Executive Summary  |   Portfolio  |   Guru Analysis  |   Watch List

Executive Summary July 17, 2015

The Economy

While investors seem heartened that Eurozone leaders have reached a deal to help Greece stave off a financial collapse, economic news at home has been more mixed over the past fortnight.

For starters, there was the June jobs report, which looked solid but had some big caveats. The economy added 223,000 jobs during June, the Labor Department said, with the unemployment rate falling to 5.3%, the lowest it has been since April 2008. The broader "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 10.5%, the lowest it has been since before Lehman Brothers collapsed and triggered the 2008-09 financial crisis.

On the down side, however, average hourly wages were flat vs. May, and the number of people not in the workforce jumped by more than 600,000. And the jobs-added figures for April and May were revised downward by a total of 60,000.

Good news came from the service sector, which expanded in June for the 65th straight month, according to the Institute for Supply Management, doing so at about the same strong pace it did in May. New orders also grew at a solid pace. Employment conditions weren't as strong as they were in May, but were still good.

Elsewhere, it continues to be a bumpy ride for the US consumer. After surging in May, retail and food service sales fell 0.3% in June, according to a new report from the Census Bureau. Compared to the year-ago period, they were up 2.9%, however, one of the better year-over-year gains we've seen in recent months.

Industrial production increased for only the second time this year, rising 0.3% in June, according to a new Federal Reserve report. The gains were driven by a 1.0% increase in mining output, which is likely a result of energy companies stabilizing after making big cutbacks amid the oil price declines. Utility output, which tends to be driven by seasonal factors, rose 1.5%. Manufacturing output was flat.

Speaking of energy, gas prices have indeed leveled off. A gallon of regular unleaded on average cost $2.78 as of July 15, down just slightly from $2.80 a month earlier, according to AAA. That's still about 23% below where it was a year ago. If the Iran nuclear deal goes through, significant amounts of Iranian oil could be released into world markets, putting new downward pressure on oil and gas prices.

Since our last newsletter, the S&P 500 returned 2.3%, while the Hot List returned -2.7%. So far in 2015, the portfolio has returned 10.2% vs. 3.2% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 256.4% vs. the S&P's 112.3% gain.

Portfolio Update

While it remains well ahead of the S&P 500 year-to-date, the past fortnight wasn't a good one for the Hot List. Seven of the portfolio's ten holdings were in the red since our last newsletter, as of mid-morning trading on Thursday.

The worst performer was auto loan firm Credit Acceptance Corp., which was down 8.6%. The stock has been an extremely strong performer over the past year, and hit a 52-week high just last week. The pullback may have been a case of investors tempering their enthusiasm, particularly with a new analyst initiating coverage on the firm and issuing a "sell" rating. Credit Acceptance's fundamentals remain very strong, however, as it still gets strong interest from two of my models and high scores from several others.

Another laggard was Sanderson Farms, which was down about 6%. Some bird flu outbreaks around the globe may have been hurting shares of the poultry producer. There has been a lot of short interest in the stock, but its fundamentals remain quite strong. Sanderson gets strong interest from three of my models and high marks from a few others.

The portfolio did have some nice winners over the past fortnight. Leading the way was Heritage Insurance Holdings, which was up more than 7%. Shares hit a new 52-week high and are up close to 20% since joining the portfolio on June 5. The gains may be the result of continuing momentum after a few consecutive quarters of very strong earnings and sales growth.

Also performing well was commercial real estate firm Marcus & Millichap, which gained about 5%. There didn't seem to be a stock-specific catalyst for the gains, but M&M is another firm that has been producing excellent growth over the past year and has strong share price momentum.

Despite a down couple weeks, the Hot List remains well ahead of its benchmark for the year and the long-term, and its holdings have extremely strong fundamentals. On average, its 10 holdings have a 5-year earnings per share growth rate of over 20% and trade for less than 13 times earnings. That combination of strong growth and good value bodes well going forward. In two weeks, we will rebalance the portfolio, and check back in on how the current holdings are faring.

Editor-in-Chief: John Reese

Guru Spotlight: Warren Buffett

For many investors, the hardest part of investing isn't deciding which stocks to pick -- it's knowing when to sell. So given the difficulty of selling, and his penchant for simple, out-of-the-box thinking, it shouldn't be too much of a surprise that the great Warren Buffett says his favorite time to sell a stock is, well, never.

Consider what Buffett wrote in his 1988 better to Berkshire Hathaway shareholders:

In 1988 we made major purchases of Federal Home Loan Mortgage Pfd. and Coca Cola. We expect to hold these securities for a long time. In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.

To Buffett, stellar businesses are steady, reliable compounding machines, and ideally he would rather hold onto one of them forever than try to make a profit by jumping in and out of other less worthy stocks at the right times. But that doesn't mean Buffett and Berkshire won't ever sell a stock. Just about every quarter, the company will make some adjustments to its holdings, and sometimes it will even make extremely significant changes. For example, in last year's fourth quarter, Berkshire sold off its entire 41 million share stake in Exxon Mobil amid tumbling oil prices. Exxon had been Berkshire Hathaway's eighth-largest position, but the firm ditched the oil giant after holding it for only about a year and a half.

When Buffett and Berkshire do sell, however, it doesn't seem to be because they are looking to make a quick gain or because a short-term fear has arisen. Instead, it's because the conditions that led to their initial bullish thesis have changed. Generally, that's what we do, though the way we put that idea into practice differs significantly from how Buffett operates. We reassess our holdings every month, as you know, to see if their fundamentals and financials are holding up. Our belief is that if you buy a stock because it has, say, a low P/E ratio, high return on equity, and no long-term debt, you should unload it if and when it no longer has those qualities, be it a month from now or five years from now.

Compared to quarterly or annual rebalancing approaches (which we also track), this monthly rebalancing system seems to have helped my Buffett-based model maximize returns. Check out the returns for our Buffett portfolios using various rebalancing methods:

Buffett-Based 10-Stock Portfolio, Monthly Rebalancing Approach

Screen Shot 2015-07-16 at 12.44.04 PM

Buffett-Based 10-Stock Portfolio, Quarterly Rebalancing Approach

Screen Shot 2015-07-16 at 12.44.18 PM

Buffett-Based 10-Stock Portfolio, Annual Rebalancing Approach

Screen Shot 2015-07-16 at 12.44.33 PM

The monthly rebalancing approach also has the best annualized returns among our three 20-stock Buffett portfolios.

Now, rebalancing frequencies will certainly affect trading costs, which in turn will affect your net returns, and the model portfolios we track do not include trading fees (or dividends). And there are tax implications to more frequent trading, too. Keep in mind, however, that while our monthly rebalanced 10-stock Buffett portfolio has the ability to change over all of its holdings every month, it has been far from a rapid-fire trading vehicle. Three of its current holdings have been in the portfolio for more than a year, and one of those -- Ross Stores -- has been a holding since October 2012. Coach, Inc., spent nearly five years in the portfolio before it was replaced last August.

The portfolio's lower turnover rate is a result of the stock-picking criteria the Buffett model uses. It requires a company to have a decade of persistent earnings growth, a decade of strong returns on equity, and a decade of strong returns on retained earnings. While a lot of companies might have a good year or two or three, very few are able to put up a decade of excellence, which requires that the firm perform well during good economic times and bad times as well. So there are not going to be scores of new stocks popping up every month that pass the strategy. Plus, companies that can meet those targets often have a durable competitive advantage, so they continue to meet the targets as time rolls on and stay in the portfolio. In addition, the model also looks at certain fundamentals like earnings and return on equity on a full-year basis, so a business's quarterly ups and downs don't always have an immediate impact on its stock's rating.

That being said, it does appear that having the ability to more frequently ditch stocks whose fundamentals deteriorate rapidly, and the ability to shift from one "Buffett-type" stock to another that is cheaper, have added value to the monthly rebalanced portfolio.

All of this is not to say that I think Buffett should be rebalancing Berkshire's portfolio every month. When you are managing a $100 billion portfolio with many multi-billion-dollar positions, buying and selling stocks presents logistical challenges that individual investors don't have to deal with. For our portfolios, the monthly rebalancing seems to generate the best gross returns, but for different strategies and circumstances different frequencies may be best. To me, the key broader point is that you sell a stock not when it has a bad month in terms of price performance, or when scary headlines about it surface, or when it reaches a certain price target. You sell a stock when the reasoning used to buy it no longer holds up. If you can do that with consistency and discipline, you should succeed no matter what you're rebalancing frequency is.

News about Validea Hot List Stocks

Heritage Insurance Holdings, Inc. (HRTG): Heritage has continued to make new 52-week highs over the past fortnight. There didn't appear to be a clear catalyst for the stock's recent rise -- it is up close to 20% since joining the portfolio on June 5. Heritage has posted several quarters in a row of very strong earnings, so the recent gains may be the result of continuing earnings-driven momentum.

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   |   SAFM   |   HRTG   |   LL   |   GTLS   |   WRLD   |   SC   |   SSL   |   MMI   |   CACC   |  

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.

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.

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.

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.

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.

World Acceptance Corporation operates a small-loan consumer finance business in fourteen states and Mexico. The Company is engaged in the small-loan consumer finance business, offering short-term small loans, medium-term larger loans, related credit insurance and ancillary products and services to individuals. The Company offers standardized installment loans of between $300 and $4,000 through 1,271 offices in Alabama, Georgia, Illinois, Indiana, Kentucky, Louisiana, Mississippi, Missouri, New Mexico, Oklahoma, South Carolina, Texas, Tennessee, Wisconsin and Mexico as of March 31, 2014. The Company serves individuals with limited access to consumer credit from banks, credit unions, other consumer finance businesses and credit card lenders. In the United States offices, the Company also offers income tax return preparation services to its customers and others.

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.

Sasol Limited (Sasol) is a South Africa-based international integrated energy and chemicals company. The Company develops and commercializes technologies, builds and operates facilities to produce a range of product streams, including liquid fuels, high-value chemicals and low-carbon electricity. The Company's operations are organized into three focused business clusters: South African Energy Cluster; International Energy Cluster and Chemical Cluster. The South African Energy Cluster is involved in coal mining, gas production, synfuels manufacturing and oil refining. The International Energy Cluster manages the Company's oil and gas business outside South Africa. The Chemical Cluster is involved in making polymers, solvents, olefins and surfactants and other chemicals.

Marcus & Millichap, Inc. is a brokerage firm specializing in commercial real estate investment sales, financing, research and advisory services. The Company also offers market research, consulting and advisory services to developers, lenders, owners and investors. It also offers two services to its clients: commercial real estate investment brokerage and financing. The Company divides the commercial real estate market into three segments by investment: Private client segment, which include properties with prices under $10 million; Hybrid segment, which include properties with prices equal to or over $10 million and less than $20 million, and Institutional segment, which include properties with prices of $20 million and above. As of December 31, 2014, the Company had nearly 1,500 investment sales and financing professionals in 78 offices in the United States and Canada that provide investment brokerage and financing services to sellers and buyers of commercial real estate.

Credit Acceptance Corporation (Credit Acceptance) is a provider of financing programs to automobile dealers that enable them to sell vehicles to consumers. The Company's financing programs are offered through a nationwide network of automobile dealers; from repeat and referral sales generated by customers, and from sales to customers responding to advertisements for it products. The Company has two programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, it advances money to dealer (Dealer Loan) in exchange for the right to service the underlying consumer loans. Under the Purchase Program, the Company buys the consumer loans from the dealer (Purchased Loan) and keeps all amounts collected from the consumer. Its target market is independent and franchised automobile dealers in the United States. It provides dealers the ability to offer vehicle service contracts to consumers through its relationships with third-party providers (TPPs).

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.