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Executive Summary November 20, 2015

The Economy

To begin this week, I'd like to say that our hearts go out to anyone impacted by the horrific attacks in France. At times like these, a discussion of monthly economic reports can seem trivial. This is what we do, however, though as we do it this week our thoughts are with all of those impacted by the senseless violence.

As for the economy, the news was generally good in the US. The economy added 271,000 jobs during October, the Labor Department said, which came close to the combined 290,000 jobs added in September and August. In addition, the September and August jobs-added figures were revised higher by a total of 12,000. Average hourly wages also rose at an annual pace of more than 4.3% vs. September. Amid all this, the unemployment rate fell to 5.0%, the lowest it has been since April 2008. The "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 9.8% in October, the first time since May 2008 that it has been below 10%.

New claims for unemployment, meanwhile, have fallen slightly since our last newsletter, and are now about 8% below where they were a year ago. Continuing claims, the data for which lag new claims by a week, ticked slightly higher, but are also 8% below year-ago levels..

Retail sales, meanwhile, edged higher by 0.1% in October, according to a new report from the Census Bureau. That's about 1.8% higher than the year-ago level -- not a great year-over-year increase, but improvement nonetheless.

Housing starts tumbled more than 11% in October, according to the Census Bureau, and are slightly below where they were a year ago. Permit issuance for new construction rose 4.1%, but is also slightly below where it stood a year ago.

Elsewhere, inflation actually picked up in October. The Consumer Price Index rose 0.2%, according to the Labor Department, drawing ahead of its year-ago level by just 0.2%. Stripping out volatile food and energy prices, so-called "core" inflation, which was also up 0.2% in October, is 1.9% ahead of its year-ago pace. The huge commodity price declines we've seen over the past year are, of course, the reason for the big gap between the overall inflation number and the core inflation number.

As for gas prices, they keep on falling. As of November 19, a gallon of regular unleaded on average cost $2.12, down from $2.20 a month earlier. That's more than 26% below where it was one year ago.

Finally, despite plenty of global concerns, Corporate America is continuing to hang in there. With about 93% of the S&P 500 companies having reported third-quarter results, 74% have beaten earnings expectations, while 45% beat revenue expectations, according to FactSet, in line with what we have seen in recent quarters. Earnings are now expected to decline by 1.8% once all of the third-quarter results are, and revenues are expected to be down 4%. Energy companies are again the main culprit, thanks to those commodity price declines. Excluding energy firms, third-quarter earnings growth is expected to now be 5.0%, with revenue growth at 1.1%.

In addition, American companies issued $107.9 billion in dividends for the third quarter, a whopping 23.4% increase, CNBC reported, citing data from Henderson Global Investors. The jump "comfortably" set a new record, according to Henderson.

Amid all this, the S&P 500 has returned -0.9% since our last newsletter, while the Hot List has returned -5.8%. So far in 2015, the portfolio has returned -5.1% vs. 1.1% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 207.0% vs. the S&P's 108.0% gain.

A Quant's Journey: Mental Lessons

In our last rebalancing newsletter, I looked at some of the lessons I've learned in my dozen years of running quantitative strategies, focusing on what I've learned from the copious amounts of data that we've compiled while monitoring our model portfolios. In Part Two this week, I will focus more on the psychological lessons I've taken away from the past dozen years. These lessons are a bit broader and more abstract, but in the end they may be even more important because they involve the ways in which one can combat the many emotional and behavioral biases that we humans face as investors.

Lesson 1: Don't Try To Be Perfect
As an investor, we all have the urge to be perfect. Want to be right on all of our stock picks, and we envision that great investors like Warren Buffett are, indeed, right far, far more than they are wrong. But the reality is that they aren't anywhere close to perfect, and you don't need to be right all the time. As Martin Zweig said, "If you are right 60% of the time, ride your profits, and rein in your losses, you'll find that when you're right you're very right, and when you're wrong you're only moderately wrong. In the long run, a 60% success rate translates into huge gains, a 50% rate into solid gains, and even a 40% rate can beat the market."

My Guru Strategies are proof of that. The Hot List has just about doubled the S&P 500 since its mid-2003 inception, yet its accuracy rate (that is, the percentage of stocks that it has made money on) is 54.1%. My other 13 ten-stock portfolios -- all but three of which are beating the market since their inceptions -- have accuracy rates no higher than 59.6% and as low as 46.7%. Yes, that's right -- the Momentum Investor portfolio has actually been wrong more than it has been right, but despite its 46.7% accuracy rate it has nearly doubled the market since its mid-2003 inception.

What's the significance of all this? To me, it is that the "shotgun" approach, as Zweig called it, is the way to go. As opposed to the "rifle approach", which calls for intensely studying a very small number of individual stocks, the shotgun method involves buying up a larger basket of stocks through the use of systematic fundamental analysis. Sure, this approach means you might get some duds, but that's okay. If your winners outnumber your losers (sometimes even if they don't), you can still make a heck of a lot of money. If you focus all of your energy on intense research of a small number of firms, you're going to spend a lot more time, be a lot more (perhaps too) concentrated, and still be wrong sometimes.

In addition to the time and diversification benefits, the shotgun approach also lends itself to systematic, unemotional investing. Since you are just screening for stocks that have particular fundamental qualities, there's no hunch playing or guesswork. If the stock meets your criteria, you buy it; if not, you pass. With a rifle approach, you're going to get into more subjective analyses of the firm's products and business. Rare investors like Buffett, who have exceptional business acumen and the ability to keep their emotions at bay, can have great success doing that. But most individual investors lack the discipline (and time, frankly) needed to thoroughly analyze a business and not be swayed by what the rest of the world thinks. A quantitative, shotgun approach keeps emotion at bay, if you ...

Lesson 2: Stay Out Of The Way
Just about every guru I follow stresses the importance of discipline, and my own experience has done nothing to refute their advice. Believe me, there been many times when I've seen a stock pop up on the Hot List's "buy" list and wished we could just skip that one. But many times, those are just the types of stocks that perform the best -- their low expectations or abundant fears hovering over them create incredible value opportunities.

Remember USANA Health Sciences? Fears of its multi-level marketing approach for years created all sorts of negative headlines around the nutrition/personal care product maker, so I wasn't jumping for joy when the Hot List picked it up in late 2012. About 16 months and 115% of gains later, I was glad I had trusted my models.

There are numerous other examples like this, and I believe that the Hot List's purchase of these sort of stocks -- and our willingness not to override the portfolio's decisions -- is one of the big reasons that it has been so successful over the long-term.

Of course, not overriding a model's picks can be incredibly hard. Because of that, any investor using quantitative strategies should ask himself or herself some hard questions before beginning: Will I trust the models even when times are tough and my portfolio is struggling? How big a loss will I be able to handle before I jump in and start overriding the models' decisions? What safeguards can I put in place to keep myself from meddling with the models? If you haven't asked yourself these questions -- and come up with good answers -- you're not ready to start investing via quantitative strategies.

Lesson 3: Different Styles Win At Different Times
In terms of dealing with the inevitable ups and downs of investing, it's critical to remember that strategies go in and out of favor over time. At one point early in our existence, the David Dreman-based portfolio was our top performer. Today, it is bringing up the rear. That's an extreme case, but it illustrates what can happen as difference forces lead the market. From 2003 to 2006 or 2007, value strategies were very successful, and the Dreman model flourished. Since then, however, growth has been on a major run, and the Dreman portfolio has felt the reprecussions.

Ideally, you'd like to have a portfolio that is as "all-weather" as possible. We try to do that with the Hot List by using multiple, uncorrelated strategies that use a wide assortment of variables to assess stocks. Still, unless you have a portfolio that is, essentially, the market, your portfolio will ebb and flow relative to the market depending on what sections of the market are doing best. Being aware of these cyclical trends can help you ride out the tough times, just as it can help prevent you from jumping onto a hot strategy that is simply reaping the short-term benefits of a broader cyclical trend that may well run out soon after you get on board.

It is not just the growth/value, large-cap/small-cap cycles that you need to be aware of. You also need to be aware of other strategy-specific issues. For example, in 2008, our Benjamin Graham-based model did far better than the broader market. Part of that, I believe, is because it is a good strategy, but there's no getting around the fact that it benefited greatly from circumstance: the model does not invest in financial stocks, which were the bane of the market during the 2008 meltdown.

The Graham strategy's exceptional relative performance that year led to a lot of interest from investors, and I tried to be clear with anyone who was interested in the model that, while it is a very good long-term strategy, no one should expect it to beat the market by 20-plus percent every year, as it did in 2008. Indeed, because it did not invest in financials, the Graham-based strategy didn't get some of the bounce back that occurred following the financial crisis. Investors who did not understand that may well have been disappointed by the short-term results, and bailed on a very good long-term strategy.

Timeless Lessons

Twelve years is a good amount of time, but I'd be foolish to think that these past dozen years have taught me all there is to know about using quantitative strategies -- or that the specifics of what has happened over that time won't change. But while specifics will change, I would be stunned if the lessons I've learned and shared with you today become less relevant in the next dozen years, or the dozen years after that. In particular, preparation, discipline, and value, which are at the center of these lessons, are concepts that have been crucial to investing success since Benjamin Graham's day. Their importance endures because they get to the heart of good business principles and provide ways for us to deal with our own hard-wired emotions and behavioral biases, which aren't likely to change any time soon. Over the next dozen years and beyond, I'll be keeping these lessons at the forefront of my investment process, and I hope you will, too.

Editor-in-Chief: John Reese

The Fallen

As we rebalance the Validea Hot List, 7 stocks leave our portfolio. These include: Wisdomtree Investments, Inc. (WETF), Chart Industries, Inc. (GTLS), Heritage Insurance Holdings Inc (HRTG), Universal Insurance Holdings, Inc. (UVE), Eagle Bancorp, Inc. (EGBN), Pinnacle Financial Partners (PNFP) and Foot Locker, Inc. (FL).

The Keepers

3 stocks remain in the portfolio. They are: Apple Inc. (AAPL), Polaris Industries Inc. (PII) and Sanderson Farms, Inc. (SAFM).

The Newbies

We are adding 7 stocks to the portfolio. These include: Valero Energy Corporation (VLO), Tesoro Corporation (TSO), Cal-maine Foods Inc (CALM), Syntel, Inc. (SYNT), Silicon Motion Technology Corp. (Adr) (SIMO), Banco Macro Sa (Adr) (BMA) and Trueblue Inc (TBI).

Portfolio Changes

Newcomers to the Validea Hot List

Syntel Inc. (SYNT): This Michigan-based firm provides business analytics, cloud computing, IT infrastructure management, and other services. Syntel ($4 billion market cap) has taken in close to $1 billion in sales over the past year.

Syntel gets strong interest from my Peter Lynch- and Warren Buffett-based models. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

Tesoro Corporation (TSO): This Texas-based petroleum refining and marketing company transports crude oil and manufactures, transports, and sells transportation fuels. It owns and operates six petroleum refineries in the western United States and sells transportation fuels in approximately 16 states through a network of about 2,267 retail stations under the ARCO, Shell, Exxon, Mobil, USA Gasoline and Tesoro brands.

Tesoro ($14 billion market cap) has taken in about $31 billion in sales over the past 12 months and gets strong interest from my Peter Lynch-based model and high marks from several other strategies. To read more about it, check out the "Detailed Stock Analysis" section.

Cal-Maine Foods (CALM): This egg producer sells its eggs in the southwestern, southeastern, mid-western and mid-Atlantic regions of the United States. The $2.7-billion-market-capitalization firm has taken in about $1.8 billion in sales over the past 12 months.

Cal-Maine gets strong interest from my Peter Lynch- and Joel Greenblatt-based models. See the "Detailed Stock Analysis" section below to read more about it.

TrueBlue (TBI): This blue-collar staffing services firm operates about 700 branches in all 50 states, Puerto Rico, and Canada. It has taken more than $2.5 billion in revenues over the past year.

TrueBlue ($1.2 billion market capitalization) gets strong interest from my Peter Lynch-based model, as well as my James O'Shaughnessy-based model. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

Banco Macro SA (BMA): This Argentina-based bank ($6 billion market cap) focuses on low- and mid-income individuals and small and mid-sized companies organized under the laws of Argentina. The company has taken in about $1.8 billion in sales over the past year, and has a nice combination of growth (39% long-term revenue growth), momentum (92 relative strength), and value (9.8 P/E ratio).

BMA gets strong interest from my David Dreman-, Warren Buffett-, and Peter Lynch-based models. To read more about it, scroll down to the "Detailed Stock Analysis" section.

Valero Energy Corp. (VLO): Valero makes transportation fuels, other petrochemical products, and power. Its refineries can produce everything from conventional and premium gasolines and diesel fuel, to jet fuel, to asphalt, petrochemicals and lubricants. It markets branded and unbranded refined products through approximately 7,400 outlets and owns 11 ethanol plants in the central plains region of the United States that primarily produce ethanol.

VLO gets strong interest from my Peter Lynch-based model. For details about its impressive fundamentals, scroll down to the "Detailed Stock Analysis" section.

Silicon Motion Technology Corporation (SIMO): Silicon Motion is a fabless semiconductor company that makes high-performance, low-power semiconductor solutions for the multimedia consumer electronics market. Its products include mobile storage, mobile communications, multimedia systems-on-a-chip (SoCs), and other products.

Silicon Motion ($1.2 billion market cap) gets strong interest from my Peter Lynch-based model and high marks from several other strategies. To read more about it, check out the "Detailed Stock Analysis" section.

News about Validea Hot List Stocks

Universal Insurance Holdings (UVE): UVE shares plunged 34% on Nov. 17. According to the South Florida Business Journal, the decline occurred after a Lakewood Capital Management managing partner gave a presentation during which he allegedly identified UVE as a good short candidate. UVE fired back, saying in a release, "The Company believes that the statements made by Lakewood Capital Management are misleading and contain partial information, designed to negatively affect Universal's stock." Shares made up some ground on Nov. 18 before falling again on Nov. 19, and a decline in the firm's fundamentals is leading the Hot List to sell the holding today.

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

BMA   |   VLO   |   SIMO   |   SAFM   |   TBI   |   CALM   |   SYNT   |   TSO   |   PII   |   AAPL   |  

Banco Macro S.A. (the Bank) is a bank. The Bank offers traditional bank products and services to companies, including those operating in regional economies, as well as to individuals. The Bank offers savings and checking accounts, credit and debit cards, consumer finance loans (including personal loans), mortgage loans, automobile loans, overdrafts, credit-related services, home and car insurance coverage, tax collection, utility payments, automatic teller machines (ATMs) and money transfers. The Bank offers Plan Sueldo payroll services, lending, corporate credit cards, mortgage finance, transaction processing and foreign exchange. The Bank offers transaction services to its corporate customers, such as cash management, customer collections, payments to suppliers, payroll administration, foreign exchange transactions, foreign trade services, corporate credit cards and information services, such as its Datanet and Interpymes services.

Valero Energy Corp (Valero) is an international manufacturer and marketer of transportation fuels, other petrochemical products and power. The Company's refineries can produce conventional gasolines, premium gasolines, gasoline, diesel fuel, low-sulfur diesel fuel, ultra-low-sulfur diesel fuel, CARB diesel fuel, other distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products. The Company markets branded and unbranded refined products through approximately 7,400 outlets. The Company also owns 11 ethanol plants in the central plains region of the United States that primarily produce ethanol. The Company operates through two segments. The refining segment includes refining operations, wholesale marketing, product supply and distribution, and transportation operations in the United States, Canada, the United Kingdom, Aruba and Ireland. Its ethanol segment primarily includes sale of internally produced ethanol and distillers grains.

Silicon Motion Technology Corporation (SMTC) is a fabless semiconductor company. The Company designs, develops and markets low-power semiconductor solutions to original equipment manufacturers (OEMs) and other customers in the mobile storage and mobile communications markets. For the mobile storage market, the Company's products are microcontrollers used in solid state storage devices, such as Solid State Drives (SSDs), Embedded Multimedia Cards (eMMCs) and other embedded flash applications, as well as removable storage products. For the mobile communications market, the Company's products are mobile communication transceivers and mobile television (TV) System on Chips (SoCs). The Company's products are used in smartphones, tablets, notebooks, desktop personal computers, and industrial and commercial applications. The Company markets its mobile storage products under the SMI brand and mobile communications products under the FCI brand.

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.

TrueBlue, Inc. (TrueBlue), is a provider of specialized workforce solutions, helping clients improve growth and performance. The Company provides staffing, recruitment process outsourcing, and managed service provider solutions. The Company operates through two reportable segments, Staffing Services and Managed Services. The Company offers on-premise temporary blue-collar staffing together with outsourced service offerings in recruitment process outsourcing (RPO) and managed services provider (MSP) solutions. On-premise staffing is sourcing, screening, recruiting and management of the contingent labor workforce at a customer's facility. RPO is high-volume sourcing, screening, and recruiting of permanent employees for all industries and jobs. MSP solutions manage its customer's overall contingent labor program including vendor selection, vendor performance management, vendor compliance monitoring and risk management, and reducing vendor costs.

Cal-Maine Foods, Inc. is a producer and marketer of shell eggs in the United States. The Company's primary business is the production, grading, packaging, marketing and distribution of shell eggs. The Company sells its shell eggs in the southwestern, southeastern, mid-western and mid-Atlantic regions of the United States. The Company markets its shell eggs through its distribution network to a group of customers, including national and regional grocery store chains, club stores, foodservice distributors and egg product consumers. Some of its sales are completed through co-pack agreements. It has a total flock of approximately 33.7 million layers and 8.4 million pullets and breeders. The Company markets its specialty shell eggs under brands, such as Egg-Land's Best, Land O' Lakes, Farmhouse and 4-Grain. The Company also produces, markets and distributes private label specialty shell eggs to several customers.

Syntel, Inc. (Syntel) is a provider of digital transformation, information technology (IT) and knowledge process outsourcing (KPO) services. Syntel operates through five segments: Banking and Financial Services, Healthcare and Life Sciences, Insurance, Retail, Logistics and Telecom, and Manufacturing. The Banking and Financial Services segment serves financial institutions around the world. The Healthcare and Life Sciences segment serves various companies in the healthcare industry. The Insurance segment serves property and casualty insurers, insurance brokers, personal, commercial, life and retirement insurance service providers. The Retail, Logistics and Telecom segment serves a range of retailers and distributors, and clients in the logistics and telecom industry. The Manufacturing segment provides business consulting and technology services for industrial and automotive clients. The Company offers its products and services under the Syntel brand.

Tesoro Corporation is an independent petroleum refining and marketing company. Through its subsidiaries, the Company primarily transports crude oil and manufactures, transports and sells transportation fuels. The Company operates through three business segments: Refining operating segment, which owns and perates six petroleum refineries with a combined crude oil capacity of 850 thousand barrels per day (Mbpd) located in the western United States and sells transportation fuels to a variety of customers; TLLP, a publicly traded limited partnership, which includes certain crude oil and natural gas gathering assets, natural gas processing and crude oil and refined products terminalling, transportation and storage assets, and Retail operating segment, which sells transportation fuels in approximately 16 states through a network of approximately 2,267 retail stations under the ARCO, Shell, Exxon, Mobil, USA Gasoline and Tesoro brands.

Polaris Industries Inc. (Polaris) designs, engineers and manufactures off-road vehicles (ORV), including all-terrain vehicles (ATV) and side-by-side vehicles for recreational and utility use, snowmobiles, motorcycles and small vehicles (SV). These products are sold through dealers and distributors located in the United States, Canada and Europe. The Company's ORVs include core ATVs, and RANGER and RZR side-by-side vehicles. The Company produces a range of snowmobiles, consisting of 32 models, ranging from youth models to utility and economy models to performance and competition models. Polaris' Motorcycles division consists of Victory, Indian motorcycles and three-wheel roadster motorcycle, Slingshot. The Company offer products in the light-duty hauling, people mover and urban/suburban commuting sub-sectors of the small vehicles industry. The Company produces or supplies a range of replacement parts and accessories for its product lines.

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

Watch List

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


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