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Executive Summary May 24, 2013

The Economy

Though economic data has been mixed over the past couple weeks and some key overseas headwinds have picked up, the numbers coming out of the U.S. employment and housing sectors have been good enough to bolster the stock market.

New claims for unemployment, for example, fell in the most recent week after having risen the previous week, according to the Labor Department. They now stand nearly 9% lower than they were a year ago, a very good sign. Continuing claims, meanwhile, fell below the 3 million mark for the first time in five years. (Continuing claim data lags new claim data by a week.)

In the housing market, a new government report showed that new home sales increased 2.3% in April, and now stand 32.4% above where they were a year ago. The report also showed that median sale prices were 15% above their year-ago level.

Housing starts, however, dipped 16.5% in April, according to a separate government report, though they remained nearly 15% above their year-ago level. But it appears the dip may be shot-lived; permit issuance for new home construction, a forward-looking indicator, jumped 14.3% in the month, according to the report. Permit issuance is now 42.9% above where it was a year ago.

Elsewhere, retail sales edged higher by 0.1% in April, according to the Commerce Department. That put them 4.5% ahead of where they were last April, a decent year-over-year gain. Industrial production fell, however, by 0.5% for the month, according to a Federal Reserve report. Part of that was due to utility output declining nearly 4% as more normal temperatures brought heating usage back to normal levels. Still, manufacturing output declined 0.4%. Mining output did rise, gaining nearly 1%.

Inflation -- or lack thereof -- continues to be a concern. The Consumer Price Index declined 0.4% in April, the Labor Department said, making for a year-over-year increase of just 1.1%. Despite all of the Federal Reserve's stimulus efforts, a good deal of the liquidity being supplied is not making its way through the financial system and onto Main Street.

Speaking of the Fed, many investors grew fearful this week when Fed minutes showed that some members were willing to consider tapering the central bank's asset purchases as soon as next month. Fed Chairman Ben Bernanke also said the group could cut back on its bond buying efforts at one of its next few meetings, with the caveat that the economy would have to be continuing to gain momentum for the Fed to do so.

Other concerns came from Asia. The Purchasing Managers' Index for China fell into contraction territory in May, HSBC said on May 23. Fears of trouble in the huge global growth engine were blamed for the big decline in Japanese markets that day, as well as the decline in U.S. stocks.

Finally, U.S. companies are continuing to post good earnings. With 93% of S&P 500 companies having reported first-quarter results, 66.2% had beaten earnings expectations, according to Standard & Poor's, in line with what we've seen in recent quarters.

Since our last newsletter, the S&P 500 returned 1.5%, while the Hot List returned 3.1%. So far in 2013, the portfolio has returned 26.4% vs. 15.7% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 242.8% vs. the S&P's 65.0% gain.

 
Editor-in-Chief: John Reese










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Portfolio Update

It's been another solid fortnight for the Hot List portfolio -- and particularly for one of its holdings. As of this writing, USANA Health Sciences was up more than 20% since our last newsletter, pushing it over the 100% gain mark since it joined the portfolio just five months ago. There was no direct catalyst for the stock's big move over the past two weeks, but it appears that valuation and general economic optimism were factors. It also may be that investors are growing more comfortable with USANA's business model. The model has been the subject of controversy, being compared to that of Herbalife, the fellow nutritional supplement firm that has been blasted by high profile investor Bill Ackman (but defended by others, like Carl Icahn). So far, USANA (and Herbalife) has fared quite well and those concerns haven't been borne out. We remain aware of the questions and concerns about USANA, but given our stop-loss system, we're comfortable keeping the stock in the portfolio -- particularly given its exceptional fundamentals.

Another nice performer since our last newsletter has been Valero Energy, the petroleum refiner, which was up nearly 6% (all performance figures in this section are as of early afternoon trading on May 23). Catalysts seem to have been better-than-expected economic data, and a report from the International Energy Agency that said "supply shock created by a surge in North American oil production will be as transformative to the market over the next five years as was the rise of Chinese demand over the last 15". NetEase, which reported solid Q1 results, was also a nice gainer, up about 3.4%.

There have been some laggards in the portfolio, though none have fared all that poorly. Royal Dutch Shell has been the worst performer, losing a little over 2%. Shell and two other European energy firms have been the subject of an investigation into possible price manipulation, which appeared to be the catalyst for the Shell shares' decline. Regulators have not taken any actions against the company yet, though, and its fundamentals remain strong. We'll see whether those fundamentals are good enough to keep the stock in the portfolio when we conduct our regularly scheduled rebalancing in two weeks.



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. Here are the current holdings of the 10-stock Graham portfolio:

HollyFrontier Corp. (HFC)
Cheung Kong Holdings Limited (CHEUY)
Alliant TechSystems (ATK)
National-Oilwell Varco (NOV)
NTT DoCoMo, Inc. (DCM)
Bridgepoint Education (BPI)
Chevron Corporation (CVX)
Inter Parfums (IPAR)
Western Digital Corp. (WDC)
Apollo Group (APOL)


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 May 20, the 10-stock Graham-based portfolio was up 311.8% since its July 2003 inception, making it my best 10-stock performer. That's a 15.4% annualized return in a period in which the S&P 500 has gained just 5.3% 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 22.0% so far this year.

It's also worth noting that 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 389.4% since its July 2003 inception -- that's 17.5% 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

NetEase, Inc. (NTES): On May 15, NetEase reported first-quarter earnings per share of $1.32 on revenue of $350.0 million, beating analysts' expectations of $1.23 in EPS on $349.7 million in revenue, the Motley Fool reported. The earnings figure was a 16% jump over the year-ago quarter, while the revenue figure represented an 11% gain. Shares actually dipped a bit after the announcement, but a few days later an analyst upgrade and generally stronger news coming out of China helped push NetEase shares up sharply. As of early-afternoon trading on May 23, the stock was up 3.4% since joining the portfolio on May 10.

USANA Health Sciences (USNA): USANA shares have continued to surge, rising another 20.7% since our last newsletter (as of early-afternoon trading on May 23). That put them up more than 100% since the portfolio added them back on Dec. 21, 2012. There was no clear catalyst for the continued gains, though it seems many investors may be growing more comfortable with the firm's business model, which had been compared to much-criticized Herbalife's model, and warming up to USANA's excellent valuation story.



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

USNA   |   TJX   |   LEA   |   VLO   |   HFC   |   RDS.A   |   LUKOY   |   CVX   |   WSM   |   NTES   |  



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.





The TJX Companies, Inc. (TJX) is the off-price apparel and home fashions retailer in the United States and worldwide. As of January 28, 2012, the Company operated in four business segments. It has two segments in the United States, Marmaxx (T.J. Maxx and Marshalls) and HomeGoods; one in Canada, TJX Canada (Winners, Marshalls and HomeSense) and one in Europe, TJX Europe (T.K. Maxx and HomeSense). As a result of the consolidation of the A.J. Wright chain, all A.J. Wright stores ceased operations by the end of February 2011. It completed the consolidation of A.J. Wright, converting 90 of the A.J. Wright stores to T.J. Maxx, Marshalls or HomeGoods banners and closed the remaining 72 stores, two distribution centers and home office. In December 2012, the Company acquired Sierra Trading Post, an off-price Internet retailer.





Lear Corporation is a tier 1 supplier to the global automotive industry. The Company supplies its products to automotive manufacturers with automotive seat systems and related components, as well as electrical distribution systems and related components. The Company has two segments: seating and electrical power management systems (EPMS). The seating segment includes seat systems and related components, such as seat frames, recliner mechanisms, seat tracks, seat trim covers, headrests and seat foam. The EPMS segment includes electrical distribution systems for traditional powertrain vehicles, as well as for hybrid and electric vehicles. As of December 31, 2011, it had 20 joint ventures located throughout Asia, as well as five in North America, two in Europe and Africa and one with operations in all three regions.





Valero Energy Corporation (Valero) is an independent petroleum refining and marketing company. Valero's refineries can produce conventional gasoline's, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products, as well as a slate of premium products, including conventional blendstock for oxygenate blending and reformulated gasoline blendstock for oxygenate blending, gasoline meeting the specifications of the California Air Resources Board, a diesel fuel, and low-sulfur and ultra-low-sulfur diesel fuel. It also owns 10 ethanol plants in the central plains region of the United States with a combined ethanol nameplate production capacity of about 1.1 billion gallons per year. It operates in three business segments: refining, ethanol, and retail. In May 2013, CST Brands Inc announced that the Company which includes Corner Store and Depanneur du Coin, spun off from Valero Energy Corporation.





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.





Royal Dutch Shell plc (Shell) is an independent oil and gas company. The Company owns, directly or indirectly, investments in the numerous companies constituting Shell. Shell is engaged worldwide in the principal aspects of the oil and gas industry and also has interests in chemicals and other energy-related businesses. The Company operates in three segments: Upstream, Downstream and Corporate. Upstream combines the operating segments Upstream International and Upstream Americas, which are engaged in searching for and recovering crude oil and natural gas; the liquefaction and transportation of gas; the extraction of bitumen from oil sands that is converted into synthetic crude oil, and wind energy. Downstream is engaged in manufacturing; distribution and marketing activities for oil products and chemicals. Corporate represents the key support functions, comprising holdings and treasury, headquarters, central functions and Shells self-insurance activities.





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. As of December 31, 2011, the Company's major shareholder was ING Bank (Eurasia) ZAO with a stake of 75.93%. In April 2013, the Company acquired a 100% of Samara-Nafta ZAO. In April 2013, the Company completed acquisition of CJSC Kama-Oil.





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 petroleum operations, chemicals operations, mining operations, power generation and energy services. Upstream operations consist primarily of exploring for, developing and producing crude oil and natural gas; processing, liquefaction, transportation and regasification associated with liquefied natural gas; transporting crude oil by international oil export pipelines; transporting, storage and marketing of natural gas; and a gas-to-liquids project. Downstream operations consist primarily of refining crude oil into petroleum products; marketing of crude oil and refined products; transporting crude oil by pipeline, motor equipment and rail car, and manufacturing and marketing of commodity petrochemicals, plastics for industrial uses and fuel and lubricant additives.





Williams-Sonoma, Inc. is a multi-channel specialty retailer of products for the home. The direct-to-customer segment of the Company's business sells its products through its six e-commerce Websites (williams-sonoma.com, potterybarn.com, potterybarnkids.com, pbteen.com, westelm.com and rejuvenation.com) and seven direct-mail catalogs (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Bed and Bath, PBteen, West Elm and Rejuvenation). Its e-commerce platform is available to customers in more than 75 countries, while its catalogs reach customers throughout the United States. The retail segment of its business sells products through its five retail store concepts (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation). As of January 29, 2012, it operated 576 stores in 44 states, Washington, D.C., Canada and Puerto Rico. On November 1, 2011, the Company acquired Rejuvenation Inc.





NetEase, Inc. is a holding company. The Company is an Internet technology company. The Company provides its Internet and wireless value-added applications, services and technologies and advertising services to Guangzhou NetEase and Guangyitong Advertising and they operate the NetEase Websites and the online advertising business. Guangzhou NetEase has two majority-owned subsidiaries, Youdao Computer (a search business operator) and Wangyibao (the operator of its Wangyibao payment system). Through its subsidiaries and contracts with its affiliates Guangzhou NetEase, Guangyitong Advertising and Shanghai EaseNet and their respective shareholders, it operates an interactive online community in China and are a provider of Chinese language content and services through its online games, Internet portal and wireless value-added services businesses. During the year ended December 31, 2011, it developed its online games and advertising business.





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.





Disclaimer


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.