|Executive Summary | Portfolio | Guru Analysis | Watch List|
|Executive Summary||August 6, 2010|
While it may not be faring quite as well as some would like, the economy is continuing to push forward.
One of the pieces of economic news bearing that out since our last newsletter was the announcement of the U.S.'s second-quarter gross domestic product. While many headlines portrayed the results as a disappointment, the numbers really weren't bad when put in a broader context. Yes, the 2.4% increase in GDP was less than economists expected, but it fell short by a mere tenth of a percentage point. And while GDP growth in the second quarter was lower than first-quarter growth (which was revised upward to 3.7%), it nonetheless marked the fourth straight quarter of growth for the economy -- no small feat given how bleak the future looked during the "Great Recession".
Another positive came from the manufacturing sector. The Institute for Supply Management reported that its manufacturing index showed an expansion in the sector for the 12th straight month in July. Like the GDP reading, it showed a slowing of growth -- the July figure was slightly lower than the June reading -- but the index remained well in expansion territory. It also indicated the sector is still expanding more rapidly than it was at any time during 2009. The group's manufacturing employment sub-index showed that employment increased in the sector for the eighth straight month.
ISM's service sector index, meanwhile, showed strong growth in July. It was the seventh straight month of service sector expansion, and the expansion was more rapid than it was in June, the data showed. The service sector employment sub-index also showed growth for the second time in three months, after more than two years of contraction.
While ISM's data showed gains in employment in July, the broader employment picture remains a big concern. New claims for unemployment rose unexpectedly last week, and, while ADP's July employment report showed that the private sector employment increased, the gains were fairly tepid. Today, the government will release its July employment report, and investors are sure to be watching with much anticipation.
Another concern -- one that is related to unemployment -- is the U.S. consumer. While reports initially showed that consumer spending increased by 3% in the first quarter, the Commerce Department's recent GDP report revised that figure downward to 1.9%. And, it showed that consumer spending increased by 1.6% in the second quarter -- a significant, but unspectacular, gain.
Retailers did report decent July sales, however -- though the headlines seemed to give a much bleaker picture. Same-store sales (sales from stores open at least a year) growth for July fell short of analysts' 3.1% expectations, according to Thomson Reuters, but it still came in at 2.9% -- a pretty healthy figure. With consumer spending making up about 70% of the U.S. economy, continued gains will be key to sustaining the economic recovery.
As it digested the latest economic reports, the market remained fairly volatile, but all in all it was a positive fortnight. The S&P returned 2.9%, while the Hot List has returned 2.0%. For the year, the portfolio stands at -3.8% vs. 1.0% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 132.0% vs. the S&P's 12.5% gain.
The Hot List is really shaking things up on today's regularly scheduled rebalancing. It's dropping six of its ten holdings, and replacing them with six new stocks that get better ratings from my Guru Strategies.
On the whole, the six departing stocks fared pretty well during their tenures in the portfolio. AstraZeneca, AIXTRON, Sterlite Industries, and Cosan Limited were all solidly in the black as of yesterday's close, with AstraZeneca leading the way with a gain of close to 25%. Raytheon was down slightly, while Oshkosh Corporation took a fairly big hit.
As for the newcomers, they seem to reflect the Hot List's penchant for contrarian-type value plays, with all of them coming from sectors or industries that have been hit by fear recently. Three of them -- Aeropostale, Ross Stores, and lululemon -- are retail clothing/apparel firms, which are dealing with fears about the state of the U.S. consumer. But these companies have excellent long-term track records, through both good times and bad. Aeropostale has upped earnings per share in every year of the past decade (even in the trying times of 2008 and 2009); lululemon has upped EPS in each of the past five years; and Ross has increased EPS in all but one year of the past decade (and that was back in 2004). These are companies that found a way to succeed during the rough recession that began in late 2007, and their strong balance sheets (of the three, Ross is the only one carrying any long-term debt) have them in good position to continue their success.
Two of the other newcomers come from another sector still dogged by fears -- the financial sector. And, interestingly, both specialize in a bit of an unusual type of finance: pawn loans. EZCORP and Cash America both do what they do very well -- over the past decade, EZCORP has upped EPS every single year, while Cash America has just one dip (and that was a minor 3-cent dip back in 2002). Pawn loans may sound a bit risky, but they may actually be one of the safer types of loans for the lender, since such firms collect tangible collateral to hold against the loans.
The final company added to the Hot List is a familiar one: Chevron. Like the financial and retail firms, Chevron comes from an area of the market that has been dogged by concerns; in Chevron's case, the big spill in the Gulf has cast a shadow over the oil industry, though oil stocks have made some nice rebound gains in the past few weeks. Chevron has a solid long-term track record, however, and it is producing a ton of cash ($7.20 in free cash per share). It's also cheap, selling for less than 10 times trailing 12-month earnings and 0.8 times sales.
The Hot List newcomers all present some great stories of individual companies that are performing well, and have reasonably priced shares. They're not the only ones out there, to be sure. But much of the market talk of late has focused not on specific firms, but instead on macroeconomic factors. It's not surprising, given how strong an impact the macroeconomic headwinds and tailwinds have alternately had on the market over the past couple years.
Lately, one of the biggest macro fears is the specter of a "double-dip" recession. The economic recovery has slowed, unemployment remains high, and the U.S. consumer is tapped out, the "double-dippers" say. In the past couple weeks, those fearing a double-dip have pointed to the slowdown in second-quarter GDP, and the slowing of growth in the manufacturing sector, as reasons to be fearful.
To be sure, the recovery has slowed in the past couple months, and there are still very legitimate concerns about the economy. But before you get caught up in the headlines announcing the slowing GDP and manufacturing growth, there are a few pieces of data you should consider.
First, let's take GDP growth. Yes, the gains in GDP have slowed over each of the past two quarters, with the 5.0% increase in last year's fourth quarter slowing to a 3.7% gain in this year's first quarter, and then to 2.4% in the most recent quarter. But that isn't so different than some past recession rebounds. Nor is the magnitude of the rebound any worse than some past rebounds.
In the first three full quarters following the end of the 1990-91 recession, for example, GDP rose (from earliest to latest) by 2.7%, 1.7%, and 1.6%. In the first three quarters following the 2001 recession, the gains were 3.5%, 2.1%, and 2.0%. If, as some top strategists say, the most recent recession ended in the summer of 2009, the three full quarters that have followed featured GDP growth of 5.0%, 3.7%, and 2.4% -- figures that actually compare quite favorably with those two previous post-recession turnarounds.
That's not to say that other recoveries haven't been stronger. The first three full quarters following the 1981-82 recession averaged 7.5% growth; the first three following the 1973-75 recession averaged 5.1%, both of which are greater than the 3.7% average we've seen in the last three quarters. But I'm not trying to argue that the current recovery has been going gangbusters. I am trying to point out, rather, that in a historical context, the growth we've seen since mid-2009 hasn't been "tepid", as some have argued -- and the slowing of growth we've seen this year is by no means anomalous when compared to past recessions.
A similar picture can be found when looking at manufacturing data. Double-dip forecasters can point to the fact that the Institute for Supply Management's manufacturing index has declined in each of the past three months. But that shouldn't be a surprise. The index can't go up forever, and the reality of the situation is that, even after declining these past three months, the index still shows that the manufacturing sector is expanding -- and doing so at a faster rate than it did at anytime in 2009.
Also consider this: according to ISM, the manufacturing sector has been expanding for 12 straight months now. Once it got back into expansion territory following the 2001 recession, the sector expanded for eight months; then, it proceeded to contract in seven of the next nine months -- while the broader economy was in an expansion. Once the sector started expanding following the 1990-91 recession, it posted just five straight months of expansion. Then it went through three straight months of contraction.
As for the recessions that ended in early 1975 and late 1982, in both of those cases, once the manufacturing sector started expanding, it went on a lengthy streak of expansion (48 straight months for the former and 24 straight months for the latter). But in both those cases, the rate of expansion peaked and then slowed within a year after the expansions began -- just as it has in the current recovery.
In the end, every recession is different. But the bottom line is that the sort of growth we're seeing, both in manufacturing and the broader economy, isn't out of whack with what we've seen historically in the early stages of economic recoveries. Does that guarantee that a double-dip recession won't happen? Of course not -- no one knows for sure what will happen, and trying to predict where the economy will head is a dangerous game.
What all of this does mean, however, is that the fearful "growth is slowing" story you see in headlines and hear from pundits is not a signal that a double-dip recession is imminent. And the "growth is slowing" fears are by no means a reason to flee stocks. In fact, with interest rates low, plenty of companies sporting strong balance sheets, and valuations reasonable, the facts and data point toward this being a good buying opportunity for long-term investors.
As we rebalance the Validea Hot List, 6 stocks leave our portfolio. These include: Oshkosh Corporation (OSK), Astrazeneca Plc (Adr) (AZN), Raytheon Company (RTN), Aixtron Ag (Adr) (AIXG), Sterlite Industries India Limited (Adr) (SLT) and Cosan Limited (CZZ).
4 stocks remain in the portfolio. They are: Western Digital Corp. (WDC), Jos. A. Bank Clothiers, Inc. (JOSB), China Automotive Systems, Inc. (CAAS) and Healthspring, Inc (HS).
We are adding 6 stocks to the portfolio. These include: Ross Stores, Inc. (ROST), Cash America International, Inc. (CSH), Ezcorp, Inc. (EZPW), Chevron Corporation (CVX), Aeropostale, Inc. (ARO) and Lululemon Athletica Inc. (LULU).
Newcomers to the Validea Hot List
Aeropostale, Inc. (ARO): Headquartered in New York, this mall-based clothing retailer targets youngsters age 14 to age 17 through more than 900 stores in 49 states, Puerto Rico, and Canada. Its new P.S. from Aeropostale stores also are aimed at 7- to 12-year-olds.
Aeropostale, which gained more than 36% while in the Hot List from Nov. 27, 2009 to July 9 of this year, has a market cap of about $2.6 billion. It gets approval from my Peter Lynch-, Warren Buffett-, and Joel Greenblatt-based models. To read more about the stock, see the "Detailed Stock Analysis" section below.
Cash America International, Inc. (CSH) : Based in Texas, Cash America operates in more than 1,000 locations in the U.S. and Mexico, providing secured non-recourse loans -- pawn loans. It also offers short-term cash advances and check cashing services. The firm has a market cap of just under $1 billion.
Cash America gets approval from my James O'Shaughnessy-based strategy. To read more about its fundamentals, see the "Detailed Stock Analysis" section below.
Chevron Corporation (CVX) : This California-based oil and natural gas giant does business in more than a hundred countries. It has a market cap of about $160 billion, and has taken in close to $200 billion in sales in the past year.
Chevron gets high marks from the value-stock model I base on the writings of James O'Shaughnessy, as well as my Joel Greenblatt-based approach. To read more about the stock, see the "Detailed Stock Analysis" section below.
Ross Stores, Inc. (ROST) : California-based Ross is a clothing apparel and home goods retailer, which operates under the Ross Dress for Less and dd's DISCOUNTS names. It's the nation's second-largest off-price retailer, and has taken in about $7.4 billion in sales in the past year.
Ross, which has a $6.5 billion market cap, gets approval from my Peter Lynch-, Warren Buffett-, and James O'Shaughnessy-based models. To read more about it, scroll down to the "Detailed Stock Analysis" section below.
lululemon athletica inc. (LULU): This Vancouver-based firm makes clothing for a variety of athletics, focusing largely on technical athletic apparel for yoga, running, and dancing. It has more than 100 stores across Canada, the U.S., Australia, and Hong Kong.
lululemon, which has a market cap of about $3 billion, It gets strong interest from two of my growth strategies, my Martin Zweig-based model and the model I base on the writings of Tom and David Gardner, the creators of The Motley Fool investment web site. The "Detailed Stock Analysis" section below has more on the stock.
EZCORP, Inc. (EZPW): Like Cash America, EZCORP is based in Texas and is involved in pawn loans. The firm, which has more than 670 shops in 13 states and Mexico, also offers some other options for obtaining short-term cash, and sells used merchandise (usually property that was forfeited as collateral). It has a market cap of about $1 billion.
EZCORP gets approval from my Peter Lynch- and James O'Shaughnessy-based models. To read more about the stock, see the "Detailed Stock Analysis" section below.
News about Validea Hot List Stocks
HealthSpring (HS): HealthSpring's profits jumped 75% in the second quarter, the Nashville Business Journal reported last week. Earnings were $55.8 million ($0.98 per diluted share) on revenue of $768.5 million. Analysts estimated $0.58 in earnings per share on revenue of $754.8 million, the NBJ reported. The firm also upped its earning guidance to $3.15 to $3.25 a share, from $2.60 to $2.75.
Ross Stores (ROST): Ross announced this week that its sales increased 7% to $573 million for the four weeks ended July 31, 2010, compared to the year-ago weeks. Comparable store sales for the month were up 2%. Comparable store sales for the quarter ended July 31, 2010 were up 4%, the firm said.
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