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Executive Summary July 31, 2015

The Economy

Strong gains in the homebuilding industry, a 40-year low in new unemployment claims, falling oil prices -- US economic data has looked quite promising over the past fortnight.

According to the Labor Department, initial claims for unemployment fell to their lowest level since November 1973 in the week ending July 18, before rising slightly in the most recent week. They are more than 10% below year-ago levels. Continuing claims, the data for which lag new claims by a week, have moved slightly higher since our last newsletter but are 11% below year-ago levels..

Good news also came from the housing market. Housing starts jumped almost 10% in June,, according to the Census Bureau, putting them about 26% above year-ago levels. Permit issuance for new construction rose 7.4%, and is more than 40% above where it stood a year ago.

On the negative side, new home sales fell 6.8% in June, according to the Census Bureau. Compared to a year ago, however, they are 18% higher. Median sale prices were about 2% below where they were a year ago.

Inflation picked up in June. The Consumer Price Index rose 0.3% , according to the Labor Department. That put it just 0.1% ahead of its year-ago pace, mostly because of the oil and gas price declines. But if you strip out volatile food and energy prices, so-called "core" inflation, which was up 0.2% in June, is 1.8% ahead of its year-ago pace.

Oil and gas prices, meanwhile, have slid recently. As of July 28, a gallon of regular unleaded on average cost $2.70, down from $2.78 a month earlier. That's far below the year-ago level of $3.52.

Finally, the Federal Reserve held interest rates steady at its July meeting. There had been some speculation that the Fed might at long last start raising rates at the meeting, but most observers seem to be forecasting that the first increases will be announced in September.

Since our last newsletter, the S&P 500 returned -0.7%, while the Hot List returned -2.7%. So far in 2015, the portfolio has returned 7.3% vs. 2.4% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 246.9% vs. the S&P's 110.8% gain.

Beyond Value

I often talk about value investing and the importance of buying attractively priced stocks in this space. That's because history shows that value investing works over the long haul, and many of the top performing investing greats upon whose writings I base my strategies embraced value-centric approaches. Over the long term, I believe that the Hot List's value tilt has played a big role in its significant outperformance of the broader market.

But another big key to the portfolio's performance is momentum. If you are a dyed-in-the-wool value investor, the notion of using momentum to pick stocks -- that is, looking for stocks that have been red-hot -- is sacrilege. After all, value investors try to buy stocks that are cheap compared to business fundamentals like earnings, sales, and book value. They get excited when a stock of a good company is falling in price, because it means that, all things being equal, they can get a better deal. In fact, John Neff -- one of the most successful value investors of all-time -- said scouring the financial pages for stocks making new 52-week lows was one way he found investment ideas.

But remember, "cheap" and "falling" are two separate concepts (just as "expensive" and "rising" are). Sometimes a stock is so cheap that it can go on a tear and still be undervalued. Other times, a firm's business will excel as its shares surge, and earnings, sales, and/or book values keep up with (or outpace) the stock's price gain. That keeps valuations low.

In those situations, having strong momentum behind a stock isn't a negative -- it's actually an added boost. Some of history's best stock-pickers have found that stocks with strong momentum are often good bets to continue rising -- if they're still attractively valued. While buying a hot stock with an exorbitant valuation can be the equivalent of jumping on a rocket ship that's almost out of gas and about to plummet back to Earth, buying a hot stock that's still cheap is like jumping on a ship that has plenty of fuel left in the tank.

So, while commentators often try to play them off as opposites, momentum and value can -- and do -- peacefully coexist. Some of my Guru Strategies use both momentum and value metrics in choosing stocks. For example, the growth model I base on the writings of James O'Shaughnessy (whose study of quantitative investing approaches may be the most extensive ever performed) looks for stocks that have market capitalizations of at least $150 million; increased earnings per share in each year of the past half-decade; and price/sales ratios under 1.5. It then takes all stocks that pass those tests and ranks them by their 12-month relative strength -- a measure of how they've performed compared to all stocks in the market over the last year. Those with the highest relative strengths are then chosen.

My Motley Fool-inspired model, meanwhile, has an even tougher momentum criterion. It targets stocks with 12-month relative strengths of at least 90, meaning that they have outperformed at least 90% of all other stocks over that period. The Fool strategy, which is based on an approach laid out by Fool co-creators Tom and David Gardner, also uses a key valuation criterion: the PE-to-growth ratio, which mutual fund legend Peter Lynch pioneered. The "PEG" divides a firm's price/earnings ratio by its historical earnings growth rate; the Fool-based model looks for PEGs of 0.5 or below. This strategy has been my top performer over the long haul -- a 10-stock portfolio picked using the approach has averaged annualized returns of 16.0% since its mid-2003 inception. Over the same stretch, the S&P 500 has returned 6.4% annualized. My O'Shaughnessy-based growth portfolio has also beaten the S&P since its inception.

There is a side benefit to using a momentum component in your investment strategy: It can actually serve as a risk management tool -- stocks whose RSs drop significantly aren't viewed as highly by the strategy, and are likely to be removed from the portfolio. That essentially means the RS criterion acts as a stop-loss.

Research supports this idea. In a 2001 paper for the Journal of Technical Analysis, William K.N. Chan of HSBC Asset Management found that using stop-losses could add value to a portfolio, depending on what kind of strategy you used. For mean-reversion trading strategies -- that is, value approaches -- he found that there was a 73% probability that stop-losses improved performance. When it came to using stop-losses in trend-following strategies, Chan found "no significant evidence that it either improves or undermines performance in a consistent manner."

The bottom line here is to not let conventional thinking and overly simplistic commentators put you in a box. The false debate of value versus momentum isn't the only context in which conventional thinking gets you in trouble. "Market commentators and investment managers who glibly refer to 'growth' and 'value' styles as contrasting approaches to investment are displaying their ignorance, not their sophistication," Warren Buffett explained in his 2000 annual letter to Berkshire Hathaway shareholders. "Growth is simply a component -- usually a plus, sometimes a minus -- in the value equation."

To Buffett, all investing is about value, and assessing a company's growth prospects is simply one part of gauging value. Growth (and a myriad of other factors) can add a ton of value to companies whose shares may at first glance look on the pricey side.

Investing isn't just about growth or value or momentum; it's about all of them and more. Focus on just one, and you will be like a baseball team that focuses only on offense and does nothing to build a good defense or pitching staff. Just as such a team will likely fall short of its goals, you'll likely fall short of your investment goals if you fixate solely on one aspect of what makes an attractive stock while turning a blind eye to the others.

Editor-in-Chief: John Reese

The Fallen

As we rebalance the Validea Hot List, 10 stocks leave our portfolio. These include: Sasol Limited (Adr) (SSL), Marcus & Millichap Inc (MMI), World Acceptance Corp. (WRLD), Credit Acceptance Corp. (CACC), .

The Keepers

6 stocks remain in the portfolio. They are: Sanderson Farms, Inc. (SAFM), Chart Industries, Inc. (GTLS), Amtrust Financial Services Inc (AFSI), Lumber Liquidators Holdings Inc (LL), Santander Consumer Usa Holdings Inc (SC) and Heritage Insurance Holdings Inc (HRTG).

The Newbies

We are adding 10 stocks to the portfolio. These include: Apple Inc. (AAPL), Jones Lang Lasalle Inc (JLL), Eagle Bancorp, Inc. (EGBN), Foot Locker, Inc. (FL), .

Portfolio Changes

Newcomers to the Validea Hot List

Apple, Inc. (AAPL): The largest publicly traded company in the world is rejoining the Hot List this week. The tech sector giant has taken in nearly $225 billion in sales over the past year, and has a $700 billion market cap. Its fundamentals are impeccable: a 41% return on equity, 23% profit margins, 27% long-term revenue growth, and a 0.49 PE-to-Growth ratio.

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

Foot Locker (FL): This specialty athletic retailer operates nearly 3,500 stores in 23 countries in North America, Europe, Australia, and New Zealand, offering athletic footwear and apparel.

Foot Locker ($10 billion market cap) gets strong interest from my James O'Shaughnessy- and Peter Lynch-based models. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

Jones Lang LaSalle (JLL): Like Apple and Foot Locker, JLL is another former Hot List favorite. It's a financial and professional services firm specializing in real estate. It has over 200 corporate offices worldwide and operations in more than 1,000 locations in 80 countries, offering integrated real estate and investment management services on a local, regional and global basis to owner, occupier and investor clients.

JLL ($8 billion market cap) gets strong interest from my Peter Lynch- and James O'Shaughnessy-based strategies. To read more about it, scroll down to the "Detailed Stock Analysis" section.

Eagle Bancorp, Inc. (EGBN): This $1.5 billion market cap firm is the parent of EagleBank, a local community business bank with twenty-two offices in Maryland, Northern Virginia and Washington, DC. It also offers a complete line of competitive personal banking products and services.

Eagle is another favorite of my Lynch-based model. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

World Acceptance Corp. (WRLD): World Acceptance reported fiscal first-quarter profit of $23.6 million, or $2.71 per share, beating Wall Street expectations. Analysts surveyed by Zacks Investment Research on average forecast EPS of $2.38. Revenue was $137.2 million in the period, which fell short of the $142.5 million analysts expected, according to the Associated Press, however. Investors seemed to react more to the revenue miss than the earnings beat. Shares fell 11% the day of the announcement, though they began to bounce back in the following days. The Hot List is selling the position today, as others stocks' fundamentals now rate higher than Worlds'.

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

JLL   |   AFSI   |   HRTG   |   GTLS   |   SAFM   |   FL   |   LL   |   AAPL   |   EGBN   |   SC   |  

Jones Lang LaSalle Incorporated (JLL) is a financial and professional services firm specializing in real estate. The Company operates through four business segments. JLL provides real estate services through three business segments: the Americas, Europe, the Middle East and Africa (EMEA), and Asia Pacific. JLL's fourth business segment is LaSalle Investment Management (LaSalle). The Company provides a range of integrated property, project management and transaction services locally, regionally and globally through its Americas, EMEA and Asia Pacific operating segments. The Company manages its investment management business globally as LaSalle. The Company provides a range of real estate services to real estate owners, occupiers, investors and developers for a range of property types. The Company offers its products and services under the JLL, LaSalle Investment Management and Tetris brands.

Amtrust Financial Services, Inc. is an insurance holding company. Through its wholly owned subsidiaries, the Company provides specialty property and casualty insurance focusing on workers' compensation and commercial package coverage for small business, specialty risk and extended warranty coverage, and property and casualty coverage for middle market business. The Company operates through three segments. The Small Commercial Business segment provides workers' compensation and commercial package and other property and casualty insurance products. The Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans. The Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance.

Heritage Insurance Holdings, Inc. (Heritage Insurance), formerly Heritage Insurance Holdings, LLC, is a property and casualty insurance holding company. The Company is engaged in providing personal and commercial residential insurance. Through Its subsidiary, Heritage Property & Casualty Insurance Company (Heritage P&C), it provides personal residential insurance for single-family homeowners and condominium owners, rental property insurance and commercial residential insurance in the state of Florida. The Company is vertically integrated and control or manage all aspects of insurance underwriting, actulato analysis, distribution and claims processing, and adjusting. It has approximately 207,000 personal residential policies in force and approximately 2,400 commercial residential policies in force.

Chart Industries, Inc. (Chart) is a diversified manufacturer of engineered equipment engineered equipment for the industrial gas, energy, and biomedical industries. The Company's equipment and engineered systems are used for low-temperature and cryogenic applications. It operates through three segments: Energy & Chemicals (E&C), Distribution & Storage (D&S) and BioMedical. Its products include vacuum insulated containment vessels, heat exchangers, cold boxes and other cryogenic components. Its E&C and D&S segments manufacture products used in energy-related and industrial applications, such as the separation, liquefaction, distribution and storage of hydrocarbon and industrial gases. Through its BioMedical segment, it supplies cryogenic and other equipment used in the medical, biological research and animal breeding industries. The Company, through Thermax, Inc., provides cryogenic fluid vaporizers utilized in industrial gas, petro-chemical and liquefied natural gas applications.

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.

Foot Locker, Inc. is a retailer of shoes and apparel. The Company operates in two segments: Athletic Stores and Direct-to-Customers. The Athletic Stores segment is an athletic footwear and apparel retailer whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction and SIX:02, as well as the retail stores of Runners Point Group, including Runners Point and Sidestep. The Direct-to-Customers segment includes Footlocker.com, Inc. and other affiliates, including Eastbay, Inc., and the direct-to-customer subsidiary of Runners Point Group, which sell to customers through their Internet and mobile sites and catalogs. As of January 31, 2015, the Company operated 3,423 primarily mall-based stores in the United States, Canada, Europe, Australia and New Zealand. As of January 31, 2015, the Company operated a total of 78 franchised stores, of which 31 are in the Middle East, 27 in Germany and Switzerland, and 20 in the Republic of Korea.

Lumber Liquidators Holdings, Inc. (Lumber Liquidators) is a retailer of hardwood flooring, and hardwood flooring enhancements and accessories in North America. The Company's product categories include Solid and Engineered Hardwood; Laminate; Bamboo, Cork and Vinyl Plank, and Moldings and Accessories. The Company sells its products primarily to homeowners or to contractors on behalf of homeowners. The Company offers wood flooring under18 brand names, led by Bellawood, a collection of solid and engineered hardwood flooring, bamboo flooring, moldings and accessories. The Company also offers a range of flooring enhancements and installation accessories, including moldings, noise-reducing underlay and tools. It offers around 400 different flooring product stock-keeping units. As of February 23, 2015, Lumber Liquidators operated around 354 stores located in 46 states of the United States and nine store locations in Canada.

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.

Eagle Bancorp, Inc. is a bank holding company for EagleBank (the Bank). The Bank is the Company's principal operating subsidiary. The Bank is a chartered commercial bank. The Bank operates twenty two banking offices: seven in Montgomery County, Maryland; five located in the District of Columbia, and ten in Northern Virginia. The Bank offers a range of commercial banking services to its business and professional clients, as well as consumer banking services to individuals living or working in the service area. The Bank also provides commercial banking services to sole proprietorships, small, medium and large-sized businesses, partnerships, corporations, non-profit organizations and associations, and investors. The Bank offers a range of retail banking services to accommodate the individual needs of both corporate customers as well as the community the Bank serves. The Bank also offers online banking, mobile banking and a remote deposit service.

Santander Consumer USA Holdings Inc. is a holding company. The Company is a specialized consumer finance company focused on vehicle finance and unsecured consumer lending products. The Company offers various auto financing products and services to Chrysler customers and dealers under the Chrysler Capital brand. These products and services include consumer retail installment contracts and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. The Company also originates vehicle loans through a Web-based direct lending program, purchases vehicle retail installment contracts and services automobile and recreational and marine vehicle portfolios for other lenders. Its products and services include vehicle finance, and origination and servicing.

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.