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Executive Summary December 21, 2012

The Economy

While the fiscal cliff talks drag on, the U.S. economy is continuing to make gains in several key areas.

In November, for example, the private sector added 147,000 jobs, according to the Labor Department. That was enough to lower the unemployment rate to 7.7%, the lowest it has been since December 2008. The so-called "U-6" unemployment rate, which unlike the headline figure takes into account workers who have given up looking for a job or those working part-time who want full-time work, also fell to 14.4%. That's still significantly higher than historical averages, but it's the lowest the figure has been since January 2009.

Industrial production, meanwhile, increased 1.1% in November, according to a new Federal Reserve report. Part of the reason for the big gain was a rebound in production in the aftermath of Superstorm Sandy, which had limited production in some areas the previous month. Still, November's gains wiped out all of October's losses, and more -- overall production for November was about 0.4% higher than it was in September, before Sandy's arrival.

The housing market also continues to improve. Existing home sales rose 5.9% in November, according to the National Association of Realtors, reaching the highest level in three years. Construction starts, meanwhile, dipped a bit in November, falling 3%, according to the Commerce Department, but they remain more than 20% above year-ago levels. Permit issuance for new home construction rose 3.6%.

Big news also came from the Federal Reserve. The Fed last week said that, starting in January, it will begin buying $45 billion of Treasury securities per month to support financial markets and bolster the economy. It will continue its ongoing plan of buying $40 billion in mortgage-backed securities per month. The Fed also took the unusual step of linking its interest rate policy to hard economic data. It said it will keep rates low at least as long as the unemployment rate stays above 6.5%, so long as the projected inflation rate a year or two out doesn't exceed 2.5%. The Fed is thus again expanding its balance sheet in an attempt to boost the economic recovery.

Since our last newsletter, the S&P 500 returned 2.1%, while the Hot List returned 4.1%. So far in 2012, the portfolio has returned 20.2% vs. 14.8% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 171.6% vs. the S&P's 44.3% gain.

Five Reasons for Optimism

As 2012 winds down, the general mood surrounding the market and the economy remains one of fear. The fiscal cliff, unresolved debt problems in Europe, and the lingering scars of the financial crisis and Great Recession seem to be giving pessimism the upper hand over optimism, and keeping investors lukewarm (at best) on stocks.

But as we head into 2013, I think there are several reasons to be optimistic about where we stand. That doesn't mean we aren't facing some serious problems; there is no doubt that the U.S. and much of the developed world indeed have a lot on their plates. But what it does mean is that overall, a number of factors are combining to make stocks look like attractive investments right now for long-term investors. Here's a handful of those reasons:

The Housing Rebound: It's hard to believe that six years have passed since the housing bubble began to burst, but it's true. And while the nascent rebound hasn't been as dramatic as the decline was, it is significant. Housing starts are up 21.9% since a year ago. Permit issuance for new home construction is up 28.1% in that period. Existing-home sales have risen 15.5% in the last 12 months, meanwhile, and pending home sales are up 18%. Home prices are on the rise, too, having jumped 3.6% in the year ending Sept. 30 (the most recent data available), according to the S&P/Case-Shiller Home Price Indices.

That's a big deal. Housing is usually a big part of economic recoveries, but until recently it's been absent from this one. The sector's impacts are so wide-ranging -- impacting everything from construction companies to carpet manufacturers to home furnishing stores -- that housing market improvements can lead to the creation of thousands and thousands of jobs.

Employment: It's no surprise, then, that the housing recovery has been accompanied by a significant improvement in the jobs market. Yes, unemployment is still far too high, but we've seen real progress lately. The headline unemployment number (7.7%) is down a full percentage point from a year ago, and more than two full percentage points from where it was two years ago. The broader "U-6" measure (which also includes workers who have given up looking for a job or those working part-time who want full-time work) is down 1.2 percentage points in the past year, and 2.5 points in the past two years.

More employed workers means more people with money to spend. More people with money to spend means more profits for consumer-related businesses, which drive our economy. More money for them is leading to more jobs, which leads to more people with money to spend -- and so on goes the cycle. As the fiscal cliff mess gets resolved, the hiring may well increase even more. Many companies have been staying in a holding pattern until they get clarity on tax policy and government spending plans. They want to know the rules of the game -- whatever the rules may be -- before they start to really play. If Congress and the President can reach some sort of agreement that lays the tax and policy rules out for them -- whatever it involves -- businesses may have the clarity they need to start spending their cash on new employees, and capital improvements.

Global Monetary Conditions: Yes, the Federal Reserve has been sharply criticized by some for its loose money policies in recent years. And, to be sure the Fed has been far from perfect in its decisions. But whether you're pro-Fed or anti-Fed, the reality is that the central bank -- and other central banks around the globe -- are doing what they can to push investors toward riskier assets by keeping interest rates so low. And while that hasn't resulted in a deluge of cash flowing into stocks, it has no doubt helped increase demand for stocks somewhat, and it should continue to do so in 2013.

Of course, there are unintended repercussions of loose monetary policy. One is that, if conditions were right, encouraging investors away from bonds and toward stocks could lead to a bubble, with stocks becoming highly overvalued. But that brings me to my next point ...

Valuations Are Reasonable: As I noted in a recent Hot List, the broader market seems to be priced somewhere near fair value. Sure, there are some valuation metrics that are flashing warning signals, like the ten-year P/E ratio and Tobin's Q. But there are many more that are indicating the market is in the range of fair value or undervalued. Trailing 12-month P/E ratios are in the low- to mid-teens; the market's price-to-book ratio is lower than its long-term average; the price/sales ratio is a reasonable 1.3 or so; and the stock market-to-GDP ratio has been hovering around the high end of the fair value range/low-end of the modestly overvalued range. In addition, dividend yields are significantly higher than the yields on long-term treasury bonds, a historical rarity and a bullish sign for stocks.

Also keep in mind that those figures are for the broader market. When it comes to individual stocks, there are a myriad of good companies with strong track records whose shares are trading at extremely attractive valuations, the type of stocks that the Hot List continues to target. And, as Charles Schwab's Chief Investment Strategist Liz Ann Sonders recently noted, even if the U.S. does go off the fiscal cliff and a recession results, the reasonable valuations should help provide a cushion that would keep a bear market relatively mild.

Time: It takes time -- a lot of it -- to recover from financial crises. It may sound obvious, but it's very important to remember. Every year further out we get from the epicenter of the crisis, the more bad debt gets worked off, and the more the nation's collective bearish psyche heals. Professors Kenneth Rogoff and Carmen Reinhart have done perhaps the most extensive research on past financial crises. In examining about 15 pre-2007 financial crises across the globe, Reinhart and Rogoff said in a 2008 paper that on average real house prices fell for six years before rebounding. In very few cases did the declines last less than five years. Unemployment, meanwhile, increased on average for nearly five years by an average of 7 percentage points. Real public debt jumped 86% on average in the three years after the crises. In other words, the tepid recovery we've seen in the past few years isn't a sign that we're headed for disaster, or that America will never grow the way it used to. It is instead a sign that we are experiencing a typical recovery from a financial crisis. (In fact, in a recent piece for Bloomberg.com, the professors said that the economy has in some key ways actually performed better than the average country has in the aftermath of past financial crises).

These five factors are, I believe, creating an environment that is pretty supportive for stocks overall, and very attractive for long-term investment strategies that can identify cheap shares of good companies. That doesn't mean 2013 will be an easy, upward climb for the market, or the Hot List portfolio. In the short term, emotions drive the market, and right now there are still a lot of strong emotions out there on the negative side. But good investing is about looking past the short term and focusing on where the best long-term opportunities lie. Right now, I think the stock market is home to plenty excellent opportunities.

CNBC Appearance

Since our last newsletter, I was interviewed on CNBC about my Warren Buffett-based Guru Strategy. In the interview, I talk about how the Buffett-inspired approach works, and look at a handful of stocks in the Buffett-inspired portfolio we track on Validea.com. The portfolio has been a solid performer over the long-term, and has done extremely well in the last few years. If you'd like to watch the video, click here.

Last but not least, have a wonderful holiday and a very happy, very healthy New Year. I'll see you in 2013.

Editor-in-Chief: John Reese

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** Validea Capital Management is a separate investment advisory firm managed by Validea.com founder John Reese. Thre information above in not intended as personal investment advice and should not be interpreted as such.

The Fallen

As we rebalance the Validea Hot List, 5 stocks leave our portfolio. These include: Vale Sa (Adr) (VALE), Guess?, Inc. (GES), Hibbett Sports, Inc. (HIBB), Autoliv Inc. (ALV) and Lukoil (Adr) (LUKOY).

The Keepers

5 stocks remain in the portfolio. They are: Ross Stores, Inc. (ROST), The Tjx Companies, Inc. (TJX), Western Digital Corp. (WDC), Main Street Capital Corporation (MAIN) and Hollyfrontier Corp (HFC).

The Newbies

We are adding 5 stocks to the portfolio. These include: Oracle Corporation (ORCL), Jos. A. Bank Clothiers Inc (JOSB), Nu Skin Enterprises, Inc. (NUS), Usana Health Sciences, Inc. (USNA) and Statoil Asa(Adr) (STO).

Portfolio Changes

Newcomers to the Validea Hot List

Jos. A. Bank Clothiers (JOSB): Maryland-based Bank ($1.2 billion market cap) sells men's dress and casual apparel. It has upped EPS every year of the past decade and is set to do so again in 2012. That's one reason it gets very high marks from my Warren Buffet-based model. For more on the stock, see the "Detailed Stock Analysis" section below.

USANA Health Sciences, Inc. (USNA): Utah-based USANA makes nutritional and personal care products such as vitamins, nutrition bars, and skin and hair cleansers. It has customers in the U.S., Canada, Australia, New Zealand, Mexico, the U.K., and a number of countries in Asia. Its subsidiary, BabyCare, Ltd., has a direct selling business in China.

USANA ($534 million market cap) gets strong interest from my Warren Buffett- and Joel Greenblatt-based models. To read more about it, scroll down to the "Detailed Stock Analysis" section.

Oracle Corporation (ORCL): This California-based hardware and software giant ($164 billion market cap) has taken in more than $37 billion in sales in the past year. The firm gets strong interest from my Peter Lynch- and Warren Buffett-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

Statoil ASA (STO): Based in Norway, this integrated oil and gas firm ($80 billion market cap) has operations in three dozen countries across the globe. It has raked in more than $133 billion in sales in the past year.

Statoil gets high marks from my Peter Lynch- and James O'Shaughnessy-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

Nu Skin Enterprises, Inc. (NUS): Utah-based Nu Skin ($2.4 billion market cap) is a direct selling company that sells personal care, nutrition, and technology products, such as skin creams, supplements intended to fight aging, and a biophotonic scanner that measures carotenoid antioxidant activity. It sells its products through a network of more than 750,000 independent distributors and preferred customers around the world.

Nu Skin gets approval from my Peter Lynch- and Joel Greenblatt-based strategies. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Main Street Capital Corporation (MAIN): Main Street said on Dec. 17 that it closed its underwritten public offering of 2.5 million shares of common stock at a price of $28.00 per share. The underwriters also fully exercised their option to purchase 375,000 additional shares of Main Street common stock to cover over-allotments. Net proceeds from the offering were approximately $77.1 million, which the firm said will be used to initially repay outstanding debt borrowed under its credit facility, and then through re-borrowing under the credit facility, "to make investments in accordance with its investment objective and strategies, to make investments in marketable securities and idle funds investments, to pay operating expenses and other cash obligations, and for general corporate purposes."

Vale S.A. (VALE): Vale shares have jumped about 16% (through Dec. 19) since the Hot List added it to the portfolio a month ago. The exact catalysts for the surge were unclear, though it appears that the stock's attractive valuation and signs that China's economy is turning around were part of the jump. The portfolio is taking the profits and selling its position in Vale on today's rebalancing.

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

MAIN   |   USNA   |   WDC   |   JOSB   |   STO   |   ORCL   |   NUS   |   HFC   |   ROST   |   TJX   |  

Main Street Capital Corporation is a United States-based principal investment firm that primarily provides long-term debt and equity capital to lower middle market companies. The Firm targets investments associated with ownership transitions, recapitalizations, strategic acquisitions, business expansion and other growth initiatives for later stage businesses. In addition to providing companies with necessary capital, Main Street provides management with expertise in corporate finance, operations and growth strategy implementation.

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.

Western Digital Corporation (WD) is a provider of solutions for the collection, storage, management, protection and use of digital content, including audio and video. Its principal products are hard drives, which are devices that use one or more rotating magnetic disks (magnetic media) to store and allow access to data. Its hard drives are used in desktop and notebook computers, corporate and cloud computing data centers, home entertainment equipment and stand-alone consumer storage devices. In addition to hard drives, its other products include solid-state drives and home entertainment and networking products. Effective March 8, 2012, it acquired Viviti Technologies Ltd. In May 2012, the Company completed the divestiture of certain 3.5-inch hard drive assets to Toshiba Corporation. As part of its deal with Toshiba, WD also completed its purchase of Toshiba Storage Device (Thailand) Company Limited (TSDT), which manufactured hard drives.

Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, manufacturer, retailer and direct marketer (through stores, catalog call center and Internet) of men's tailored and casual clothing and accessories and is a retailer of tuxedo rental products. Jos. A. Bank sells all of its products under the Jos. A. Bank label through 556 retail stores (as of January 28, 2012, which includes 25 outlet and factory stores and 15 franchise stores) located throughout 43 states and the District of Columbia in the United States, as well as through its catalog call center and Internet (www.josbank.com) operations. It sources substantially all of its merchandise from suppliers and manufacturers or through buying agents using Jos. A. Bank designs and specifications. It has two segments: Stores and Direct Marketing. The Stores segment includes all Company-owned stores, excluding outlet and factory stores (full-line stores). The Direct Marketing segment includes the catalog call center and the Internet.

Statoil ASA (Statoil) is an integrated energy company primarily engaged in oil and gas exploration and production activities. As of December 31, 2011, the Company had business operations in 41 countries and territories. Effective from January 1, 2011, the Company's segments were Development and Production Norway; Development and Production International; Marketing, Processing and Renewable Energy; Fuel & Retail, Other. As of 31 December 2011, the Company had proved reserves of 2,276 million barrels (mmbbl) and 3,150 billion cubic meters (bcm) (equivalent to 17,681 trillion cubic feet (tcf)) of natural gas, corresponding to aggregate proved reserves of 5,426 mmboe. In June 2012, the Company divested its 54% interest in Statoil Fuel & Retail ASA to Alimentation Couche-Tard.

Oracle Corporation is a provider of enterprise software and computer hardware products and services. The Company's software, hardware systems, and services businesses develops, manufactures, markets, hosts and supports database and middleware software, applications software, and hardware systems, with the latter consisting primarily of computer server and storage products. It is organized into three businesses: software, hardware systems and services. Its software business consists of two segments: new software licenses and software license updates and product support. Its hardware systems business consists of two segments: hardware systems products and hardware systems support. The Company's services business consists of the remainder of its segments and offers consulting services, managed cloud services, and education services. On January 25, 2012, it acquired RightNow Technologies, Inc. (RightNow). On April 5, 2012, the Company acquired Taleo Corporation (Taleo).

Nu Skin Enterprises, Inc. is a global direct selling company with operations in 52 markets worldwide. The Company develops and distributes anti-aging personal care products and nutritional supplements under its Nu Skin and Pharmanex brands, respectively. The Company operates through a direct selling model with independent distributors in all of its markets except Mainland China. As of December 31, 2011, the Company had more than 850,000 distributors. The Company has two primary product categories, each operating under its own brand. It markets its personal care products under the Nu Skin brand and its nutritional supplements under the Pharmanex brand. During the year ended December 31, 2011, approximately 88% of its revenues came from its markets outside of the United States. On December 13, 2011, the Company acquired LifeGen Technologies, LLC (LifeGen).

HollyFrontier Corporation (HollyFrontier), formerly Holly Corporation, is a petroleum refiner, which produces light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. HollyFrontier operates in two segments: Refining and Holly Energy Partners, L.P. (HEP). The Refining segment includes the operations of its El Dorado, Tulsa, Navajo, Cheyenne and Woods Cross Refineries and NK Asphalt. The HEP segment involves all of the operations of HEP. As of December 31, 2011, it operated five refineries having a combined crude oil processing capacity of 443,000 barrels per day that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. The Company merged with Frontier Oil Corporation (Frontier), on July 1, 2011. On November 9, 2011, HEP acquired from the Company certain tankage, loading rack and crude receiving assets located at its El Dorado and Cheyenne Refineries.

Ross Stores, Inc., along with its subsidiaries, operates two brands of off-price retail apparel and home fashion stores. As of January 28, 2012, the Company operated a total of 1,125 stores, of which 1,037 were Ross Dress for Less (Ross) locations in 29 states, the District of Columbia, and Guam, and 88 were dd's DISCOUNTS stores in seven states: 48 in California, 19 in Texas, 12 in Florida, four in Arizona, two in Georgia, two in Nevada, and one in Maryland. Ross focuses on customers primarily from middle income households, while dd's DISCOUNTS focuses on customers from more moderate income households. During the fiscal year ended January 28, 2012 (fiscal 2012), it opened 59 new Ross stores and closed ten existing stores. During fiscal 2011, it opened 21 new dd's DISCOUNTS stores. The average approximate dd's DISCOUNTS store size is 23,900 square feet. In April 2011, it purchased a 449,000 square foot warehouse for packaway storage in Riverside, California.

The TJX Companies, Inc. (TJX) is the off-price apparel and home fashions retailer in the United States and worldwide. As of January 28, 2012, the Company operated in four business segments. It has two segments in the United States, Marmaxx (T.J. Maxx and Marshalls) and HomeGoods; one in Canada, TJX Canada (Winners, Marshalls and HomeSense) and one in Europe, TJX Europe (T.K. Maxx and HomeSense). As a result of the consolidation of the A.J. Wright chain, all A.J. Wright stores ceased operations by the end of February 2011. It completed the consolidation of A.J. Wright, converting 90 of the A.J. Wright stores to T.J. Maxx, Marshalls or HomeGoods banners and closed the remaining 72 stores, two distribution centers and home office.

Watch List

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


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

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