Economy & Markets

In January, it seemed like this year in the market was going to be a repeat of 2017, with stocks driven higher by tech giants and an economy charging ahead on tax cuts and deregulation. Yet, as of halfway through the year, the S&P 500 is only up 1.7%, the worst showing in three years. The trades that were working, like semiconductors and small caps, started to peter out toward the end of June.

To be sure, the S&P continued to be dominated by technology stocks, with the sector up nearly 11% for the year thus far, but consumer discretionary stocks have caught up, rising 9% in the last three months. With just one trading day left in the quarter, only four S&P sectors were positive for the year. Telecommunications, financials, utilities, industrials, materials and consumer staples were all down.

Volatility rushed back into the market in late January and February after a period of historic lows. Panic about rising interest rates took down the major stock indexes, though they have recovered. As the winter turned to spring and into summer, other fears piled on in a constant push and pull between bull and bear. Corporate earnings were gangbusters. But the much discussed synchronized global economic growth started to derail. Trade wars threatened to erupt, and companies were forced to think about how tariffs on their exports might affect the bottom line. The effect of tax cuts were expected to taper off or at least slow down for the remainder of the year.

The bears now have new momentum. If there are trade wars with China and the European Union, that could cut into profit for broad sectors of the S&P, but especially for industrials, technology and material goods makers.

Interest rates are another issue. While the Fed has been hiking the short term rates, the longer-term rates have remained in a stubbornly narrow band. When the difference between the two narrows or inverts, it's a signal of a possible economic downturn ahead. Financials are also not benefitting as they normally would in a rising rate environment.

Small cap U.S. stocks are a big beneficiary in the current environment. They are seen as being shielded from the effects of trade conflict and a strong U.S. dollar, which hits larger, multinational companies. Money is coming out of emerging markets stocks and funds and coming back home.

The growth trajectory of corporate profits may be slowing in the coming quarters, but there is still expected to be growth. The tax cuts have put a tailwind behind the numbers, and the U.S. economy is still growing. Companies are also buying back stock in record amounts, and that is supporting prices. But the outlook is certainly murkier than before. Expect more volatility and uncertainty to prevail.

As for Validea's model portfolios, it is perhaps not surprising that the top performer is the small-cap growth model tracking the style of the Motley Fool, which is up 15%. Other growth styles are also doing well, the Growth model tracking Martin Zweig (up 4.9%) and the momentum model (up 3.3%). The earnings yield model tracking Joel Greenblatt is up 6.4%. The value style models are not keeping pace, however. Models tracking Warren Buffett and Benjamin Graham styles are up just 0.5% and 0.4%, respectively. The worst performing model is the one tracking the blended growth and value style of James O'Shaughnessy, down 11.2%.

Some positive numbers:

1. Sales of new U.S. single-family homes increased more than expected in May as sales in the South surged to their highest level in nearly 11 years.

2. The Conference Board's Leading Economic Index increased 0.2 percent in May, the seventh month of gains.

3. Data showed a sharp narrowing in the goods trade deficit last month, and solid increases in retail and wholesale inventories, the latest indications that the economy was accelerating this quarter.

Some not-so-positive numbers:

1. Global equity funds had outflows of $12.4 billion in June, a level not seen since October 2008, Trim Tabs said.

2. Gross domestic product increased 2 percent annually in January through March, Commerce said, but that was down from the 2.2 percent pace revision last month.

3. U.S. companies had a record $6.3 trillion of debt, according to S&P Global, and a record $2.1 trillion in cash to pay it down. But the riskiest borrowers were more levered than in the past.

Recommended Reading

Volatility and bear markets are good for advisory businesses, which tend to get more customers that way, not surprisingly. There are some lessons to be learned here, says Mark Hulbert, who wrote a recent MarketWatch column linked below. First, market timing is a bad idea for most investors, who don't have the battle scars and mental stamina to ignore impulses. That's why picking an advisor with a good track record and having realistic expectations and goals are important. Here are some more articles and blog posts in case you missed them.

Top Picks Lately the market has been dominated by large-cap tech companies, which drive a huge share of the daily market swings. MarketWatch recently wrote that even a well-diversified portfolio can lag the market if it doesn't own the top profit generators. Read more

Fund Winners Morningstar recently said that while investors are leaving actively managed funds, a lot of the outflows are going to "winning" large growth mutual funds. Read more

Dirty Secret When volatility spikes and investors feel nervous, subscriptions to advisory services go up, notes Mark Hulbert in MarketWatch. The dirty little secret is bear markets are good for business. Read more

Emerging danger Harvard professor Carmen Reinhart told Bloomberg the opportunity in emerging markets might not be a strong as it seems. Rising U.S. interest rates pressure emerging markets because about two-thirds of emerging market debt is dollar-denominated. Read more

Data Mining When it comes to factor investing, data mining presents a huge problem, a recent article in Advisor Perspectives found. True relationships can be obscured by randomness and noise and even back-tested results don't guarantee future performance. Read more

Bogle's Thoughts Barron's recently interviewed Vanguard's Jack Bogle, the indexing pioneer, and asked him about the "age of the ETF." He fears ETFs are speculative and encourage selling at the bottom and buying at the top. Read more

1960s Lessons The late 1960s may provide some clues to today, according to BlackRock strategists. Late-cycle fiscal stimulus then led to aggressive Fed tightening, and then to a drop in stocks and bonds, Bloomberg reports. Read more

Oil Wells Oil company stocks are cheap relative to their own history and to the current market, according to a recent article in The Wall Street Journal. That compares to high-flying tech stocks. Both sectors could have more gains if sentiment holds. Read more

Einhorn Profile Institutional Investor profiled hedge fund manager David Einhorn, whose Greenlight Capital has been struggling with big bets that have gone against it. The story said his adherence to a value investing style has limited his options. Read more

Pension Woes In California, local governments threatened by pension costs have urged the state's public pension fund to "think out of the box" to beat its current 7% return projections. Read more

Small-cap Gains Momentum may be stalling in global stocks, but small-caps have continued to climb thanks to strong U.S. growth trends and the notion that small companies are shielded from trade wars and tariffs. Read more

Passive Worries Larry Swedroe says people shouldn't worry that index funds have taken on some outsized influence on the market. Just 20% of the global equity market is in index funds. And passive investors ride the coattails of active managers. Read more

Hot List Performance Update/p>

Since our last newsletter, the S&P 500 returned -2.4%, while the Hot List returned -3.4%. So far in 2015, the portfolio has returned -8.7% vs. 1.6% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 231.9% vs. the S&P's 171.5% gain.


The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Bofi Holding, Inc. (BOFI), Micron Technology, Inc. (MU), Lgi Homes Inc (LGIH) and Svb Financial Group (SIVB).

The Keepers

6 stocks remain in the portfolio. They are: Thor Industries, Inc. (THO), Credit Acceptance Corp. (CACC), Sanderson Farms, Inc. (SAFM), Universal Forest Products, Inc. (UFPI), Seacoast Banking Corporation Of Florida (SBCF) and New Residential Investment Corp (NRZ).

The New Additions

We are adding 4 stocks to the portfolio. These include: Magna International Inc. (Usa) (MGA), Schnitzer Steel Industries, Inc. (SCHN), Acuity Brands, Inc. (AYI) and Trinet Group Inc (TNET).

Latest Changes

Additions  
MAGNA INTERNATIONAL INC. (USA) MGA
SCHNITZER STEEL INDUSTRIES, INC. SCHN
ACUITY BRANDS, INC. AYI
TRINET GROUP INC TNET
Deletions  
BOFI HOLDING, INC. BOFI
MICRON TECHNOLOGY, INC. MU
LGI HOMES INC LGIH
SVB FINANCIAL GROUP SIVB

Common Mistakes in Factor Investing

Most investors hate admitting mistakes, but those are often the most valuable lessons.

Even the world's savviest of investors make them, for starters. Michael Batnick chronicled them and their lessons in his new book "Big Mistakes: The Best Investors and Their Worse Investments." In it, he writes about Benjamin Graham, Warren Buffett, Chris Sacca and Stanley Druckenmiller, arguably among the greatest of all time.

Graham lost 70% of his money during the Crash of 1929 and Great Depression. Buffett paid for a company that no longer exists with stock that is now worth $7 billion. Sacca passed on investing in Dropbox and Snap. Druckenmiller bought tech stocks during the bubble.

Not surprisingly, these gurus spend a lot of time ruminating over their failures. More so than over their successes.

That's human nature. It's easier to assume your success comes from your own ability. Failure? That's bad luck or other outside circumstances beyond our control. This mindset can be damaging for an investor because it glosses over the opportunity to learn from those mistakes. Own it, and perhaps the same thing won't happen in the future.

Qualitative and factor-based investing would seem to be the logical answer for investors who want to avoid making mistakes. The truth is in the numbers. Computers don't have impulses, so the results should be less prone to bias. But that isn't always the case. There are still plenty of ways to make errors.

1. Believing the past is bound to repeat itself.

Factor investing is a way to boost returns by focusing on nuances, and the idea is that your odds of outperforming increase by relying on one or more factors in your portfolio. But the problem is factors, like other strategies, can run out of gas. What has worked before with one set of variables stops working or deviates. And there's no telling when or if it will recover.

Take a look at one of the tenets of value investing: Price to book. Despite decades of success and plenty of research supporting it as an indicator of value, in the current market, price to book as an indicator has failed. Corey Hoffstein of Newfound Research found that the factor hasn't established new highs in over a decade, and many investors no longer consider it to be a valid stand-alone factor. O'Shaughnessy Asset Management concluded that changes to accounting rules have made it a less valuable measurement of value.

So here's the first lesson: What has worked in the past is not 100% predictive of future success, something investors need to know and embrace.

2. Performance doesn't always match with an investor's goals.

There's that saying that the market can remain irrational for longer than you can stay solvent. Investors may gravitate to proven long-term strategies, but they need to consider the time horizon. Price to book, it has been shown, is successful but over more than a half century, longer than many investors are actively investing. Are you able to wait that long? Or are your investments made with different goals in mind? Retirement portfolios may be able to withstand short-term underperformance, considering they need to be invested over many decades. But a down payment for a house or an account for a child's college education have far shorter shelf lives. Investors picking factors have to have complete buy-in. Many believe they do when they start out; many realize they don't have the stamina after a period of underperformance.

3. Factor investing isn't free of emotion or bias.

Computers may make things easier, but there are still decisions humans have to make. One of them is coding the computer. A human has to pick what factor to follow, or even the mix of factors. Some factors have a better track record, and it's up to human judgment to find the ones that are going to sustain that performance or even turn around from a period of underperformance. Statistics can deceive. And circumstances, like accounting rule changes, can alter the trajectory. Even the best investors need to use their human reasoning to recognize where they went wrong. Buffett steered clear of technology stocks for years and admits he missed out. He has recently embraced Apple stock. Factor investing can eliminate bad decisions but it isn't perfect.

Following a disciplined, replicable strategy with consistency can eliminate a lot of mistakes but not all of them. It can increase your odds of success if you are realistic about your goals.

At Validea, we use investment strategies inspired by some of history's most successful investors, including Graham, Buffett, Peter Lynch and Ken Fisher. These strategies are built on key fundamental and financial characteristics that help identify good buy prospects.

But no strategy will beat the market every month or even every year. If that's your goal, you might end up just jumping from strategy to strategy chasing returns or the hottest stocks. This is a recipe for buying high and selling low.

It's easy to get swept up in an exciting story surrounding a stock (and buy it) or get consumed by a negative story (and sell it). But doing so without first taking a look at the numbers can lead to ill-fated actions. Good investors don't let hype influence their decisions.

By taking a step back to find perspective and by staying focused on what matters and adhering to a sound investment process, you can help avoid many of the mistakes that get investors in trouble.

Newcomers to the Hot List

Acuity Brands Inc. (AYI) -- This commercial and residential lighting manufacturer scores highly on the models tracking the styles of Peter Lynch, Kenneth Fisher and Joel Greenblatt.

Magna International (MGA) -- This global automotive supplier scores highly on the models tracking the styles of James O'Shaughnessy, Peter Lynch and Kenneth Fisher.

Schnitzer Steel Industries Inc. (SCHN) -- This metal recycler scores highly on the models tracking the styles of Peter Lynch, Kenneth Fisher and Benjamin Graham.

TriNet Group Inc. (TNET) -- This human resources services provider scores highly on the model tracking the style of James O'Shaughnessy and on Validea's momentum tracker.

News on Hot List Stocks

Magna International said it would buy the Italian auto lighting company Olsa Spa for $267 million.

Schnitzer Steel reported fiscal third quarter income of $37.4 million on revenue of $652 million.


Portfolio Holdings
Ticker Date Added Return
THO 4/6/2018 -14.1%
CACC 3/9/2018 3.9%
SCHN 6/29/2018 TBD
TNET 6/29/2018 TBD
SBCF 5/4/2018 15.9%
NRZ 5/4/2018 0.4%
MGA 6/29/2018 TBD
AYI 6/29/2018 TBD
SAFM 4/6/2018 -8.4%
UFPI 6/1/2018 -2.5%


Guru 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

THO   |   CACC   |   SCHN   |   TNET   |   SBCF   |   NRZ   |   MGA   |   AYI   |   SAFM   |   UFPI   |  

THOR INDUSTRIES, INC.

Strategy: P/E/Growth Investor
Based on: Peter Lynch

Thor Industries, Inc. manufactures a range of recreational vehicles (RVs) in the United States and sells those vehicles primarily in the United States and Canada. The Company's segments include towable recreational vehicles, which consists of the operations of Airstream, Inc. (Airstream) (towable); Heartland Recreational Vehicles, LLC (Heartland) (including Bison Coach, LLC (Bison), Cruiser RV, LLC (CRV) and DRV, LLC (DRV)); Jayco, Corp. (Jayco) (including Jayco towable, Starcraft and Highland Ridge), Keystone RV Company (Keystone) (including CrossRoads and Dutchmen) and K.Z., Inc. (KZ) (including Livin' Lite RV, Inc. (Livin' Lite)); motorized recreational vehicles, which consists of the operations of Airstream (motorized), Jayco (including Jayco motorized and Entegra Coach) and Thor Motor Coach, Inc. (Thor Motor Coach), and Other, which includes the operations of its subsidiary, Postle Operating, LLC (Postle).


DETERMINE THE CLASSIFICATION:

This methodology would consider THO a "fast-grower".


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (10.62) relative to the growth rate (27.41%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for THO (0.39) is very favorable.


SALES AND P/E RATIO: PASS

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold. THO, whose sales are $8,389.5 million, needs to have a P/E below 40 to pass this criterion. THO's P/E of (10.62) is considered acceptable.


INVENTORY TO SALES: PASS

When inventories increase faster than sales, it is a red flag. However an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for THO was 8.81% last year, while for this year it is 6.35%. Since inventory to sales has decreased from last year by -2.46%, THO passes this test.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for THO is 27.4%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for THO (4.29%) to be exceptionally low (equity is at least ten times debt). This ratio is one quick way to determine the financial strength of the company.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for THO (4.58%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for THO (2.78%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

CREDIT ACCEPTANCE CORP.

Strategy: Contrarian Investor
Based on: David Dreman

Credit Acceptance Corporation offers financing programs that enable automobile dealers to sell vehicles to consumers. The Company's financing programs are offered through a network of automobile dealers. The Company has two Dealers financing programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, the Company advances money to dealers (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 dealers (Purchased Loan) and keeps the amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans. As of December 31, 2016, the Company's target market included approximately 60,000 independent and franchised automobile dealers in the United States. The Company has market area managers located throughout the United States that market its programs to dealers, enroll new dealers and support active dealers.

MARKET CAP: PASS

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. CACC has a market cap of $6,778 million, therefore passing the test.


EARNINGS TREND: FAIL

A company should show a rising trend in the reported earnings for the most recent quarters. CACC's EPS for the latest quarter is not greater than the prior quarter, (from earliest to most recent quarter) 14.13, 6.17. Hence the stock fails this test, but the investor should evaluate this company qualitatively to see if it qualifies under this methodology's "exception rule".


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: FAIL

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. CACC's EPS growth rate over the past 6 months (18.88%) has beaten that of the S&P (5.00%), but CACC's estimated EPS growth for the current year is (-10.64%) while that of the S&P is (81.02%), therefore failing this test.


This methodology would utilize four separate criteria to determine if CACC is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. CACC's P/E of 11.54, based on trailing 12 month earnings, meets the bottom 20% criterion (below 12.17), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: FAIL

The P/CF of a company should be in the bottom 20% of the overall market. CACC's P/CF of 11.05 does not meet the bottom 20% criterion (below 7.08), and therefore fails this test.


PRICE/BOOK (P/B) VALUE: FAIL

The P/B value of a company should be in the bottom 20% of the overall market. CACC's P/B is currently 4.11, which does not meet the bottom 20% criterion (below 1.11), and it therefore fails this test.


PRICE/DIVIDEND (P/D) RATIO: FAIL

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). CACC's P/D is not available, and hence an opinion cannot be rendered at this time.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


PAYOUT RATIO: PASS

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for CACC is 0.00%. Unfortunately, its historical payout ratio is not available. Nonetheless it passes the payout criterion, as this is a very low payout.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 17.85%, and would consider anything over 27% to be staggering. The ROE for CACC of 42.32% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: PASS

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. CACC's pre-tax profit margin is 52.27%, thus passing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. CACC's current yield is not available (or one is not paid) at the present time, while the market yield is 2.58%. Hence, this criterion cannot be evaluated.

SCHNITZER STEEL INDUSTRIES, INC.

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Schnitzer Steel Industries, Inc. is a recycler of ferrous and nonferrous scrap metal, including end-of-life vehicles, and a manufacturer of finished steel products. The Company operates through two segments: the Auto and Metals Recycling (AMR) business and the Steel Manufacturing Business (SMB). The AMR segment collects and recycles auto bodies, rail cars, home appliances, industrial machinery, manufacturing scrap and construction and demolition scrap from bridges, buildings and other infrastructure. AMR's primary products include recycled ferrous and nonferrous scrap metal. The SMB segment produces finished steel products such as rebar, wire rod, coiled rebar, merchant bar and other specialty products using 100% recycled metal sourced from AMR. SMB's products are primarily used in nonresidential and infrastructure construction in North America. SMB operates a steel mini-mill in McMinnville, Oregon that produces finished steel products using recycled metal and other raw materials.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Smokestack (cyclical) companies with a Price/Sales ratio between .4 and .8 represent good values according to this methodology. SCHNpasses this test as its P/S of 0.42 based on trailing 12 month sales, falls within the "good values" range for cyclical companies.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. SCHN's Debt/Equity of 28.08% is acceptable, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. SCHN is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in SCHN At this Point

Is SCHN a "Super Stock"? NO


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-Smokestack(non-cyclical) companies with a Price/Sales ratio between .75 and 1.5 are good values. Otherwise, Smokestack(cyclical) companies with a Price/Sales ratio between .4 and .8 represent good values. SCHN's P/S ratio of 0.42 falls within the "good values " range for cyclical industries and is considered attractive.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. SCHN's inflation adjusted EPS growth rate of 37.65% passes the test.


FREE CASH PER SHARE: PASS

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. SCHN's free cash per share of 1.25 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: FAIL

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. SCHN, whose three year net profit margin averages -3.03%, fails this evaluation.

TRINET GROUP INC

Strategy: Growth/Value Investor
Based on: James P. O'Shaughnessy

TriNet Group, Inc. is a provider of human resources (HR) solutions for small to medium-sized businesses (SMBs). The Company's HR solutions include services, such as multi-state payroll processing and tax administration, employee benefits programs, including health insurance and retirement plans, workers' compensation insurance and claims management, employment and benefit law compliance, and other services. The Company provides an HR technology platform with online and mobile tools that allow its clients and their worksite employees (WSEs) to store, view and manage their HR-related information and conduct a range of HR-related transactions anytime and anywhere. The Company's HR products and solutions include capabilities, such as technology platform, HR expertise, benefits and compliance. The Company's clients are distributed across a range of industries, including technology, life sciences, financial services, property management, retail, manufacturing and hospitality.


MARKET CAP: PASS

The first requirement of the Cornerstone Growth Strategy is that the company has a market capitalization of at least $150 million. This will screen out the companies that are too illiquid for most investors, but still include a small growth company. TNET, with a market cap of $3,771 million, passes this criterion.


EARNINGS PER SHARE PERSISTENCE: PASS

The Cornerstone Growth methodology looks for companies that show persistent earnings growth without regard to magnitude. To fulfill this requirement, a company's earnings must increase each year for a five year period. TNET, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 0.06, 0.22, 0.44, 0.85 and 2.49, passes this test.


PRICE/SALES RATIO: PASS

The Price/Sales ratio should be below 1.5. This value criterion, coupled with the growth criterion, identify growth stocks that are still cheap to buy. TNET's Price/Sales ratio of 1.13, based on trailing 12 month sales, passes this criterion.


RELATIVE STRENGTH: PASS

The final criterion for the Cornerstone Growth Strategy requires that the Relative Strength of the company be among the top 50 of the stocks screened using the previous criterion. This gives you the opportunity to buy the growth stocks you are searching for just as the market is embracing them. TNET, whose relative strength is 89, is in the top 50 and would pass this last criterion.

SEACOAST BANKING CORPORATION OF FLORIDA

Strategy: Small-Cap Growth Investor
Based on: Motley Fool

Seacoast Banking Corporation of Florida is a bank holding company. The Company's principal subsidiary is Seacoast National Bank, a national banking association (the Bank). The Company and its subsidiaries offer an array of deposit accounts and retail banking services, engage in consumer and commercial lending and provide a range of trust and asset management services, as well as securities and annuity products to its customers. The Company, through its bank subsidiary, provides a range of community banking services to commercial, small business and retail customers, offering a range of transaction and savings deposit products, treasury management services, brokerage, and secured and unsecured loan products, including revolving credit facilities, letters of credit and similar financial guarantees, and asset based financing. The Bank also provides trust and investment management services to retirement plans, corporations and individuals.


PROFIT MARGIN: PASS

This methodology seeks companies with a minimum trailing 12 month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns. A true test of the quality of a company is that they can sustain this margin. SBCF's profit margin of 24.85% passes this test.


RELATIVE STRENGTH: FAIL

The investor must look at the relative strength of the company in question. Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive. Companies whose price has been rising much quicker than the market tend to keep rising. SBCF, with a relative strength of 78, fails this test.


COMPARE SALES AND EPS GROWTH TO THE SAME PERIOD LAST YEAR: PASS

Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for SBCF (90.00% for EPS, and 36.05% for Sales) are good enough to pass.


INSIDER HOLDINGS: FAIL

SBCF's insiders should own at least 10% (they own 1.65%) of the company's outstanding shares. This does not satisfy the minimum requirement, and companies that do not pass this criteria are less attractive.


CASH FLOW FROM OPERATIONS: PASS

A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. SBCF's free cash flow of $1.00 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

SBCF's profit margin has been consistent or even increasing over the past three years (Current year: 22.37%, Last year: 19.72%, Two years ago: 19.02%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise.


R&D AS A PERCENTAGE OF SALES: NEUTRAL

This criterion is not critically important for companies that are not high-tech or medical stocks because they are not as R&D dependant as companies within those sectors. Not much emphasis should be placed on this test in SBCF's case.


CASH AND CASH EQUIVALENTS: PASS

SBCF's level of cash $104.0 million passes this criteria. If a company is a cash generator, like SBCF, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.


"THE FOOL RATIO" (P/E TO GROWTH): FAIL

The "Fool Ratio" is an extremely important aspect of this analysis. The methodology says consider holding the shares when the company's Fool Ratio is greater than 0.65 (SBCF's is 0.71), but initial purchases in this range are unfavorable.

The following criteria for SBCF are less important which means you would place less emphasis on them when making your investment decision using this strategy:

AVERAGE SHARES OUTSTANDING: FAIL

SBCF has either issued a significant amount of new shares over the past year or has been issuing more and more shares over the past five years. SBCF currently has 48.0 million shares outstanding. Neither of these are a good sign. Generally when a small-cap company issues more stock, the existing stock becomes devalued by the market, and hence diluted.


SALES: PASS

Companies with sales less than $500 million should be chosen. It is among these small-cap stocks that investors can find "an uncut gem", ones that institutions won't be able to buy yet. SBCF's sales of $206.3 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". SBCF passes the sales test.


DAILY DOLLAR VOLUME: PASS

SBCF passes the Daily Dollar Volume (DDV of $11.8 million) test. It is required that this number be less than $25 million because these are the stocks that remain relatively undiscovered by institutions. "You'll be scoring touchdowns against the big guys on your turf."


PRICE: PASS

This is a very insignificant criterion for this methodology. But basically, low prices are chosen because "small numbers multiply more rapidly than large ones" and the potential for big returns expands. SBCF with a price of $31.93 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions.


INCOME TAX PERCENTAGE: PASS

SBCF's income tax paid expressed as a percentage of pretax income this year was (35.03%) and last year (33.77%) are greater than 20% which is an acceptable level. If the tax rate is below 20% this could mean that the earnings that were reported were unrealistically inflated due to the lower level of income tax paid. This is a concern.

NEW RESIDENTIAL INVESTMENT CORP

Strategy: P/E/Growth Investor
Based on: Peter Lynch

New Residential Investment Corp. is a real estate investment trust (REIT). The Company focuses on investing in, and managing, investments related to residential real estate. The Company's segments include investments in excess mortgage servicing rights (Excess MSRs); investments in mortgage servicing rights (MSRs); investments in servicer advances; investments in real estate securities; investments in residential mortgage loans; investments in consumer loans, and corporate. Its portfolio includes mortgage servicing related assets, residential mortgage backed securities (RMBS), residential mortgage loans and other investments. The Company's servicing related assets include its investments in Excess MSRs, MSRs and servicer advances. The Company invests in agency RMBS and non-agency RMBS. The Company's other investments consist of consumer loans.


DETERMINE THE CLASSIFICATION:

This methodology would consider NRZ a "fast-grower".


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (4.02) relative to the growth rate (24.79%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for NRZ (0.16) is very favorable.


SALES AND P/E RATIO: PASS

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold. NRZ, whose sales are $2,687.7 million, needs to have a P/E below 40 to pass this criterion. NRZ's P/E of (4.02) is considered acceptable.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for NRZ is 24.8%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered very good.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

NRZ is a financial company so debt to equity rules are not applied to determine the company's financial soundness.


EQUITY/ASSETS RATIO: PASS

This methodology uses the Equity/Assets Ratio as a way to determine a financial intermediary's health, as it is a better measure than the Debt/Equity Ratio. NRZ's Equity/Assets ratio (26.00%) is extremely healthy and above the minimum 5% this methodology looks for, thus passing the criterion.


RETURN ON ASSETS: PASS

This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. NRZ's ROA (7.05%) is above the minimum 1% that this methodology looks for, thus passing the criterion.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for NRZ (7.99%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for NRZ (-112.24%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

MAGNA INTERNATIONAL INC. (USA)

Strategy: Contrarian Investor
Based on: David Dreman

Magna International Inc. (Magna) is a global automotive supplier. The Company's segments are North America, Europe, Asia, Rest of World, and Corporate and Other. The Company's product capabilities include producing body, chassis, exterior, seating, powertrain, electronic, active driver assistance, vision, closure, and roof systems and modules, as well as vehicle engineering and contract manufacturing. The Company has over 320 manufacturing operations and approximately 100 product development, engineering and sales centers in over 30 countries. It provides a range of body, chassis and engineering solutions to its original equipment manufacturer (OEM) customers. It has capabilities in powertrain design, development, testing and manufacturing. It offers bumper fascia systems, exterior trim and modular systems. It offers exterior and interior mirror systems. It offers sealing, trim, engineered glass and module systems. It offers softtops, retractable hardtops, modular tops and hardtops.

MARKET CAP: PASS

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. MGA has a market cap of $21,382 million, therefore passing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. MGA's EPS for the past 2 quarters, (from earliest to most recent quarter) 1.47, 1.83 have been increasing, and therefore the company passes this test.


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: PASS

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. MGA passes this test as its EPS growth rate over the past 6 months (34.55%) has beaten that of the S&P (5.00%). MGA's estimated EPS growth for the current year is (20.72%), which indicates the company is expected to experience positive earnings growth. As a result, MGA passes this test.


This methodology would utilize four separate criteria to determine if MGA is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. MGA's P/E of 9.57, based on trailing 12 month earnings, meets the bottom 20% criterion (below 12.17), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: PASS

The P/CF of a company should be in the bottom 20% of the overall market. MGA's P/CF of 6.08 meets the bottom 20% criterion (below 7.08) and therefore passes this test.


PRICE/BOOK (P/B) VALUE: FAIL

The P/B value of a company should be in the bottom 20% of the overall market. MGA's P/B is currently 1.78, which does not meet the bottom 20% criterion (below 1.11), and it therefore fails this test.


PRICE/DIVIDEND (P/D) RATIO: FAIL

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). MGA's P/D of 44.64 does not meet the bottom 20% criterion (below 19.42), and it therefore fails this test.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


CURRENT RATIO: FAIL

A prospective company must have a strong Current Ratio (greater than or equal to the average of it's industry [1.50] or greater than 2). This is one identifier of financially strong companies, according to this methodology. MGA's current ratio of 1.24 fails the test.


PAYOUT RATIO: PASS

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for MGA is 18.30%, while its historical payout ratio has been 21.18%. Therefore, it passes the payout criterion.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 17.85%, and would consider anything over 27% to be staggering. The ROE for MGA of 20.42% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: FAIL

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. MGA's pre-tax profit margin is 7.54%, thus failing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. MGA's current yield is 2.24%, while the market yield is 2.58%. MGA fails this test.


LOOK AT THE TOTAL DEBT/EQUITY: PASS

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry of 156.40%. MGA's Total Debt/Equity of 30.56% is considered acceptable.

ACUITY BRANDS, INC.

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Acuity Brands, Inc. is a provider of lighting solutions for commercial, institutional, industrial, infrastructure and residential applications throughout North America. The Company offers a portfolio of indoor and outdoor lighting and building management solutions for commercial, industrial, infrastructure and residential applications. The portfolio of lighting solutions include lighting products utilizing fluorescent, light emitting diode (LED), organic LED (OLED), high intensity discharge, metal halide, and incandescent light sources to illuminate a number of applications. The solutions portfolio of the Company includes modular wiring, LED drivers, sensors, glass and inverters sold primarily to original equipment manufacturers (OEMs). Its lighting and building management solutions are marketed under various brand names, including Lithonia Lighting and Holophane. Through its subsidiary, IOTA Engineering, L.L.C., the Company provides emergency lighting products and power equipment.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratio between .75 and 1.5 are good values. AYI's P/S ratio of 1.39 based on trailing 12 month sales, falls within the "good values" range for non-cyclical companies and is considered attractive.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. AYI's Debt/Equity of 21.82% is acceptable, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. AYI is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in AYI At this Point

Is AYI a "Super Stock"? NO


PRICE/SALES RATIO: FAIL

The prospective company should have a low Price/Sales ratio. To be considered a "Super Stock", non-cyclical (non-Smokestack) companies should have Price/Sales ratios below .75. However, AYI, who has a P/S of 1.39, does not fall within the "Super Stock" range. It does fall between 0.75 and 1.5, which is considered the "good values" range for non-cyclical companies. Nonetheless, it does not pass this "Super Stock" criterion.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. AYI's inflation adjusted EPS growth rate of 21.15% passes the test.


FREE CASH PER SHARE: PASS

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. AYI's free cash per share of 5.22 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: PASS

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. AYI, whose three year net profit margin averages 8.74%, passes this evaluation.

SANDERSON FARMS, INC.

Strategy: P/E/Growth Investor
Based on: Peter Lynch

Sanderson Farms, Inc. is a poultry processing company. The Company is engaged in the production, processing, marketing and distribution of fresh and frozen chicken, and also preparation, processing, marketing and distribution of processed and minimally prepared chicken. 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, casual dining operators, customers reselling frozen chicken into export markets. The Company, through its subsidiaries, Sanderson Farms, Inc. (Production Division) and Sanderson Farms, Inc. (Processing Division), conducts its chicken operations. Sanderson Farms, Inc. (Production Division) is engaged in the production of chickens to the broiler-stage. Sanderson Farms, Inc. (Foods Division) is engaged in the processing, sale and distribution of chickens. The Company, through Sanderson Farms, Inc. (Foods Division), conducts its prepared chicken business.


DETERMINE THE CLASSIFICATION:

This methodology would consider SAFM a "fast-grower".


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (9.68) relative to the growth rate (21.64%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for SAFM (0.45) is very favorable.


SALES AND P/E RATIO: PASS

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold. SAFM, whose sales are $3,437.3 million, needs to have a P/E below 40 to pass this criterion. SAFM's P/E of (9.68) is considered acceptable.


INVENTORY TO SALES: PASS

When inventories increase faster than sales, it is a red flag. However an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for SAFM was 7.82% last year, while for this year it is 7.56%. Since inventory to sales has decreased from last year by -0.26%, SAFM passes this test.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for SAFM is 21.6%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered very good.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for SAFM (0.00%) to be wonderfully low (equity is at least ten times debt). This ratio is one quick way to determine the financial strength of the company.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for SAFM (8.41%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for SAFM (17.53%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

UNIVERSAL FOREST PRODUCTS, INC.

Strategy: P/E/Growth Investor
Based on: Peter Lynch

Universal Forest Products, Inc. is a holding company. The Company, through its subsidiaries, supplies wood, wood composite and other products to three primary markets, such as retail, construction and industrial. Its segments include North, South, West, Alternative Materials, International, idX Holdings, Inc. (idX) and Corporate divisions. idX is a designer, manufacturer and installer of in-store environments. It designs, manufactures and markets wood and wood-alternative products for national home centers and other retailers; structural lumber and other products for the manufactured housing industry; engineered wood components for residential and commercial construction; specialty wood packaging, components and packing materials for various industries, and customized interior fixtures used in a range of retail stores, commercial and other structures. Its customers comprising retail market are national home center retailers and retail-oriented regional lumberyards, among others.


DETERMINE THE CLASSIFICATION:

This methodology would consider UFPI a "fast-grower".


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (15.81) relative to the growth rate (33.48%), based on the average of the 3, 4 and 5 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for UFPI (0.47) is very favorable.


SALES AND P/E RATIO: PASS

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth high enough to support a P/E above this threshold. UFPI, whose sales are $4,088.9 million, needs to have a P/E below 40 to pass this criterion. UFPI's P/E of (15.81) is considered acceptable.


INVENTORY TO SALES: PASS

When inventories increase faster than sales, it is a red flag. However an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for UFPI was 12.26% last year, while for this year it is 11.68%. Since inventory to sales has decreased from last year by -0.58%, UFPI passes this test.


EPS GROWTH RATE: PASS

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for UFPI is 33.5%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for UFPI (29.13%) to be acceptable (equity is three to ten times debt). This ratio is one quick way to determine the financial strength of the company.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for UFPI (2.09%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for UFPI (-10.14%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


Watch List

The top scoring stocks not currently in the Hot List portfolio.

Ticker Company Name Current
Score
LGIH LGI HOMES INC 47%
AGX ARGAN, INC. 46%
DHI D. R. HORTON INC 44%
ESNT ESSENT GROUP LTD 43%
BOFI BOFI HOLDING, INC. 42%
PLNT PLANET FITNESS INC 42%
TSM TAIWAN SEMICONDUCTOR MFG. CO. LTD. (ADR) 41%
APPF APPFOLIO INC 41%
HLI HOULIHAN LOKEY INC 41%
FB FACEBOOK INC 40%



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