter Lynch or Marty Zweig. What you can do, however, is stack the odds in your favor. And the way to do that is to do what gurus like Buffett, Lynch, and Zweig did: focus on the numbers and the facts, and check your emotions at the door.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 2 stocks leave our portfolio. These include: Ross Stores, Inc. (ROST) and Cash America International, Inc. (CSH).

The Keepers

8 stocks remain in the portfolio. They are: Western Digital Corp. (WDC), Jos. A. Bank Clothiers, Inc. (JOSB), Aeropostale, Inc. (ARO), Sanofi-aventis Sa (Adr) (SNY), China Automotive Systems, Inc. (CAAS), Healthspring, Inc (HS), Gamestop Corp. (GME) and Dollar Tree, Inc. (DLTR).

The Newbies

We are adding 2 stocks to the portfolio. These include: Research In Motion Limited (Usa) (RIMM) and L&l Energy, Inc. (LLEN).

Portfolio Changes

Newcomers to the Validea Hot List

Research in Motion Limited (RIMM): Based in Waterloo, Ontario, this Canadian tech giant designs and manufactures the BlackBerry smartphone. RIM, which has offices in North America, the Asia-Pacific region, and Europe, also makes software and the operating system used by the BlackBerry.

RIM has a market cap of about $25 billion and has taken in close to $17 billion in sales in the past year. Despite posting strong earnings numbers in the past two quarters (earnings per share grew at 76% last quarter and 23% in the previous quarter, vs. the respective year-ago quarters), RIM's stock has taken a pounding since the market started to correct in early summer. That's made it a bargain, according to my Joel Greenblatt-based strategy. RIM also gets high marks from the model I base on the writings of Martin Zweig. To read more about the stock, check out the "Detailed Stock Analysis" section below.

L&L Energy, Inc. (LLEN): This Seattle-based firm actually does its business in China. The coal-mining company's subsidiaries operate coal mines, coal wholesale, coking, and coal-washing facilities in China's Yunnan and Guizhou Provinces.

L&L is a small-cap ($245 million), and it's been growing earnings at a blistering 149.6% pace over the long haul (using an average of the three-, four-, and five-year EPS growth rates), and an even faster rate in the past year or so. That's part of why, after briefly falling below $1 in late March of 2009, its stock has roared back and now trades above $8 a share today. It's also part of why, like Research in Motion, it gets approval from my Joel Greenblatt-inspired model, and high marks from my Martin Zweig-based strategy. See the "Detailed Stock Analysis" section below to learn more about the stock.

News about Validea Hot List Stocks

Sanofi-Aventis SA (SNY): On Sept. 30, Sanofi reported promising results for a final-stage study on an experimental drug used to treat Type 2 diabetes, according to The Wall Street Journal. Sanofi said the Phase-III clinical trial of lixisenatide found that once-daily doses of the drug significantly improved control of blood sugar levels in Asian patients, and presented no safety concerns, the Journal reported.

GameStop Corp. (GME): The firm has announced plans to buy back $185 million worth of its 8% bonds that are coming due in 2012, the Associated Press reported on Sept. 23. GameStop said it will offer bondholders a 2% premium over the face value of the notes, AP stated, adding that one analyst says the move could cut GameStop's annual interest expenses by about $15 million.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will take a closer look at my strategies and investment approach. 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   |   ARO   |   HS   |   WDC   |   CAAS   |   LLEN   |   RIMM   |   SNY   |   GME   |   DLTR   |  

Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, manufacturer, retailer and direct marketer (through stores, catalog and Internet) of men's tailored and casual clothing and accessories. The Company sells substantially all of its products exclusively under the Jos. A. Bank label through its 473 retail stores (as of January 30, 2010, which includes seven outlet stores and 13 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. Jos. A. Bank operates through two segments: Stores and Direct Marketing. The Company's Stores segment consists of its 453 Full-line Stores. The Company opened 14 stores (and closed one store) during the fiscal year ended January 30, 2010 (fiscal 2009). The Company's Direct Marketing segment consists of its Internet and catalog channels.

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 Aropostale merchandise through its e-commerce Website, www.aeropostale.com. During the fiscal year ended January 30, 2010 (fiscal 2009), the Company launched P.S. from Aeropostale, which offers casual clothing and accessories focused on elementary school children between the ages of 7 and 12. During fiscal 2009, the Company completed the closure of its 14 store Jimmy'Z concept. Jimmy'Z Surf Co., Inc., a wholly owned subsidiary of Aeropostale, Inc., was a contemporary lifestyle brand targeting young women and men aged 18 to 25.

HealthSpring, Inc. (HealthSpring) is a managed care organization with a primary focus on Medicare, the federal government-sponsored health insurance program for United States citizens aged 65 and older, qualifying disabled persons and persons suffering from end-stage renal disease. As of December 31, 2009, the Company operated coordinated care Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas. As of January 1, 2010, it also commenced operations of Medicare Advantage plans in three counties in Northern Georgia. As of December 31, 2009, the Company's Medicare Advantage plans had over 189,000 members. The Company also offers prescription drug benefits in accordance with Medicare Part D to its Medicare Advantage plan members, in addition to providing other medical benefits (MA-PD) plans. It also offers prescription drug benefits nationally on a stand-alone basis in accordance with Medicare Part D (PDP).

Western Digital Corporation (WD) designs, develops, manufactures and sells hard drives. It sells its products worldwide to original equipment manufacturers (OEMs) and original design manufacturers (ODMs) for use in computer systems, subsystems or consumer electronics (CE) devices, and to distributors, resellers and retailers. Its hard drives are used in desktop computers, notebook computers, and enterprise applications such as servers, workstations, network attached storage, storage area networks and video surveillance equipment. Its hard drives are used in CE applications, such as digital video recorders (DVRs), and satellite and cable set-top boxes (STBs). It also sells its hard drives as stand-alone storage products by integrating them into finished enclosures, embedding application software and offering the products as WD-branded external storage appliances for personal data backup and portable or expanded storage of digital music, video and other digital data.

China Automotive Systems, Inc. (China Automotive) is a holding company and has no significant business operations or assets other than its interest in Great Genesis Holdings Limited (Genesis). Through Genesis, the Company manufactures power steering systems and other component parts for automobiles. All operations are conducted through eight Sino-foreign joint ventures in China and a wholly owned subsidiary in the United States. The Company has business relations with more than 60 vehicle manufacturers, including FAW Group and Dongfeng Auto Group, automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., light vehicle manufacturer in China; Chery Automobile Co., Ltd, state-owned car manufacturer in China, and Xi'an BYD Auto Co., Ltd and Zhejiang Geely Automobile Co., Ltd., car manufacturers.

L & L Energy, Inc. (L & L) is engaged in the businesses of coal mining, coal washing, coal coking and coal wholesaling. The Company's operations are conducted in Yunnan and Guizhou provinces in the southwest region of the People's Republic of China. As of April 30, 2010, the Company had three operating subsidiaries: KMC, which has coal wholesale operations and Ping Yi Coal Mine (mining operations PYC); two coal mining operations (DaPuAn Mine and SuTsong Mine), including DaPuAn's coal washing operations (the 2 Mines or LLC), and L&L Yunnan Tianneng Industry Co. Ltd. (including Hong Xing coal washing and ZoneLin coking operations) (TNI).

Research In Motion Limited (RIM) is a designer, manufacturer and marketer of wireless solutions for the worldwide mobile communications market. Through the development of integrated hardware, software and services that support multiple wireless network standards, RIM provides platforms and solutions for seamless access to time-sensitive information, including e-mail, phone, short message service (SMS), Internet and intranet-based applications. RIM's portfolio of products, services and embedded technologies are used by organizations worldwide and include the BlackBerry wireless solution, the RIM Wireless Handheld product line, software development tools and other software and hardware. Its subsidiaries include Research In Motion Corporation, Research In Motion UK Limited and RIM Finance, LLC. On June 2, 2010, Harman International sold its software operating systems unit, QNX Software Systems, to the Company.

Sanofi-Aventis is a pharmaceutical group engaged in the research, development, manufacture and marketing of healthcare products. The Company's business includes two main activities: pharmaceuticals and human vaccines through sanofi pasteur. The Company is also present in animal health products through Merial Limited (Merial). In its pharmaceutical activity, the Company specializes in six therapeutic areas: diabetes, oncology, thrombosis and cardiovascular, central nervous system (CNS), and internal medicine. The global portfolio of sanofi-aventis also consists of a range of other pharmaceutical products in Consumer Health Care (CHC) and other prescription drugs, including generics. It offers vaccines in five areas: pediatric combination vaccines, influenza vaccines, adult and adolescent booster vaccines, meningitis vaccines and travel and endemic vaccines.

GameStop Corp. (GameStop) is a retailer of video game products and personal computer (PC) entertainment software. The Company sells new and used video game hardware, video game software and accessories, as well as PC entertainment software, and related accessories and other merchandise. As of January 30, 2010, the Company operated 6,450 stores in the United States, Australia, Canada and Europe, primarily under the names GameStop and EB Games. GameStop also operates the electronic commerce Website www.gamestop.com and publish Game Informer, a multi-platform video game magazine in the United States based on circulation, with approximately 4 million subscribers. During the fiscal year ended January 30, 2010 (fiscal 2009), GameStop operated its business in four segments: United States, Canada, Australia and Europe.

Dollar Tree, Inc. (Dollar Tree) is an operator of discount variety stores offering merchandise at the fixed price of one dollar. At January 30, 2010, the Company operated 3,806 discount variety retail stores. Approximately 3,650 of these stores sell substantially all items for one dollar or less. The remaining stores, operating as Deal$, sell items for one dollar or less but also sell items for more than one dollar. Dollar Tree's stores operate under the names of Dollar Tree, Deal$ and Dollar Bills.

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.