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Executive Summary November 7, 2014

The Economy

Stocks are continuing to bounce back from their early fall doldrums, and more good data from the US economy has been supporting their rebound.

Private payroll processor ADP said the private sector added 230,000 jobs in October, the second highest figure of 2014. ADP also revised its September jobs-added estimate from 213,000 to 225,000. The Labor Department is slated to announce its October jobs numbers today, and investors will no doubt be keeping a close eye on the report.

New claims for unemployment have declined over the past two weeks, and in the most recent week were an impressive 20% lower than they were in the year-ago period. The four-week moving average of new claims continues to make long-term lows; in the most recent week it was the lowest it has been since April 2000. Continuing claims, the data for which lag new claims by a week, edged very slightly upward since our last newsletter but are 18.9% below year-ago levels.

Manufacturing and service sector data also remains strong. The Institute for Supply Management said manufacturing activity increased in October for the 17th straight month, doing so at an accelerating rate. In fact, the rate of increase was tied for the highest monthly reading since March 2011.The sub-indices for new orders and employment both increased, with new orders in particular making a big jump. The prices sub-index, meanwhile, declined rather sharply. It still remained at a level that indicated prices are rising, and given how high the prices sub-index has been, the decline may well be good news.

ISM also said the service sector expanded in October for the 57th straight month. The rate of expansion was down for the second straight month since August's record high, but was still at a very strong level. The new orders sub-index and the employment sub-index both remained at high levels. The prices sub-index, which had been quite elevated over the summer, fell but remained at a level indicative of price increases.

New home sales, meanwhile, edged higher by 0.2% in September, according to a new government report. While the monthly gain was minor, the year-over-year gain of 22.6% was quite impressive.

The latest consumer data from the Commerce Department showed that personal income rose 0.2% in September. Real disposable personal income was flat, while real personal consumption expenditures fell 0.2% as consumers tightened their wallets a bit after increasing expenditures sharply in August. That pushed the personal savings rate higher, to a very solid 5.6%.

Gas prices continue to tumble. A gallon of regular unleaded on average cost $2.96 as of Nov. 6, down 33 cents from a month earlier, according to AAA. In an environment in which wage growth has been meager, the gas price declines should give consumers a bit of a boost.

Last but not least, after six years, the Federal Reserve announced that it is ending its quantitative easing efforts. Citing "a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program" and "sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability," the Fed decided to end its asset purchase program in October. It is, however, maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities, and of rolling over maturing Treasury securities at auction. In other words, while the Fed won't be buying up huge piles of new bonds, its balance sheet will remain quite large, leaving monetary conditions quite accommodative.

Since our last newsletter, the S&P 500 returned 4.1%, while the Hot List returned 4.6%. So far in 2014, the portfolio has returned -12.7% vs. 9.9% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 217.8% vs. the S&P's 103.0% gain.

Portfolio Update

It's been a good fortnight for both the Hot List and the broader market. As of late morning trading on November 6, eight of the portfolio's ten holdings were in the black, with the two losers down less than 1%.

Leading the way were real estate operations firm Jones Lang LaSalle, which was up 10.2%, and Credit Acceptance Corp., which was up 10.1%. Both reported strong earnings, helping drive shares up. Jones Lang LaSalle reported profit of $104.3 million in its third quarter, or $2.30 per share. Earnings, adjusted for amortization costs, were $2.31 per share. Analysts were expecting earnings of $1.77 per share, the Associated Press said. Revenue was $1.37 billion, beating estimates of $1.15 billion.

Credit Acceptance, meanwhile, announced consolidated net income of $74.0 million, or $3.38 per diluted share, up from $65.1 million, or $2.75 per diluted share, for the same period in 2013. Total revenue was $181.7 million, up from $172.7 million a year ago.

Another big gainer was generic drugmaker Lannett Company, which was up just over 9%. It also reported strong earnings. Fiscal first-quarter net income was $34.9 million, or 94 cents per share, beating analysts' expectations of 83 cents per share, according to AP. It posted net sales of $93.4 million in the period, more than doubling its year-ago net sales.

With the economy continuing to improve and a number of its holdings putting up strong earnings results, the Hot List is hopefully turning the corner after a rough first three quarters of 2014. We'll see which of its holdings remain in the portfolio when we rebalance two weeks from now.

Editor-in-Chief: John Reese

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Guru Spotlight: John Neff

Most investors wouldn't give a fund described as "relatively prosaic, dull, conservative" a second glance. That, however, is exactly how John Neff described the Windsor Fund that he headed for more than three decades. And, while his style may not have been flashy or eye-catching, the returns he generated for clients were dazzling -- so dazzling that Neff's track record may be the greatest ever for a mutual fund manager.

By focusing on beaten down, unloved stocks, Neff was able to find value in places that most investors overlooked. And when the rest of the market caught on to his finds, he and his clients reaped the rewards. Over his 31-year tenure (1964-1995), Windsor averaged a 13.7 percent annual return, beating the market by an average of 3.1 percent per year. Looked at another way, a $10,000 investment in the fund the year Neff took the reins would have been worth more than $564,000 by the time he retired (with dividends reinvested); that same $10,000 invested in the S&P 500 (again with dividends reinvested) would have been worth less than half that after 31 years, about $233,000. That type of track record made the understated, low-key Neff a favorite manager of many other professional fund managers -- an "investor's investor", if you will.

How did Neff do it? By focusing first and foremost on value, and a key part of how he found value involved the Price/Earnings Ratio. While others have called him a "contrarian" or "value investor", Neff writes in John Neff on Investing that, "Personally, I prefer a different label: 'low price-earnings investor.' It describes succinctly and accurately the investment style that guided Windsor while I was in charge."

To Neff, the P/E ratio was key because it involved expectations. If investors were willing to buy stocks with high P/E ratios, they must be expecting a lot from them, because they are willing to pay more for each dollar of future earnings per share; conversely, if a stock has a low P/E ratio, investors aren't expecting much from it. Much like David Dreman, the great contrarian guru who we examined a few newsletters back, Neff found that stocks with lower P/E ratios -- and lower expectations -- tended to outperform, because any hint of improvement exceeded the low expectations investors had for them. Similarly, stocks with high P/Es often flopped, because even strong results couldn't match investors' expectations.

To Neff, however, the P/E wasn't always a lower-is-better ratio. If investors knew that a firm was a dog, they'd rightly avoid its stock, giving it a low P/E ratio but little in the way of future growth prospects. Because of that, he wrote that Windsor targeted stocks with P/E ratios between 40 and 60 percent of the market average.

While it was at the heart of his investment philosophy, the P/E ratio was also by no means the only metric Neff used to judge stocks. He wanted to see earnings growth, but here again it was not a case of more-is-better. A stock with too high a growth rate -- more than 20 percent -- could have trouble sustaining that growth over the long haul. He thus preferred to see growth between 7 and 20 percent per year, the kind of steady, unspectacular growth that could be sustained.

Sustainable growth also meant growth that was driven by sales -- not one-time gains or cost-cutting measures. Neff thus liked to see companies whose earnings growth and sales growth were rising at similar rates. (My Neff-based model interprets this as sales growth needing to be at least 7 percent per year, or at least 70 percent of EPS growth.)

One more key aspect of Neff's strategy involved dividends. He believed that many investors valued stocks strictly on their price appreciation potential, meaning that you can often essentially get their dividend payouts for free. He estimated that about two-thirds of Windsor's 3 percent per year market outperformance during his tenure came from dividends.

To make sure that his analysis captured dividend payments, Neff used the Total Return/PE ratio. This measure divides a stock's total return (that is, its EPS growth rate plus its dividend yield) by its P/E ratio. He looked for stocks whose Total Return/PE ratios doubled either the market average or their industry average.

In recent years, very few companies have passed all of my Neff-inspired model's tests. In fact, only one stock in the U.S. market currently gets a 100% score on the model. Here's a look at the stocks that currently make up my 10-stock Neff-based portfolio:

United Insurance Holdings Corp. (UIHC)
Banco Bradesco SA (BBD)
Itau Unibanco Holding SA (ITUB)
Home Loan Servicing Solutions (HLSS)
Starwood Property Trust (STWD)
Canadian Imperial Bank of Commerce (CM)
ResMed Inc. (RMD)
Franklin Resources (BEN)
Valero Energy Corporation (VLO)
AXIS Capital Holdings Limited (AXS)

I began tracking my Neff-based portfolio at the start of 2004, and it's had some significant ups and downs. In the past few years it was mostly downs, but it's started to rebound -- it's my top performer this year, returning 19.0% vs. 8.9% for the S&P 500. All in all, it is averaging annualized returns of 5.7% since inception, just ahead of the S&P 500's 5.6% annualized return (through Nov. 4). Keep in mind that while Neff believed dividends were very important (as do we), our system only can track returns without dividends.

Just like Neff himself, the Neff-based model often treads into the most unloved parts of the market. As it was when we last checked in on it in January, the portfolio is heavily concentrated in the financial sector, with seven of its ten holdings being financials. Most of them are dirt-cheap thanks to lingering fears about the economy and financial sector. By treading into such unloved areas, a value-focused strategy can languish for lengthy periods of time, and the Neff-based portfolio has indeed struggled in recent years. But Neff succeeded by staying disciplined, focusing on value, and having the patience to wait for others to recognize the value in his picks. That's what we've tried to do, and in 2014 it has paid off, as investors have begun to recognize the value in the Neff portfolio. Over the long term, I expect the strategy's picks will continue to demonstrate their value.

News about Validea Hot List Stocks

Zumiez Inc. (ZUMZ): On Nov. 5, Zumiez announced that total net sales for the four-week period ended November 1, 2014 increased 11.7% to $51.7 million, compared to $46.3 million for the year-ago period. The Company's comparable sales increased 3.1% vs. 1.2% for the year-ago period. The news helped Zumiez shares climb 5.5% since our last newsletter (as of late morning trading on November 6).

Valero Energy (VLO): On Nov. 4, Valero said third-quarter earnings more than tripled, amid strong results from its refining and ethanol segments, The Wall Street Journal reported. Profit was $1.06 billion, or $2 a share, up from $312 million, or 57 cents a share, a year earlier. Revenue declined 4.8% to $34.41 billion, but was well ahead of the $31.6 billion analysts polled by Thomson Reuters had projected.

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

AFSI   |   VLO   |   ZUMZ   |   AGCO   |   CACC   |   OVTI   |   LCI   |   MNST   |   JLL   |   ANIK   |  

Amtrust Financial Services, Inc. is a holding company. The Company is a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. The Company operates in four business segments: small commercial business, specialty program and personal lines reinsurance. The Company transacts business through 11 insurance company subsidiaries: Technology Insurance Company, Inc. (TIC), Rochdale Insurance Company (RIC), Wesco Insurance Company (WIC), Associated Industries Insurance Company, Inc. (AIIC), Milwaukee Casualty Insurance Company (MCIC), Security National Insurance Company (SNIC), AmTrust Insurance Company of Kansas, Inc. (AICK) and AmTrust Lloyd's Insurance Company of Texas (ALIC). In December 2013, the Company announced that it its wholly owned subsidiary completed the acquisition of Sagicor Europe Limited. In January 2014, the Company acquired Insco Dico Group.

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.

Zumiez Inc. (Zumiez) is a specialty retailer of action sports related apparel, footwear, equipment and accessories operating under the Zumiez brand name. As of January 28, 2012, the Company operated 434 stores in the United States and 10 stores in Canada. In addition, the Company operates a Website that sells merchandise online. At January 28, 2012, its stores averaged approximately 2,900 square feet. Its apparel offerings include tops, bottoms, outerwear and accessories, such as caps, bags and backpacks, belts, jewelry and sunglasses. Zumiez's footwear offerings primarily consist of action sports related athletic shoes and sandals. Its equipment offerings, or hardgoods, include skateboards, snowboards and ancillary gear, such as boots and bindings. The Company also offers a selection of other items, such as miscellaneous novelties.

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

Credit Acceptance Corporation (Credit Acceptance) is a provider of auto loans to consumers. The Company offers auto loans and related products and services to consumers through its network of Dealer-Partners. It refers to dealers who participate in the Company's programs as Dealer-Partners. Credit Acceptance has two programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, it advances money to Dealer-Partners (referred to as a Dealer Loan) in exchange for the right to service the underlying Consumer Loans. Under the Purchase Program, Credit Acceptance buys the Consumer Loans from the Dealer-Partners (referred to as a Purchased Loan) and keeps all amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans.

OmniVision Technologies, Inc. (OmniVision) designs, develops and markets integrated and semiconductor image-sensor devices. The Company's main products, image-sensing devices, which the Company refers to as CameraChip image sensors, capture an image electronically and is used in a number of consumer and commercial mass-market applications. The Company's CameraChip image sensors are manufactured using the complementary metal oxide semiconductor (CMOS), fabrication process and are single-chip solutions that integrate several distinct functions, including image capture, image processing, color processing, signal conversion and output of a fully processed image or video stream. The Company has also integrated its CameraChip image sensors with wafer-level optics, which the Company refers to as CameraCubeChip imaging devices. The Company's CameraCubeChip imaging device is a small footprint, total camera solution.

Lannett Company, Inc. is engaged in developing, manufacturing, marketing and distributing generic versions of branded pharmaceutical products. All of the Company's products manufactured and/or sold are prescription products. The Company's products containing Levo are produced and marketed with 12 varying potencies. In addition to generic Levo tablets, the Company also markets and distributes Unithroid tablets, a branded version of Levo, which is produced and marketed with 11 varying potencies. The Company's Levo tablets are used to treat hypothyroidism and other thyroid disorders. The Company's generic Levo tablets and Unithroid tablets are manufactured by Jerome Stevens Pharmaceuticals (JSP). As of June 30, 2012, the Company manufactured and/or distributed 30 products.

Monster Beverage Corporation is a holding company. The Company develops, markets, sells and distributes alternative beverage, such as non-carbonated ready-to-drink iced teas, lemonades, juice cocktails, single-serve juices and fruit beverages, ready-to-drink dairy and coffee drinks, energy drinks, sports drinks, and single-serve still water (flavored and unflavored) with beverages, including sodas that are considered natural, sparkling juices and flavored sparkling beverages. It has two reportable segments, namely Direct Store Delivery (DSD), whose principal products comprise energy drinks, and Warehouse (Warehouse), whose principal products comprise juice-based and soda beverages. The DSD segment develops, markets and sells products primarily through an exclusive distributor network. The Warehouse segment develops, markets and sells products directly to retailers.

Jones Lang LaSalle Incorporated (Jones Lang LaSalle), is a financial and professional services firm specializing in real estate. Jones Lang LaSalle has over 200 corporate offices worldwide and operations in more than 1,000 locations in 70 countries. The Company offers integrated real estate and investment management services on a local, regional and global basis to owner, occupier and investor clients. It delivers an array of Real Estate Services (RES) across its three geographic business segments: the Americas, Europe, Middle East and Africa (EMEA), and Asia Pacific. LaSalle Investment Management, a wholly owned member of the Jones Lang LaSalle group that consists of its fourth business segment, is a diversified real estate investment management company. In July 2014, Jones Lang LaSalle Inc acquired CLEO Construction Management (CLEO), a construction project management services firm that specializes in medical facilities.

Anika Therapeutics, Inc. (Anika) develops, manufactures and commercializes therapeutic products for tissue protection, healing and repair. These products are based on hyaluronic acid (HA), a naturally occurring, biocompatible polymer found throughout the body. As of December 31, 2011, Anika's wholly owned subsidiary, Anika Therapeutics S.r.l., had over 20 products commercialized, primarily in Europe. These products are also all made from hyaluronic acid, based on two technologies: HYAFF, which is a solid form of HA, and ACP gel, an autocross-linked polymer of HA.

Watch List

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


The names of individuals (i.e., the 'gurus') appearing in this report are for identification purposes of his methodology only, as derived by Validea.com from published sources, and are not intended to suggest or imply any affiliation with or endorsement or even agreement with this report personally by such gurus, or any knowledge or approval by such persons of the content of this report. All trademarks, service marks and tradenames appearing in this report are the property of their respective owners, and are likewise used for identification purposes only.

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Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. Past performance is not necessarily indicative of future results. Individual stocks mentioned throughout this web site may be holdings in the managed portfolios of Validea Capital Management, a separate asset management firm founded by Validea.com founder John Reese. Validea Capital Management, which is a separate legal entity and an SEC registered investment advisory firm, uses, in part, the strategies on the web site to select stocks for its clients.