The Economy

Continued weakness in commodity prices and lingering concerns about China's economy have roiled markets over the past couple weeks, and some mediocre US economic data hasn't helped matters.

Industrial production fell for the third straight month, declining 0.4% in December, according to a new Federal Reserve report. But November's big loss was revised from 0.9% to 0.6%, which almost balanced out the December decline. Just as in November, the big driver of last month's decline was utility output, which tends to be seasonally driven. It fell 2.0%. Manufacturing output slipped just 0.1%, while mining output dropped 0.8%, with a sharp decline in oil and gas drilling the big issue.

Housing starts slid 2.5% in December, according to the Census Bureau, but they are still 6.4% above year-ago levels. Permit issuance for new construction fell 3.9%, but is well above (14.4%) where it stood a year ago.

Some good news also came from the housing market, however, as new home sales jumped 10.8% in December, according to the Census Bureau. That put them about 10% above where they were a year ago. Median sales prices slid about 3%, and are about 4% below last year's level.

Retail and food service sales dipped 0.1% in December, meanwhile, according to a new report from the Census Bureau. Compared to the year-ago period, they were up 2.8%, however, one of the better year-over-year gains we've seen in recent months.

Overseas, China and oil continue to dominate market discussions. China's economy continues to show weakness, though not nearly as much as you might expect, given the level of anxiety we have seen in the stock market. A non-manufacturing index for smaller Chinese companies rose in January, Bloomberg reported, though it still indicated contraction in the sector. A similar index for small manufacturers fell to a record low in January, however. Still, China is still growing: Bloomberg's monthly GDP tracker indicated China grew at a 6.69% pace in December, just short of both November's figure and the officially announced 6.8% fourth-quarter growth.

As for oil and gas prices, it remains a wild ride -- mostly to the downside. While their rate of decline had slowed toward the end of 2015, gas prices have again been falling sharply in the New Year. A gallon of regular unleaded on average cost $1.83 on January 26, down from $2.00 a month earlier, according to AAA. That's about 10% below where it was a year ago.

The oil plunge has been driven by a combination of supply growth, demand weakness, and good old fear. It didn't help on Tuesday when the American Petroleum Institute said US oil inventories increased by a larger-than-usual 11.4 million barrels in the latest week, the Wall Street Journal reported. OPEC nations, meanwhile, continue to discuss the possibility of cutting back on supply, though they seem unwilling to do so without commitments from competitors to do the same. At least one big competitor -- Russia -- has been unwilling to do so. Signs emerged this week, however, that both Russia and OPEC power Saudi Arabia are starting to show more flexibility on the supply negotiations, Reuters reported.

Since our last newsletter, the S&P 500 returned -1.5%, while the Hot List returned 0.9%. So far in 2016, the portfolio has returned -2.4% vs. -7.4% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 175.1% vs. the S&P's 89.3% gain.

Portfolio Update: Bucking the Trend

While it's been a difficult first month of the year for the broader market, the Hot List has been hanging in there, and has put up some nice gains over the past two weeks. Since our last newsletter, all but one of the portfolio's 10 holdings are in the black, as of early morning trading on January 28.

Leading the way: LendingTree Inc. (TREE). A couple days before the Hot List added it to the portfolio on Jan. 15, LendingTree shares had been pounded, falling about 30% in a single day. The declines came after the firm actually said its fourth-quarter and full-year results would exceed its previous guidance. Investors appeared to focus more on the fact that it did not also increase its guidance for 2016. But the firm's CEO said he expects to release raised 2016 guidance next month, and LendingTree also announced that it had upped its share repurchase program by $50 million, and the stock has started to rebound. It seems to be a classic case of investors overreacting and creating a bargain for value-focused stock-pickers to snatch up.

The portfolio also benefited from two other holdings that produced bounce-back gains. Egg producer Cal-Maine Foods (CALM) was up about 4%, recapturing some of the losses suffered in December after a disappointing earnings announcement. Oil services firm Dril-Quip (DRQ), which, like many oil-related firms, has struggled in recent months, also gained about 4%, as investors may have started to recognize its value.

The lone Hot List stock to lose ground since our last newsletter was oil refiner Valero Energy Corp. (VLO), which was down about 2.6%. Valero actually reported a higher-than-expected fourth-quarter profit, thanks to lower crude oil costs and strong US gasoline demand. On an adjusted basis, the firm reported earnings of $1.79 per share, easily beating the average analyst estimate of $1.45 per share, according to Thomson Reuters I/B/E/S. Net income attributable to stockholders was $298 million, or 62 cents per share, down sharply from $1.16 billion, or $2.22 per share, a year earlier, however, as the company incurred a $790 million inventory valuation adjustment charge, Reuters said.

The Hot List's strong recent performance is encouraging as we head deeper into 2016. Hopefully, last year's rough patch is behind us and we will continue to benefit from picking up undervalued shares of solid companies. We'll see where we stand in two weeks, at which time we will rebalance the portfolio.

Recommended Reading

As you probably know, when it comes to stock-picking, I'm not a big believer in technical analysis strategies. Years ago, when I was looking for stock market gurus whose strategies I could computerize, I found no purely technical strategies with proven, long-term track records of success that were replicable. That's why my Guru Strategies are all focused on fundamentals.

But that doesn't mean I shun all technical factors. Several of my models, for example, use a relative strength criterion, so that they look for fundamentally sound stocks that also have good momentum behind them. My research has also shown that, when examining broader market trends, certain types of moving averages can be helpful. Given all that, I was very interested to read a recent piece by Kiplinger's Anne Kates Smith about the pros and cons of technical analysis. The article suggests such analysis "works best when it's part of a holistic look at the market," and I agree. Smith interviews technical analysis skeptics, including one who compares the field to "quasi-religious numerology" because it can "add to the feeling that we can understand the market [but it] doesn't work like that." But she also talks to advocates who say that just because technical analysis is not perfect, that doesn't mean it has no value. Ralph Acampora, co-founder of the Market Technicians Association, explains: "It's naive to think that because you know what a company is doing you know what its stock is doing," because it is the buying and selling of investors -- the "herd" -- that often moves stocks. Along with providing a glossary of some key technical terms and patterns, Smith notes that technical analysis shows a "decidedly cautious" picture of the current market.

I recommend checking out Smith's article. While I remain skeptical of technical strategies that ignore fundamentals, I do think technical analysis can help explain what's going on in the market at a given time. The more you understand about the stock market, the less anxiety you'll have when times get tough, which can help you stay disciplined -- and staying disciplined is always a good thing.



Guru Spotlight: David Dreman On Why Analysts' Predictions Are Like Powerball Tickets

The huge recent Powerball jackpot captured the attention of just about everyone, sending millions of Americans to their local convenience stores in search of a winning ticket. Of course, if you were buying tickets for any other reason than sheer entertainment value, you were throwing your money away: The odds that you would be the winner were lower than the odds that you will become president of the United States.

Unfortunately, the Wall Street analysts who so often get cited for their predictions of companies' earnings -- predictions that often get investors in a tizzy -- have success rates similar to those of lottery ticket buyers. Consider what David Dreman wrote in his 1998 classic Contrarian Investment Strategies:

"There is only a 1 in 130 chance that the analysts' consensus forecast will be within 5 percent for any four consecutive quarters," he wrote. "To put this in perspective, your odds are ten times greater of being the big winner of the New York State Lottery than of pinpointing earnings five years ahead."

Ouch.

One reason Dreman gives for analysts' poor performances involves something that affects individual investors, too: overoptimism. Analysts know that high-flying stocks will plummet if earnings come in below the Street's expectations. Yet the same analyst will still recommend high flyers because he is confident he knows enough about the stocks he has recommended so there is no chance they will experience negative surprises. That might happen to other analysts, he thinks, but not to him. Of course, given the unpredictability of the market and events surrounding it, there's a good chance it will happen to him.

From Contrarian Investment Strategies: The Next Generation, 1998 (Simon & Schuster)

Screen Shot 2016-01-28 at 4.11.31 PM



I don't mean to pick on analysts. They have a tough job. The real problem may be less about their inaccuracies and more about the way that the investing public takes their word as gospel. But however you look at it, the fact that analysts are so often wrong is good news for disciplined contrarian investors, Dreman says. To understand why, you need to understand to beliefs that are at the core of his strategy. First, he found that investors -- being emotional human beings -- are prone to overreaction. If a stock is considered "good" -- it's one of the "hot" stocks you read about in the paper, hear about on cable TV, or get tips about from your friends and coworkers -- investors consistently overprice it. If a stock is "bad" -- its price has been dropping, the company is making negative headlines, there are concerns about its industry's future -- investors underprice it. What's more, this overvaluing of the supposed "best" stocks and undervaluing of the supposed "worst" often goes to extremes.

Second, Dreman found that surprises occur frequently in the stock market, and that many of those surprises involve earnings results that differ significantly from analysts' estimates. When you put investors' tendency to overreact together with the frequent surprises in the market, you get to the crux of why Dreman believed so much in a contrarian approach: Because the "best" stocks are often overvalued, good surprises can't increase their values that much more. Bad surprises, however, can have a very negative impact on them. On the other hand, because they already tend to be undervalued, the "worst" stocks don't have much further down to go when bad surprises occur. When good surprises occur, however, they have a lot of room to grow.

His conclusion: Buy out-of-favor stocks because surprises (positive and negative ones), including earnings surprises, are commonplace. If you own favorites, you'll get clobbered by negative surprises but won't get much upside by positive surprises; whereas if you own out-of-favor stocks, you'll hardly be penalized for negative surprises but will be rewarded handsomely by positive ones. And given how inaccurate analysts are, there are bound to be some positive ones.

The approach I base on Dreman's writings thus involves looking for unloved stocks (those that are in the market's cheapest 20% using at least two of the following: price/earnings ratio, price/book ratio, price/sales ratio, price/cash flow ratio) that have strong underlying fundamentals (high returns on equity, strong recent earnings growth, high and sustainable dividend payouts). The strategy has been a very up-and-down performer for me. At one point a few years back, my 10-stock Dreman-inspired portfolio was my best performer over the long-term. But as value stocks have struggled in recent years, this deep value strategy has had its problems. Last year, for example, it lost more than 20%. The growth/value pendulum is fickle, but it always swings back the other way. When that happens, I expect the Dreman-inspired model will rebound fiercely. Human nature doesn't change, and the behavioral biases that Dreman highlighted aren't going anywhere. Over the long-term, investors who follow his advice should be able to take advantage of them.

Here's a look at the Dreman portfolio's current holdings:

Validea.com Contrarian Investor Portfolio, Monthly Rebalanced (as of Jan. 28)

Screen Shot 2016-01-28 at 4.20.45 PM





News about Validea Hot List Stocks

Valero Energy Corp. (VLO): Valero has acquired a 50% interest in the 440-mile "Diamond Pipeline" that runs from strategic storage terminals in Oklahoma to Memphis, San Antonio Business Journal reported. The 20-inch, $900 million pipeline is expected to be complete in early 2017, and can transport up to 200,000 barrels per day of domestically produced light sweet crude oil. Valero officials declined to comment, the SABJ said, but Valero reported in an SEC filing that the company has paid $140 million in December and has budgeted another $280 million for the project in 2016.



The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will rebalance the portfolio. If you have any questions, please feel free to contact us at hotlist@validea.com.

Portfolio Holdings
Ticker Date Added Return
VLO 11/20/2015 -10.3%
CALM 11/20/2015 -12.5%
AFSI 1/15/2016 0.9%
ASPS 1/15/2016 4.8%
LL 1/15/2016 6.1%
BMA 11/20/2015 -10.5%
TREE 1/15/2016 3.9%
EW 1/15/2016 1.6%
TJX 1/15/2016 2.8%
DRQ 1/15/2016 4.4%


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

VLO   |   CALM   |   AFSI   |   ASPS   |   LL   |   BMA   |   TREE   |   EW   |   TJX   |   DRQ   |  

VALERO ENERGY CORPORATION

Strategy: Value Investor
Based on: Benjamin Graham

Valero Energy Corp (Valero) is an international manufacturer and marketer of transportation fuels, other petrochemical products and power. The Company's refineries can produce conventional gasolines, premium gasolines, gasoline, diesel fuel, low-sulfur diesel fuel, ultra-low-sulfur diesel fuel, CARB diesel fuel, other distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products. The Company markets branded and unbranded refined products through approximately 7,400 outlets. The Company also owns 11 ethanol plants in the central plains region of the United States that primarily produce ethanol. The Company operates through two segments. The refining segment includes refining operations, wholesale marketing, product supply and distribution, and transportation operations in the United States, Canada, the United Kingdom, Aruba and Ireland. Its ethanol segment primarily includes sale of internally produced ethanol and distillers grains.


SECTOR: PASS

VLO is neither a technology nor financial Company, and therefore this methodology is applicable.


SALES: PASS

The investor must select companies of "adequate size". This includes companies with annual sales greater than $340 million. VLO's sales of $96,886.0 million, based on trailing 12 month sales, pass this test.


CURRENT RATIO: PASS

The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. VLO's current ratio of 2.03 passes the test.


LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: PASS

For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that meet this criterion display one of the attributes of a financially secure organization. The long-term debt for VLO is $7,252.0 million, while the net current assets are $8,538.0 million. VLO passes this test.


LONG-TERM EPS GROWTH: FAIL

Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. EPS for VLO were negative within the last 5 years and therefore the company fails this criterion.


P/E RATIO: PASS

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be "moderate", which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. VLO's P/E of 11.10 (using the 3 year PE) passes this test.


PRICE/BOOK RATIO: PASS

The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. VLO's Price/Book ratio is 1.46, while the P/E is 11.10. VLO passes the Price/Book test.

CAL-MAINE FOODS INC

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

Cal-Maine Foods, Inc. is a producer and marketer of shell eggs in the United States. The Company's primary business is the production, grading, packaging, marketing and distribution of shell eggs. The Company sells its shell eggs in the southwestern, southeastern, mid-western and mid-Atlantic regions of the United States. The Company markets its shell eggs through its distribution network to a group of customers, including national and regional grocery store chains, club stores, foodservice distributors and egg product consumers. Some of its sales are completed through co-pack agreements. It has a total flock of approximately 33.7 million layers and 8.4 million pullets and breeders. The Company markets its specialty shell eggs under brands, such as Egg-Land's Best, Land O' Lakes, Farmhouse and 4-Grain. The Company also produces, markets and distributes private label specialty shell eggs to several customers.


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. CALM's profit margin of 17.59% passes this test.


RELATIVE STRENGTH: PASS

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. CALM, with a relative strength of 91, satisfies 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 CALM (197.37% for EPS, and 44.20% for Sales) are good enough to pass.


INSIDER HOLDINGS: FAIL

CALM's insiders should own at least 10% (they own 1.93%) 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. CALM's free cash flow of $1.32 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

CALM's profit margin has been consistent or even increasing over the past three years (Current year: 10.23%, Last year: 7.58%, Two years ago: 3.91%), 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 CALM's case.


CASH AND CASH EQUIVALENTS: FAIL

CALM does not have a sufficiently large amount of cash, $258.63 million, on hand relative to its size. Although this criteria does not apply to companies of this size, we defined anything greater than $500 million in cash as having 'a lot of cash' to allow analysis of these companies. CALM will have more of a difficult time paying off debt (if it has any) or acquiring other companies than a company that passes this criterion.


INVENTORY TO SALES: PASS

This methodology strongly believes that companies, especially small ones, should have tight control over inventory. It's a warning sign if a company's inventory relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Inventory to Sales for CALM was 10.14% last year, while for this year it is 9.28%. Since the inventory to sales is decreasing by -0.86% the stock passes this criterion.


ACCOUNT RECEIVABLE TO SALES: PASS

This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for CALM was 6.07% last year, while for this year it is 6.47%. Although the AR to sales is rising, it is below the max 30% that is allowed. The investor can still consider the stock if all other criteria appear very attractive.


LONG TERM DEBT/EQUITY RATIO: PASS

CALM's trailing twelve-month Debt/Equity ratio (2.59%) is a little higher than what this methodology is looking for, but is still at an acceptable level. The superior companies that you are looking for don't need to borrow money in order to grow. This company has borrowed very little which is still OK.


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

The "Fool Ratio" is an extremely important aspect of this analysis. If the company has attractive fundamentals and its Fool Ratio is 0.5 or less (CALM's is 0.31), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. CALM passes this test.

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

AVERAGE SHARES OUTSTANDING: PASS

CALM has not been significantly increasing the number of shares outstanding within recent years which is a good sign. CALM currently has 48.0 million shares outstanding. This means the company is not taking any measures, with regards to the number of shares, that will dilute or devalue the stock.


SALES: FAIL

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. CALM's sales of $1,996.4 million based on trailing 12 month sales, are too high and would therefore fail the test. It is companies with $500 million or less in sales that are most likely to double or triple in size in the next few years.


DAILY DOLLAR VOLUME: FAIL

CALM does not pass the Daily Dollar Volume (DDV of $43.7 million) test. It exceeds the maximum requirement of $25 million. Stocks that fail the test are too liquid for a small individual investor and many institutions have already discovered it.


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. CALM with a price of $49.68 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

CALM's income tax paid expressed as a percentage of pretax income this year was (34.18%) and last year (32.16%) 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.

AMTRUST FINANCIAL SERVICES INC

Strategy: Contrarian Investor
Based on: David Dreman

Amtrust Financial Services, Inc. is an insurance holding company. Through its wholly owned subsidiaries, the Company provides specialty property and casualty insurance focusing on workers' compensation and commercial package coverage for small business, specialty risk and extended warranty coverage, and property and casualty coverage for middle market business. The Company operates through three segments. The Small Commercial Business segment provides workers' compensation and commercial package and other property and casualty insurance products. The Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans. The Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance.

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. AFSI has a market cap of $4,957 million, therefore passing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. AFSI's EPS for the past 2 quarters, (from earliest to most recent quarter) 0.83, 2.17 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. AFSI passes this test as its EPS growth rate over the past 6 months (17.29%) has beaten that of the S&P (1.85%). AFSI's estimated EPS growth for the current year is (11.01%), which indicates the company is expected to experience positive earnings growth. As a result, AFSI passes this test.


This methodology would utilize four separate criteria to determine if AFSI 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. AFSI's P/E of 9.84, based on trailing 12 month earnings, meets the bottom 20% criterion (below 10.48), 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. AFSI's P/CF of 9.04 does not meet the bottom 20% criterion (below 5.45), 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. AFSI's P/B is currently 2.18, which does not meet the bottom 20% criterion (below 0.81), 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%). AFSI's P/D of 46.95 does not meet the bottom 20% criterion (below 16.34), 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.


PAYOUT RATIO: FAIL

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for AFSI is 17.88%, while its historical payout ratio has been 14.73%. Therefore, it fails 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 16.74%, and would consider anything over 27% to be staggering. The ROE for AFSI of 25.00% 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. AFSI's pre-tax profit margin is 12.25%, thus passing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. AFSI's current yield is 2.13%, while the market yield is 2.99%. AFSI fails this test.

ALTISOURCE PORTFOLIO SOLUTIONS S.A.

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

Altisource Portfolio Solutions S.A. is a provider of marketplace and transaction solutions for the real estate, mortgage and consumer debt industries offering both distribution and content. The Company operates in three segments: Mortgage Services, Financial Services and Technology Services. The Company's Mortgage Services segment provides services that span the mortgage and real estate lifecycle, and are outsourced by loan servicers, loan originators, investors and other sellers of single family homes. The Financial Services segment provides collection and customer relationship management services to debt originators and servicers, and the utility, insurance and hotel industries. The Company's Technology Services consists of REALSuite of software applications, Equator, LLC (Equator) software applications, Mortgage Builder software applications and its information technology (IT) infrastructure management services.


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. ASPS, with a market cap of $550 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. ASPS, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 1.88, 2.77, 4.43, 5.19 and 5.69, 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. ASPS's Price/Sales ratio of 0.53, 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. ASPS, whose relative strength is 91, is in the top 50 and would pass this last criterion.

LUMBER LIQUIDATORS HOLDINGS INC

Strategy: Patient Investor
Based on: Warren Buffett

Lumber Liquidators Holdings, Inc. (Lumber Liquidators) is a retailer of hardwood flooring, and hardwood flooring enhancements and accessories in North America. The Company's product categories include Solid and Engineered Hardwood; Laminate; Bamboo, Cork and Vinyl Plank, and Moldings and Accessories. The Company sells its products primarily to homeowners or to contractors on behalf of homeowners. The Company offers wood flooring under18 brand names, led by Bellawood, a collection of solid and engineered hardwood flooring, bamboo flooring, moldings and accessories. The Company also offers a range of flooring enhancements and installation accessories, including moldings, noise-reducing underlay and tools. It offers around 400 different flooring product stock-keeping units. As of February 23, 2015, Lumber Liquidators operated around 354 stores located in 46 states of the United States and nine store locations in Canada.

STAGE 1: "Is this a Buffett type company?"

A bedrock principle for Buffett is that his type of company has a "durable competitive advantage" as compared to being a "price competitive" or "commodity" type of business. Companies with a "durable competitive advantage" are more likely to be found in these sub-industries: Brand Name Fast Food Restaurants, Brand Name Beverages, Brand Name Foods, Brand Name Toiletries and Household Products, Brand Name Clothing, Brand Name Prescription Drugs, Advertising, Advertising Agencies, TV, Newspapers, Magazines, Direct Mail, Repetitive Services for Businesses, Low Cost Producers of Insurance, furniture, or Low Cost Retailers. While you should be easily able to explain where the company's pricing power comes from (i.e. a strong regional brand image, a business tollgate, its main products are #1 or # 2 in its field and has been on the market for years and hasn't changed at all, a consumer or business ends up buying the same product many times in a year, etc. or having the lowest production cost among its competition), there are certain figures that one can look at that can qualify the company as having a durable competitive advantage.


LOOK FOR EARNINGS PREDICTABILITY: PASS

Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 0.40, 0.56, 0.48, 0.82, 0.97, 0.93, 0.93, 1.68, 2.77, 2.31. Buffett would consider LL's earnings predictable, although earnings have declined 3 time(s) in the past seven years, with the most recent decline 1 years ago. The dips have totaled 35.0%. LL's long term historical EPS growth rate is 22.6%, based on the 10 year average EPS growth rate.


LOOK AT THE ABILITY TO PAY OFF DEBT PASS

Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. LL has no long term debt and therefore would pass this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: PASS

Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for LL, over the last ten years, is 17.5%, which is high enough to pass. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 67.0%, 51.2%, 13.9%, 19.2%, 18.0%, 14.2%, 12.1%, 19.5%, 24.7%, 18.8%, and the average ROE over the last 3 years is 21.0%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON TOTAL CAPITAL: PASS

Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for LL, over the last ten years, is 22.8% and the average ROTC over the past 3 years is 21.0%, which is high enough to pass. It is not enough that the average be at least 12%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROTC must be at least 9% for Buffett to feel comfortable that the ROTC is consistent. The ROTC for the last 10 years, from earliest to latest, is 45.6%, 41.9%, 13.9%, 19.2%, 18.0%, 14.2%, 12.1%, 19.5%, 24.7%, 18.8%, thus passing this criterion.


LOOK AT CAPITAL EXPENDITURES: PASS

Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. LL's free cash flow per share of $0.25 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.


LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: PASS

Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $11.85 and compares it to the gain in EPS over the same period of $1.91. LL's management has proven it can earn shareholders a 16.1% return on the earnings they kept. This return is more than acceptable to Buffett. Essentially, management is doing a great job putting the retained earnings to work.


HAS THE COMPANY BEEN BUYING BACK SHARES: BONUS PASS

Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. LL's shares outstanding have fallen over the past five years from 27,469,999 to 27,000,000, thus passing this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

The preceding concludes Buffett's qualitative analysis. If and when he gets positive responses to all the above criteria, he would then proceed with a price analysis. The price analysis will determine whether or not the stock should be bought. The following is how he would evaluate LL quantitatively.

STAGE 2: "Should I buy at this price?" Although a firm may be a Buffett type company, he won't invest in it unless he can get a favorable price that allows him a great long term return.


CALCULATE THE INITIAL RATE OF RETURN: [No Pass/Fail]

Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $-0.72 and divide it by the current market price of $12.89. An investor, purchasing LL, could expect to receive a -5.59% initial rate of return. Furthermore, he or she could expect the rate to increase 22.6% per year, based on the 10 year average EPS growth rate, as this is how fast earnings are growing.


COMPARE THE INITIAL RATE OF RETURN WITH THE LONG-TERM TREASURY YIELD: FAIL

Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.25%. Compare this with LL's initial yield of -5.59%, which will expand at an annual rate of 22.6%, based on the 10 year average EPS growth rate. Although the initial rate of return is lower than the treasury yield, Buffett has invested in solid companies regardless.


CALCULATE THE FUTURE EPS: [No Pass/Fail]

LL currently has a book value of $10.92. It is safe to say that if LL can preserve its average rate of return on equity of 17.5% and continues to retain 100.00% of its earnings, it will be able to sustain an earnings growth rate of 17.5% and it will have a book value of $54.95 in ten years. If it can still earn 17.5% on equity in ten years, then expected EPS will be $9.64.


CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now take the expected future EPS of $9.64 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (5 year average P/E in this case), which is 30.7 and you get LL's projected future stock price of $295.81.


CALCULATE THE EXPECTED RATE OF RETURN BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now add in the total expected dividend pool to be paid over the next ten years, which is $-0.00. This gives you a total dollar amount of $295.81. These numbers indicate that one could expect to make a 36.8% average annual return on LL's stock at the present time. Buffett would consider this an absolutely fantastic expected return.


CALCULATE THE EXPECTED FUTURE STOCK PRICE BASED ON AVERAGE EPS GROWTH: [No Pass/Fail]

If you take the EPS growth of 22.6%, based on the 10 year average EPS growth rate, you can project EPS in ten years to be $-5.54. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (5 year average P/E in this case), which is 30.7. This equals the future stock price of $-170.20. Add in the total expected dividend pool of $-0.00 to get a total dollar amount of $-170.20.


CALCULATE THE EXPECTED RETURN USING THE AVERAGE EPS GROWTH METHOD: [No Pass/Fail]

Now you can figure out your expected return based on a current price of $12.89 and the future expected stock price, including the dividend pool, of $-170.20. If you were to invest in LL at this time, you could expect a 0.00% average annual return on your money. Buffett likes to see a 15% return, and would even go down to 12%.


LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: PASS

Based on the two different methods, you could expect an annual compounding rate of return somewhere between 0.0% and 36.8%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 18.4% on LL stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.

BANCO MACRO SA (ADR)

Strategy: Contrarian Investor
Based on: David Dreman

Banco Macro S.A. (the Bank) is a bank. The Bank offers traditional bank products and services to companies, including those operating in regional economies, as well as to individuals. The Bank offers savings and checking accounts, credit and debit cards, consumer finance loans (including personal loans), mortgage loans, automobile loans, overdrafts, credit-related services, home and car insurance coverage, tax collection, utility payments, automatic teller machines (ATMs) and money transfers. The Bank offers Plan Sueldo payroll services, lending, corporate credit cards, mortgage finance, transaction processing and foreign exchange. The Bank offers transaction services to its corporate customers, such as cash management, customer collections, payments to suppliers, payroll administration, foreign exchange transactions, foreign trade services, corporate credit cards and information services, such as its Datanet and Interpymes services.

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. BMA has a market cap of $3,619 million, therefore passing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. BMA's EPS for the past 2 quarters, (from earliest to most recent quarter) 0.20, 1.37 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. BMA passes this test as its EPS growth rate over the past 6 months (813.33%) has beaten that of the S&P (1.85%). BMA's estimated EPS growth for the current year is (956.45%), which indicates the company is expected to experience positive earnings growth. As a result, BMA passes this test.


This methodology would utilize four separate criteria to determine if BMA 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: FAIL

The P/E of a company should be in the bottom 20% of the overall market. BMA's P/E of 13.35, based on trailing 12 month earnings, is higher than the bottom 20% criterion (below 10.48), and therefore fails 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. BMA's P/CF of 12.68 does not meet the bottom 20% criterion (below 5.45), and therefore fails this test.


PRICE/BOOK (P/B) VALUE: PASS

The P/B value of a company should be in the bottom 20% of the overall market. BMA's P/B is currently 0.07, which meets the bottom 20% criterion (below 0.81), and it therefore passes 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%). BMA's P/D of 48.54 does not meet the bottom 20% criterion (below 16.34), 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.


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 BMA 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 16.74%, and would consider anything over 27% to be staggering. The ROE for BMA of 29.14% 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. BMA's pre-tax profit margin is 37.53%, thus passing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. BMA's current yield is 2.06%, while the market yield is 2.99%. BMA fails this test.

LENDINGTREE INC

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

LendingTree, Inc. (LendingTree), formerly Tree.com, Inc. is engaged in operating an online loan marketplace for consumers an array of loan types and other credit-based offerings. The Company offers consumers tools and resources, including free credit scores, which help them to comparison-shop for mortgage loans, home equity loans and lines of credit, reverse mortgages, personal loans, auto loans, student loans, credit cards, small business loans and other related offerings. And, upon submitting their relevant information to the Company through an inquiry form, it seeks to match in-market consumers with multiple lenders on its marketplace. The Company operates in four segments: lending, auto, education and home services. It provides information and tools, including free credit scores located on its various Websites. In addition, the Company provides consumers with access to offers from multiple lenders.


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. TREE's profit margin of 9.71% passes this test.


RELATIVE STRENGTH: PASS

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. TREE, with a relative strength of 95, satisfies 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 TREE (1,080.00% for EPS, and 68.97% for Sales) are good enough to pass.


INSIDER HOLDINGS: PASS

TREE's insiders should own at least 10% (they own 40.66% ) of the company's outstanding shares which is extremely attractive since the minimum requirement is 10%. A high percentage indicates that the insiders are confident that the company will do well.


CASH FLOW FROM OPERATIONS: FAIL

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. TREE's free cash flow of $-0.41 per share fails this test.


PROFIT MARGIN CONSISTENCY: FAIL

The profit margin in the past must be consistently increasing. The profit margin of TREE has been inconsistent in the past three years (Current year: 5.59%, Last year: 2.84%, Two years ago: 60.20%), which is unacceptable. This inconsistency will carryover directly to the company's bottom line, or earnings per share.


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 TREE's case.


CASH AND CASH EQUIVALENTS: PASS

TREE's level of cash $86.2 million passes this criteria. If a company is a cash generator, like TREE, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.


ACCOUNT RECEIVABLE TO SALES: PASS

This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for TREE was 9.23% last year, while for this year it is 8.13%. Since the AR to sales is decreasing by -1.10% the stock passes this criterion.


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

The "Fool Ratio" is an extremely important aspect of this analysis. Unfortunately, TREE's "Fool Ratio" is not available due to a lack of one or more important figures. Hence, an opinion cannot be given at this time.

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

AVERAGE SHARES OUTSTANDING: PASS

TREE has not been significantly increasing the number of shares outstanding within recent years which is a good sign. TREE currently has 12.0 million shares outstanding. This means the company is not taking any measures, with regards to the number of shares, that will dilute or devalue the stock.


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. TREE's sales of $219.7 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". TREE passes the sales test.


DAILY DOLLAR VOLUME: FAIL

TREE does not pass the Daily Dollar Volume (DDV of $44.1 million) test. It exceeds the maximum requirement of $25 million. Stocks that fail the test are too liquid for a small individual investor and many institutions have already discovered it.


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. TREE with a price of $70.36 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

TREE's income tax paid expressed as a percentage of pretax income this year was (49.48%) and last year (39.82%) 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.

EDWARDS LIFESCIENCES CORP

Strategy: Patient Investor
Based on: Warren Buffett

Edwards Lifesciences Corporation is focused on technologies that treat structural heart disease and critically ill patients. The Company is engaged in the development and commercialization of heart valve therapies. It is a manufacturer of heart valve systems and repair products used to replace or repair a patient's diseased or defective heart valve. The Company develops hemodynamic monitoring systems used to measure a patient's cardiovascular function in the hospital setting. Patients in the hospital setting, including high-risk patients in the operating room or intensive care unit, are candidates for having their cardiac function or fluid levels monitored by the its Critical Care products. The Company's products and technologies it offers to treat advanced cardiovascular disease are categorized into three main areas: Transcatheter Heart Valve Therapy, Surgical Heart Valve Therapy and Critical Care.

STAGE 1: "Is this a Buffett type company?"

A bedrock principle for Buffett is that his type of company has a "durable competitive advantage" as compared to being a "price competitive" or "commodity" type of business. Companies with a "durable competitive advantage" are more likely to be found in these sub-industries: Brand Name Fast Food Restaurants, Brand Name Beverages, Brand Name Foods, Brand Name Toiletries and Household Products, Brand Name Clothing, Brand Name Prescription Drugs, Advertising, Advertising Agencies, TV, Newspapers, Magazines, Direct Mail, Repetitive Services for Businesses, Low Cost Producers of Insurance, furniture, or Low Cost Retailers. While you should be easily able to explain where the company's pricing power comes from (i.e. a strong regional brand image, a business tollgate, its main products are #1 or # 2 in its field and has been on the market for years and hasn't changed at all, a consumer or business ends up buying the same product many times in a year, etc. or having the lowest production cost among its competition), there are certain figures that one can look at that can qualify the company as having a durable competitive advantage.


LOOK FOR EARNINGS PREDICTABILITY: PASS

Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 0.32, 0.53, 0.47, 0.55, 0.98, 0.91, 0.99, 1.23, 1.71, 3.74. Buffett would consider EW's earnings predictable, although earnings have declined 2 time(s) in the past seven years, with the most recent decline 5 years ago. The dips have totaled 18.5%. EW's long term historical EPS growth rate is 42.7%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 16.5% per year in the future, based on the analysts' consensus estimated long term growth rate. For the purposes of our analysis, we will use the more conservative of the two EPS growth numbers.


LOOK AT THE ABILITY TO PAY OFF DEBT PASS

Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. EW has a debt of 604.9 million and earnings of 464.2 million, which could be used to pay off the debt in less than two years, which is considered exceptional.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: PASS

Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for EW, over the last ten years, is 18.6%, which is high enough to pass. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 11.0%, 16.2%, 12.7%, 13.9%, 19.1%, 16.1%, 16.9%, 19.0%, 24.2%, 36.8%, and the average ROE over the last 3 years is 26.7%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON TOTAL CAPITAL: FAIL

Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for EW, over the last ten years, is 15.6% and the average ROTC over the past 3 years is 21.1%, which is high enough to pass. It is not enough that the average be at least 12%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROTC must be at least 9% for Buffett to feel comfortable that the ROTC is consistent. The ROTC for the last 10 years, from earliest to latest, is 7.5%, 12.3%, 11.8%, 11.6%, 17.8%, 16.1%, 15.2%, 16.9%, 17.5%, 28.9%, thus failing this criterion.


LOOK AT CAPITAL EXPENDITURES: PASS

Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. EW's free cash flow per share of $4.28 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.


LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: PASS

Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $11.43 and compares it to the gain in EPS over the same period of $3.42. EW's management has proven it can earn shareholders a 29.9% return on the earnings they kept. This return is more than acceptable to Buffett. Essentially, management is doing a great job putting the retained earnings to work.


HAS THE COMPANY BEEN BUYING BACK SHARES: BONUS PASS

Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. EW's shares outstanding have fallen over the past five years from 230,000,000 to 220,000,000, thus passing this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

The preceding concludes Buffett's qualitative analysis. If and when he gets positive responses to all the above criteria, he would then proceed with a price analysis. The price analysis will determine whether or not the stock should be bought. The following is how he would evaluate EW quantitatively.

STAGE 2: "Should I buy at this price?" Although a firm may be a Buffett type company, he won't invest in it unless he can get a favorable price that allows him a great long term return.


CALCULATE THE INITIAL RATE OF RETURN: [No Pass/Fail]

Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $2.11 and divide it by the current market price of $75.88. An investor, purchasing EW, could expect to receive a 2.78% initial rate of return. Furthermore, he or she could expect the rate to increase 16.5% per year, based on the analysts' consensus estimated long term growth rate, as this is how fast earnings are growing.


COMPARE THE INITIAL RATE OF RETURN WITH THE LONG-TERM TREASURY YIELD: PASS

Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.25%. Compare this with EW's initial yield of 2.78%, which will expand at an annual rate of 16.5%, based on the analysts' consensus estimated long term growth rate. The company is the better choice, as the initial rate of return is close to or above the long term bond yield and is expanding.


CALCULATE THE FUTURE EPS: [No Pass/Fail]

EW currently has a book value of $11.24. It is safe to say that if EW can preserve its average rate of return on equity of 18.6% and continues to retain 100.00% of its earnings, it will be able to sustain an earnings growth rate of 18.6% and it will have a book value of $61.84 in ten years. If it can still earn 18.6% on equity in ten years, then expected EPS will be $11.50.


CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now take the expected future EPS of $11.50 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (36.0) (5 year average P/E in this case), which is 25.3 and you get EW's projected future stock price of $291.18.


CALCULATE THE EXPECTED RATE OF RETURN BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now add in the total expected dividend pool to be paid over the next ten years, which is $0.00. This gives you a total dollar amount of $291.18. These numbers indicate that one could expect to make a 14.4% average annual return on EW's stock at the present time. Although, the return is slightly below the liking of Buffett, the return would still be somewhat acceptable.


CALCULATE THE EXPECTED FUTURE STOCK PRICE BASED ON AVERAGE EPS GROWTH: [No Pass/Fail]

If you take the EPS growth of 16.5%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $9.70. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (36.0) (5 year average P/E in this case), which is 25.3. This equals the future stock price of $245.71. Add in the total expected dividend pool of $0.00 to get a total dollar amount of $245.71.


CALCULATE THE EXPECTED RETURN USING THE AVERAGE EPS GROWTH METHOD: [No Pass/Fail]

Now you can figure out your expected return based on a current price of $75.88 and the future expected stock price, including the dividend pool, of $245.71. If you were to invest in EW at this time, you could expect a 12.47% average annual return on your money. Buffett likes to see a 15% return, but nonetheless would accept this return.


LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: PASS

Based on the two different methods, you could expect an annual compounding rate of return somewhere between 12.5% and 14.4%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 13.4% on EW stock for the next ten years, based on the current fundamentals. Buffett likes to see a 15% return, but nonetheless would accept this return, thus passing the criterion.

TJX COMPANIES INC

Strategy: Patient Investor
Based on: Warren Buffett

The TJX Companies, Inc. (TJX) is an off-price apparel and home fashions. The Company operates through four segments: Marmaxx, HomeGoods, TJX Canada and TJX Europe. The Marmaxx and HomeGoods business offers family apparel, home fashions, accent furniture, lamps, rugs, wall decor, decorative accessories and giftware and other merchandise. The TJX Canada offers jewelry and home fashions. TJX Europe operates the T.K. Maxx and HomeSense chains in Europe. The Company operates approximately 3,461 stores in countries, including the United States, Canada, the United Kingdom, Ireland, Germany, Poland, Austria and Australia.

STAGE 1: "Is this a Buffett type company?"

A bedrock principle for Buffett is that his type of company has a "durable competitive advantage" as compared to being a "price competitive" or "commodity" type of business. Companies with a "durable competitive advantage" are more likely to be found in these sub-industries: Brand Name Fast Food Restaurants, Brand Name Beverages, Brand Name Foods, Brand Name Toiletries and Household Products, Brand Name Clothing, Brand Name Prescription Drugs, Advertising, Advertising Agencies, TV, Newspapers, Magazines, Direct Mail, Repetitive Services for Businesses, Low Cost Producers of Insurance, furniture, or Low Cost Retailers. While you should be easily able to explain where the company's pricing power comes from (i.e. a strong regional brand image, a business tollgate, its main products are #1 or # 2 in its field and has been on the market for years and hasn't changed at all, a consumer or business ends up buying the same product many times in a year, etc. or having the lowest production cost among its competition), there are certain figures that one can look at that can qualify the company as having a durable competitive advantage.


LOOK FOR EARNINGS PREDICTABILITY: PASS

Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 0.71, 0.82, 0.84, 1.04, 1.42, 1.65, 1.93, 2.55, 2.94, 3.15. Buffett would consider TJX's earnings predictable. In fact EPS have increased every year. TJX's long term historical EPS growth rate is 17.5%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 11.0% per year in the future, based on the analysts' consensus estimated long term growth rate. For the purposes of our analysis, we will use the more conservative of the two EPS growth numbers.


LOOK AT THE ABILITY TO PAY OFF DEBT PASS

Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. TJX has a debt of 1,624.0 million and earnings of 2,233.7 million, which could be used to pay off the debt in less than two years, which is considered exceptional.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: PASS

Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for TJX, over the last ten years, is 39.6%, which is high enough to pass. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 34.4%, 32.7%, 33.8%, 40.2%, 40.2%, 41.4%, 45.0%, 50.4%, 49.1%, 50.6%, and the average ROE over the last 3 years is 50.0%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON TOTAL CAPITAL: PASS

Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for TJX, over the last ten years, is 32.3% and the average ROTC over the past 3 years is 38.6%, which is high enough to pass. It is not enough that the average be at least 12%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROTC must be at least 9% for Buffett to feel comfortable that the ROTC is consistent. The ROTC for the last 10 years, from earliest to latest, is 24.1%, 24.2%, 24.1%, 34.1%, 31.6%, 33.0%, 36.2%, 41.6%, 37.7%, 36.6%, thus passing this criterion.


LOOK AT CAPITAL EXPENDITURES: PASS

Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. TJX's free cash flow per share of $2.32 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.


LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: PASS

Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $13.79 and compares it to the gain in EPS over the same period of $2.44. TJX's management has proven it can earn shareholders a 17.7% return on the earnings they kept. This return is more than acceptable to Buffett. Essentially, management is doing a great job putting the retained earnings to work.


HAS THE COMPANY BEEN BUYING BACK SHARES: BONUS PASS

Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. TJX's shares outstanding have fallen over the past five years from 779,320,007 to 681,000,000, thus passing this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

The preceding concludes Buffett's qualitative analysis. If and when he gets positive responses to all the above criteria, he would then proceed with a price analysis. The price analysis will determine whether or not the stock should be bought. The following is how he would evaluate TJX quantitatively.

STAGE 2: "Should I buy at this price?" Although a firm may be a Buffett type company, he won't invest in it unless he can get a favorable price that allows him a great long term return.


CALCULATE THE INITIAL RATE OF RETURN: [No Pass/Fail]

Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $3.28 and divide it by the current market price of $69.39. An investor, purchasing TJX, could expect to receive a 4.73% initial rate of return. Furthermore, he or she could expect the rate to increase 11.0% per year, based on the analysts' consensus estimated long term growth rate, as this is how fast earnings are growing.


COMPARE THE INITIAL RATE OF RETURN WITH THE LONG-TERM TREASURY YIELD: PASS

Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.25%. Compare this with TJX's initial yield of 4.73%, which will expand at an annual rate of 11.0%, based on the analysts' consensus estimated long term growth rate. The company is the better choice, as the initial rate of return is close to or above the long term bond yield and is expanding.


CALCULATE THE FUTURE EPS: [No Pass/Fail]

TJX currently has a book value of $6.50. It is safe to say that if TJX can preserve its average rate of return on equity of 39.6% and continues to retain 79.67% of its earnings, it will be able to sustain an earnings growth rate of 31.5% and it will have a book value of $100.82 in ten years. If it can still earn 39.6% on equity in ten years, then expected EPS will be $39.92.


CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now take the expected future EPS of $39.92 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (21.1) (5 year average P/E in this case), which is 18.5 and you get TJX's projected future stock price of $738.61.


CALCULATE THE EXPECTED RATE OF RETURN BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now add in the total expected dividend pool to be paid over the next ten years, which is $12.38. This gives you a total dollar amount of $750.98. These numbers indicate that one could expect to make a 26.9% average annual return on TJX's stock at the present time. Buffett would consider this an absolutely fantastic expected return.


CALCULATE THE EXPECTED FUTURE STOCK PRICE BASED ON AVERAGE EPS GROWTH: [No Pass/Fail]

If you take the EPS growth of 11.0%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $9.31. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (21.1) (5 year average P/E in this case), which is 18.5. This equals the future stock price of $172.30. Add in the total expected dividend pool of $12.38 to get a total dollar amount of $184.67.


CALCULATE THE EXPECTED RETURN USING THE AVERAGE EPS GROWTH METHOD: [No Pass/Fail]

Now you can figure out your expected return based on a current price of $69.39 and the future expected stock price, including the dividend pool, of $184.67. If you were to invest in TJX at this time, you could expect a 10.28% average annual return on your money. Buffett likes to see a 15% return, and would even go down to 12%.


LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: PASS

Based on the two different methods, you could expect an annual compounding rate of return somewhere between 10.3% and 26.9%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 18.6% on TJX stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.

DRIL-QUIP, INC.

Strategy: Value Investor
Based on: Benjamin Graham

Dril-Quip, Inc. designs, manufactures, sells and services engineered offshore drilling and production equipment. The Company's equipment is suited for use in deepwater, harsh environments and service applications. The Company's operates in Western Hemisphere, including North and South America; Eastern Hemisphere, including Europe and Africa and Asia-Pacific, including the Pacific Rim, Southeast Asia, Australia, India and the Middle East. It products include subsea equipment, surface equipment and offshore rig equipment. Its products are used to explore for oil and gas from offshore drilling rigs, such as floating rigs and jack-up rigs, and for drilling and production of oil and gas wells on offshore platforms, TLPs, Spars and moored vessels, such as FPSOs. Its services include technical advisory assistance services, reconditioning of its customer-owned products, and rental of running tools for installation and retrieval of its products.


SECTOR: PASS

DRQ is neither a technology nor financial Company, and therefore this methodology is applicable.


SALES: PASS

The investor must select companies of "adequate size". This includes companies with annual sales greater than $340 million. DRQ's sales of $897.5 million, based on trailing 12 month sales, pass this test.


CURRENT RATIO: PASS

The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. DRQ's current ratio of 9.60 passes the test.


LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: PASS

For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that meet this criterion display one of the attributes of a financially secure organization. The long-term debt for DRQ is $0.0 million, while the net current assets are $1,015.8 million. DRQ passes this test.


LONG-TERM EPS GROWTH: PASS

Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. Companies with this type of growth tend to be financially secure and have proven themselves over time. DRQ's EPS growth over that period of 260.4% passes the EPS growth test.


P/E RATIO: PASS

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be "moderate", which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. DRQ's P/E of 13.70 (using the 3 year PE) passes this test.


PRICE/BOOK RATIO: FAIL

The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. DRQ's Price/Book ratio is 1.64, while the P/E is 13.70. DRQ fails the Price/Book test.


Watch List

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

Ticker Company Name Current
Score
FET FORUM ENERGY TECHNOLOGIES INC 91%
PLUS EPLUS INC. 90%
ZUMZ ZUMIEZ INC. 77%
SYNT SYNTEL, INC. 71%
SAFM SANDERSON FARMS, INC. 65%
GILD GILEAD SCIENCES, INC. 58%
NOV NATIONAL-OILWELL VARCO, INC. 55%
THO THOR INDUSTRIES, INC. 54%
NSR NEUSTAR INC 53%
FOSL FOSSIL GROUP INC 53%



Disclaimer

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

Validea is not registered as a securities broker-dealer or investment advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Validea is not responsible for trades executed by users of this site based on the information included herein. The information presented on this website does not represent a recommendation to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment. The information on this website is generic by nature and is not personalized to the specific situation of any individual. The user therefore bears complete responsibility for their own investment research and should seek the advice of a qualified investment professional prior to making any investment decisions.

Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. Past performance is not necessarily indicative of future results. Individual stocks mentioned throughout this web site may be holdings in the managed portfolios of Validea Capital Management, a separate asset management firm founded by Validea.com founder John Reese. Validea Capital Management, which is a separate legal entity and an SEC registered investment advisory firm, uses, in part, the strategies on the web site to select stocks for its clients.