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Executive Summary March 14, 2014

The Economy

After a short stretch of fairly weak economic data, the U.S. economy seems to have rebounded, once again appearing to show the resilience that has characterized the nearly five-year long expansion.

The February jobs report, for example, wasn't exceptional but it was decent, and better than many had expected. The private sector added 162,000 new jobs during the month, according to the Labor Department, while the government added another 13,000 new jobs. In addition, December and January's jobs-added totals were revised upward by a total of 25,000. The headline unemployment rate inched a tenth of a percentage point higher, to 6.7%. But the "U-6" rate, which also includes part-time workers seeking full-time work and discouraged workers who have given up looking for a job, fell by a tenth of a percentage point, to 12.6%. That puts it at its lowest level since November 2008. Another good sign: The number of people not in the labor force declined by almost 100,000. In some past months, increases in that figure had led some to argue that improving jobs numbers were a result of discouraged job seekers leaving the labor force. That has not been the case recently. In fact, since February 2013, the U-6 rate, which includes discouraged workers, has fallen 1.7 percentage points.

Pretty good news also came from the manufacturing sector. Manufacturing activity expanded in February for the ninth straight month, according to the Institute for Supply Management, and it did so at an accelerating rate. New order activity also increased at a better pace than January, while employment conditions improved for the eighth straight month.

The service sector, meanwhile, expanded for the 49th straight month, ISM said. But it did so at its slowest rate in four years, and the employment sub-index declined sharply, indicating that service sector employment conditions worsened for the first time in 26 months. ISM officials said the weaker numbers could be a result of bad weather conditions, or a snap-back after January's very strong numbers. Whatever the case, one month does not a trend make, but it's something to keep an eye on.

Consumer data has been encouraging. Real disposable personal income rose a solid 0.3% in January, according to a new government report. Real personal consumption expenditures increased by the same amount. December's personal consumption expenditures were revised to indicate a 0.1% decline as opposed to the initially reported 0.2% gain. That meant the personal saving rate was actually better in December than previously thought, and it remained steady in January at 4.3%.

Overseas, China's first-ever corporate bond default and the continuing troubles with Russia and the Ukraine have been on investors' minds. The China default had an effect on metals markets, being viewed partially as a sign that credit would be tighter for users of metals and for financiers that have used the metal as collateral for borrowing, Reuters reported. So far, though, the default didn't seem to be leading to any sort of bond market domino effect.

Since our last newsletter, the S&P 500 returned -0.4%, while the Hot List returned -3.0%. So far in 2014, the portfolio has returned -8.3% vs. -0.1% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 233.8% vs. the S&P's 84.6% gain.

No Bull In These Lessons

The bull market that began in 2009 turned five years old last week, and doing so amid all sorts of speculation about how many more birthdays it has left. Some say the bull has plenty of legs, with valuations far from astronomical and the economy seeming to be stable. Others point to factors like the end of quantitative easing and global economic concerns in arguing that the bull may not last through Year Six.

Today, I don't want to talk about where the market is headed, because, frankly, no one -- not me, not you, not Janet Yellen, not even Warren Buffett -- knows the answer to that. What we do know is this: Since stocks bottomed on March 9, 2009, the S&P 500 has risen 176% (through March 12). We also know that the average investor has missed out on a significant portion of those gains. In the three years ending December 31, 2012, for example, the average equity fund investor generated annualized returns of 7.63%, well short of the 10.87% annualized return for the S&P 500, according to Dalbar, Inc. A 2013 Gallup poll, meanwhile, found that from April 2008 to April 2013, the percentage of Americans invested in the stock market declined from 62% to 52%. Part of that, the study suggests, was likely due to the fact that more people were unemployed, and simply unable to buy stocks. But the study also showed that, among employed people, the percentage actually fell from 73% to 61%. Even those with jobs seem to have soured on stocks even as the market has surged.

The aftermath of the worst financial crisis in 80 years, a roaring bull market, individual investors missing out -- what do we make of the past five years? I think there are a number of lessons to take -- lessons that won't help you know which way the market is going next week or next month, but which should help you benefit over the long haul. Here are five.

Lesson 1: Fear Is Your Friend

Warren Buffett has famously said, "Be greedy when others are fearful, and fearful when others are greedy." The past five years have been a tremendous example of that advice paying off. Heading into this bull market, fear was everywhere. From September 2008 through March 2009, investors yanked a net of nearly $240 billion out of stock and mixed equity mutual and exchange traded funds. In the week ending March 5, 2009, only 19% of respondents on the American Association of Individual Investors weekly sentiment survey said that they were bullish on stocks, while 70% said that they were bearish. The 51% spread between those two figures was the second widest bearish spread observed in the survey's history, which goes back to mid-1987. And the Yale School of Management's U.S. Crash Confidence Index, which measures the percentage of people who are confident that there will not be a stock market crash in the succeeding six months, reached its all-time low for both individual and institutional investors in early 2009. (For institutional investors, the low point came in February 2009, when only 18% said they were confident a crash would not occur; for individual investors the low point came in April of that year, when less than 15% of respondents said they were confident a crash would not occur.)

Of course, it was right around then that the market's turnaround began. And, as with most bull markets, the early days featured some of the biggest gains. Those who had bailed on stocks missed out on some significant profits. But those who focused on value and didn't let fear get the best of them have made out very well.

Lesson 2: There Is No Comfortable Time To "Get In"

Those who missed the rally's early days didn't come rushing back a month or two into the bull market. In the aftermath of such a jarring decline as the 2007-2009 bear market, many investors were waiting to feel more comfortable -- to feel like it was "safe" again.

But safety -- at least the sort of safety many were hoping for -- never came. In fact, it was one mini-crisis after another: Greece's debt woes, America's debt ceiling standoff, Europe's debt crisis, America's budget sequestration, trouble in China and emerging markets -- the list goes on and on. And now, in 2014, as many of those issues seem to have been dealt with or at least contained to a large degree, the new fear is that the market has risen too much, and valuations are too high, making it a bad move to get in if you've been sitting on the sidelines. So lots of investors continue to wait as more and more gains pass them by.

Here's the thing: If you're going to invest in stocks, there's never going to be a perfect time to get in. We live in a highly complex world, with a myriad of moving pieces, and you're just not going to see them all flashing green lights at one time. Frankly, if you are investing at a time when the mood is one of supreme safety and confidence, you're probably heading for trouble. Such periods occur when exuberance is irrational, as it was right before the tech bubble burst and before the housing bubble burst.

Good investing is not about waiting for just the right time to act. It's about stacking the odds in your favor by investing in good companies that are trading at reasonable valuations, regardless of what sorts of fears may be lingering in the background. If you keep waiting for all the headwinds to disappear, you'll probably miss the boat.

Lesson 3: Don't Be A Headline Investor

In today's society, it's almost impossible not to be bombarded by the news. Twenty years ago, you might have heard about a big news story a couple times a day -- maybe once on the morning drive to work, another time while reading the newspaper, and maybe again on the nightly news. Today, with laptops and smart phones and tablet computers and 24-hour news channels and Facebook and Twitter and all the rest, you can end up reading the same headline dozens of times a day. And the more you see a headline, the more important it can seem. So when debt troubles emerge in Cyprus, and you hear about it over and over and over again, your fears can start to run away with themselves (particularly with various news outlets competing to be the most sensationalist and headline grabbing). Amid all of that, you can find yourself selling off chunks of your portfolio because of potential problems in a country that has the population of the state of Rhode Island.

During this bull market, many investors seemed to be moving in and out of stocks primarily because of The Big Story of the day. A European official says debt talks are progressing, stocks rise. Another official offers a more pessimistic view, and stocks fall. Debt ceiling talks come to an impasse, stocks tumble; talks resume, stocks rebound. Often, big market moves seemed based primarily on pure macro speculation.

The fact that speculation is risky is only part of the problem. Even if you correctly guess that a macro story does mean trouble for stocks, by the time you've heard about it, millions of others have probably heard it before you, and a good deal of the impact has already gotten baked into the market's price. What's more, all too often the big story of the day doesn't move the market in the direction we thought it should. When the Federal Reserve announced its plans to start tapering its quantitative easing program -- a move that many had expected would send a shudder through the market -- stocks actually moved higher. Why? Who knows. Perhaps the speculation that the move would be coming for some time had led investors to already price it into the market. Perhaps other factors were occurring that day that investors thought were more important. Maybe investors finally started to think that QE might be more of a hindrance than a solution. There probably were a number of factors that went into the market's rise that day. But what matters is that things didn't go the way many had expected, and in the stock market that's far from a rare occurrence. Those who've bought and sold on the headlines have likely left considerable profits on the table during this bull.

Lesson 4: Beware "Paradigm Shifts" and "New Normals"

The great Sir John Templeton once said that the four most dangerous words in investing are "this time is different". The past five years have been a great example of why it's hard to argue with that. When the financial crisis hit in late 2008 and the stock market plunged, pundits and strategists -- some of whom are very smart people -- said that we had entered a New Normal in which both the economy and the stock market were doomed to subpar returns. To a degree, they were right about the economy. Growth hasn't been gangbusters since then, though it's been decent. But stock returns have been tremendous, And those who bought into New Normal/paradigm shift arguments have left a tremendous amount of money on the table.

Yes, in a sense things were different this time -- the specifics of what's happening with the economy, financial markets, and stock market are always shifting and evolving. Just think about what I discussed in the previous lesson -- there's no doubt that social media and 24-hour financial news have changed things in the investing world. But I think what Templeton meant was that the core principles behind investing don't really change. The economy will go through expansions and recessions; investors will waver between fear and greed; and investing in solid companies when shares are cheap should provide you with good returns over the long haul. Those concepts have remained the same throughout history, and I don't see them changing anytime soon, if ever. A testament to that notion is the exceptional performance of my Benjamin Graham inspired portfolio, which has been one of my best performers since its mid-2003 inception even though it's based on a strategy that Graham developed more than six decades ago. To me, that's proof that the real fundamental tenets of good investing don't change that much over time.

Lesson 5: Think Long-term, and Stay Disciplined

Nothing highlights the importance of discipline like a crisis. When fears are erupting, all of the rational, solid investing mantras you think you believe in can go flying out the window really quickly. That's why it's so important, I think, to have a good systematic approach. With the Hot List, as you know, we buy and sell stocks only on regularly scheduled monthly intervals. By setting up those rules, we've developed a routine and system that we can trust in when times get particularly tough. We've thought it through, and believe in the logic and principles behind that approach. Just knowing that a system is in place makes it easier to stay calm amid a crisis.

Staying disciplined over the long term also involves knowing and understanding history. If you know, for example, that people were proclaiming the "death of equities" back in 1974 during a treacherous bear market -- just before a bull market began -- you're more likely not to panic and do something rash when people start proclaiming that stocks are dead a few decades later. If you familiarize yourself with research such as that done by Kenneth Rogoff and Carmen Reinhart, you know that financial crises have occurred many times throughout history, and that, while difficult, they pass and countries recover. Understanding as much as you can about market history, investor psychology, and the underlying principles of good investing can give you so much perspective and help you stay focused when others panic.

That's why I think it's so important to learn from The Gurus. Highly successful investors like Peter Lynch, Ben Graham, Warren Buffett, Kenneth Fisher, and the other gurus I follow have lived through numerous ups and downs in both the economy and the stock market. (In addition, many of them, if not all, are great students of market history and have extensive knowledge about periods they didn't live through.) They know what to expect, and how to weather the storm. These investing greats have so much knowledge to offer, and, luckily, they've been quite generous in offering it. Their words and advice were of course the basis for the models that drive the Hot List, but they were also a sense of comfort and reassurance during those dark days of 2008 and 2009. Trusting their wisdom was key to the portfolio faring so well since the crisis, and you can bet we'll continue to draw from that wisdom going forward.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 6 stocks leave our portfolio. These include: Trueblue Inc (TBI), Hci Group Inc (HCI), Hollyfrontier Corp (HFC), Lukoil (Adr) (LUKOY), Ross Stores, Inc. (ROST) and Cnooc Limited (Adr) (CEO).

The Keepers

4 stocks remain in the portfolio. They are: Agco Corporation (AGCO), Parexel International Corporation (PRXL), Usana Health Sciences, Inc. (USNA) and Bofi Holding, Inc. (BOFI).

The Newbies

We are adding 6 stocks to the portfolio. These include: Drew Industries, Inc. (DW), Coach, Inc. (COH), Netease, Inc (Adr) (NTES), Lannett Company, Inc. (LCI), Caesarstone Sdot-yam Ltd (CSTE) and Hyster-yale Materials Handling Inc (HY).

Portfolio Changes

Newcomers to the Validea Hot List

Drew Industries Inc. (DW): Indiana-based Drew is a supplier to the recreational vehicle and manufactured homes industries. Through its subsidiaries, Lippert Components, Inc. and Kinro, Inc., it produces a range of components, including windows, doors, chassis, chassis parts, bath and shower units, axles, upholstered furniture, awnings and slide-out mechanisms for RVs. It also makes components for modular housing, truck caps and buses, and for trailers used to haul boats, livestock, equipment, and cargo.

Drew ($1.2 billion market cap) gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. To read more about it, check out the "Detailed Stock Analysis" section below.

Coach Inc. (COH): This New York City-based luxury goods maker and handbag specialist actually wasn't hit too hard during the Great Recession, and it has fared well since then. The $14-billion-market-cap firm and past Hot List member has long been a favorite of my Warren Buffett-based model, and currently also gets strong interest from my Peter Lynch- and Joel Greenblatt-based models. To read more about it, check out the "Detailed Stock Analysis" section below.

Caesarstone Sdot-Yam Ltd. (CSTE): This Israeli manufacturer makes quartz surfaces primarily used as kitchen countertops in the renovation and remodeling markets. It has a market cap of $2 billion and its products are sold in 42 countries.

Caesarstone is one of only a few stocks in the market that gets strong interest from my top-performing Motley Fool-based model. It also gets some interest from my Momentum Investor approach. To read more about its fundamentals, scroll down to the "Detailed Stock Analysis" section below.

Lannett Company, Inc.: This 72-year-old Philadelphia-based firm makes generic prescription pharmaceutical products for customers throughout the United States. Lannett ($1.5 billion market cap) markets its products primarily to drug wholesalers, retail drug chains, distributors, and government agencies.

Lannett gets strong interest from my Motley Fool-based model, and some interest from my Momentum Investor approach. For more on the stock, see the "Detailed Stock Analysis" section below.

Hyster-Yale Materials Handling (HY): This Cleveland-based company makes and services a comprehensive line of lift trucks and aftermarket parts marketed globally primarily under the Hyster and Yale brands. The firm, which has employees in 13 countries around the globe, conducts its business under its subsidiary, NACCO Materials Handling Group.

Hyster-Yale ($1.3 billion market cap) gets strong interest from my Kenneth Fisher-, James O'Shaughnessy-, and Peter Lynch-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

NetEase, Inc. (NTES): This $9-billion-market-cap Chinese tech firm offers a number of popular online games, including World of Warcraft, as well as e-mail services, advertising services and web portals. It's been a rapid grower, increasing EPS at a 24% rate over the long haul and revenues at a 23% rate.

NetEase gets high marks from my Peter Lynch- and Warren Buffett-based models. For more on its fundamentals, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

HCI Group Inc. (HCI): HCI shares tumbled on March 5 after the firm announced disappointing earnings. HCI reported net income of $1.31 a share in the fourth quarter, falling short of analysts estimates of $1.45 a share. Revenue was nearly 28% higher than the year-ago quarter, but at $65.25 million it missed consensus estimates by $3.05 million, TheStreet.com reported. Shares fell 17.7% on March 5. While talk of HCI's recent decline has focused on its earnings, another factor may also have been in play. When HCI shares got hit in January, that coincided with its announcement that it was the first Florida P&C insurer to offer flood insurance. The more recent hit coincided not only with earnings but with new federal flood insurance legislation being passed. Whatever the case, the Hot List is selling the stock on today's scheduled rebalancing as its fundamentals have declined in relation to those of other stocks. Despite the recent losses, the portfolio is still selling at a gain since it picked up HCI back in June.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will take a closer look at my strategies and investment approach. If you have any questions, please feel free to contact us at hotlist@validea.com.

Current Portfolio

Detailed Stock Analysis

Disclaimer: The analysis is from Validea's selection and interpretation of content from the guru's book or published writings, and is not from nor endorsed by the guru. See Full Disclaimer

NTES   |   USNA   |   HY   |   PRXL   |   CSTE   |   LCI   |   COH   |   DW   |   BOFI   |   AGCO   |  

NetEase, Inc. is a holding company. The Company is an Internet technology company. The Company operates in three segments: Online Game Services, Advertising Services and E-mail, Wireless Value-added Services and Others. The Company provides its Internet and wireless value-added applications, services and technologies and advertising services to Guangzhou NetEase and Guangyitong Advertising and they operate the NetEase Websites and the online advertising business. Guangzhou NetEase has two majority-owned subsidiaries, Youdao Computer (a search business operator) and Wangyibao (the operator of its Wangyibao payment system). Through its subsidiaries and contracts with its affiliates Guangzhou NetEase, Guangyitong Advertising and Shanghai EaseNet and their respective shareholders, it operates an interactive online community in China and is a provider of Chinese language content and services through its online games, Internet portal and wireless value-added services businesses.

USANA Health Sciences, Inc. develops and manufactures science-based nutritional and personal care products. The Company has operations in 15 markets worldwide, where it distributes and sells its products by way of direct selling. The Company reports operations in two geographic regions: North America and Asia Pacific, which is further divided into three sub-regions; Southeast Asia/Pacific, Greater China, and North Asia. North America includes the United States, Canada, Mexico, and direct sales from the United States to the United Kingdom and the Netherlands. Southeast Asia/Pacific includes Australia, New Zealand, Singapore, Malaysia, and the Philippines; Greater China includes Hong Kong, Taiwan and China; and North Asia includes Japan and South Korea. The Company's customer base consists of two types of customers: Associates and Preferred Customers. As of December 31, 2011, the Company had 222,000 active Associates and 64,000 active Preferred Customers worldwide.

Hyster-Yale Materials Handling, Inc. (Hyster-Yale), formerly NMHG Holding Co., , designs, engineers, manufactures, sells and services a line of lift trucks and aftermarket parts. The Company's products are marketed globally under the Hyster and Yale brand names. The Company segments include three management units: Americas, Europe and Asia-Pacific. Americas includes its operations in the United States, Canada, Mexico, Brazil and Latin America. Europe includes its operations in Europe, the Middle East and Africa. Asia-Pacific includes its operations in the Asia-Pacific region and China. Lift trucks and component parts are manufactured in the United States, Northern Ireland, Mexico, The Netherlands, the Philippines, Italy, Japan, Vietnam, Brazil and China. Hyster-Yale has a 20% ownership interest in Hyster-Yale Financial Services, Inc. (NFS). Hyster-Yale is a wholly owned subsidiary of NACCO Industries, Inc. (NACCO).

PAREXEL International Corporation (PAREXEL) is a biopharmaceutical services company, providing a range of expertise in clinical research, medical communications, consulting, and advanced technology products and services to the worldwide pharmaceutical, biotechnology, and medical device industries. It operates it three segments: Clinical Research Services (CRS), PAREXEL Consulting and Medical Communications Services (PCMS) and Perceptive Informatics, Inc. (Perceptive). The Company's product and service offerings include clinical trials management, observational studies and patient/disease registries, data management, biostatistical analysis, epidemiology, health economics / outcomes research, pharmacovigilance, medical communications, clinical pharmacology, patient recruitment, post-marketing surveillance. In May 2013, PAREXEL International Corp acquired the entire share capital of HERON Group Ltd.

Caesarstone Sdot-Yam Ltd. (Caesarstone) through its subsidiaries is engaged in the manufacturing of engineered quartz surfaces sold under its premium Caesarstone brand. Caesarstone's products consist of engineered quartz slabs, which are sold in 42 countries. The Company's products are primarily used as kitchen countertops in the renovation and remodeling end markets. Other applications include vanity tops, wall panels, back splashes, floor tiles, stairs and other interior surfaces that are used in a range of residential and non-residential applications. Through its design and manufacturing processes it offers a range of colors, styles, designs and textures. Its four diverse collections include Classico, Supremo, Motivo and Concetto. Kibbutz Sdot-Yam owns 70.1% of the Company's outstanding shares. On May 18, 2011, it acquired 75% of the shares of U.S. Quartz Products, Inc. During the year ended December 31, 2011, it acquired its former United States distributor, Caesarstone USA.

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

Coach, Inc. (Coach) is a marketer of accessories and gifts for women and men. The Company offers a range of modern, fashionable handbags and accessories. Its product offerings include women's and men's bags, accessories, footwear, wearables, jewelry, travel bags, sunwear, watches and fragrance. The Company operates in two segments: North America, which includes sales to North American consumers through Company-operated stores, including the Internet, and sales to wholesale customers and distributors and International, which includes sales to consumers through Company-operated stores in Japan and mainland China, including the Internet, Hong Kong, Macau, Singapore, Taiwan, Malaysia and Korea and sales to wholesale customers and distributors in 25 countries.

Drew Industries Incorporated is a supplier of components for recreational vehicle (RVs) and manufactured housing. The Company operates in two segments: the RV products segment (RV Segment), and the manufactured housing products segment (MH Segment). The Company's operations are conducted through its wholly owned subsidiaries, Lippert Components, Inc. and its subsidiaries (Lippert) and Kinro, Inc. and its subsidiaries (Kinro), each of which has operations in both the RV Segment and the MH Segment. During the year ended December 31, 2012, the RV Segment accounted for 87% of net sales and the MH segment accounted for 13% of net sales. On February 21, 2012, the Company acquired the business and certain assets of the United States RV entry door operation of Euramax International, Inc. In February 2014, the Company's wholly-owned subsidiary, Lippert Components, Inc has acquired Innovative Design Solutions, Inc. (IDS).

BofI Holding, Inc. is a holding company for BofI Federal Bank, a diversified financial services company. The Bank operate its bank from a single location in San Diego, California, serving approximately 40,000 retail deposit and loan customers across all 50 states. As of June 30, 2012, it had total assets of $2,386.8 million, loans of $1,799.7 million, mortgage-backed and other investment securities of $483.0 million, total deposits of $1,615.1 million and borrowings of $547.2 million. It distributes its deposit products through a range of retail distributions channels, and its deposits consist of demand, savings and time deposits accounts. It distributes its loan products through its retail, correspondent and wholesale channels, and the loans it retains are primarily first mortgages secured by single family real property and by multifamily real property.

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

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.


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