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Executive Summary July 8, 2011

The Economy

The training wheels are off, and the economy is now trying to show that it can continue to roll ahead without the big push it's been getting from the Federal Reserve.

Last week, the Fed ended its second round of quantitative easing, the program through which it essentially printed $600 billion and tried to pump it into the financial system by buying up Treasury bonds. And, lo and behold, the end of QE2 has not caused the economy to devolve into chaos, as some feared.

To be sure, we're only about a week into a post-QE2 world, and the true impact of the program's end remains to be seen. But what's encouraging is that as we enter this new landscape, many of the fears that plagued the financial and equity markets in June appear to be coming under control. The Greek debt crisis fears -- which may well have been overblown to begin with -- have lessened, the stock market has shaken off its June swoon and has been heading back upward, and signs have been rolling in that the economy is continuing to push forward.

The manufacturing sector is a good example. As I noted in our last newsletter, some weak regional manufacturing reports worried many investors last month, even though temporary ebbs and flows in manufacturing activity are quite normal in any expansion. But, last week, the Institute for Supply Management reported that, overall, manufacturing activity expanded in June for the 23rd straight month, and it did so at a pretty solid pace. The group's employment sub-index also showed strong growth, with 34% of respondents indicating growth in hiring, and only 10% indicating a decrease.

Employment conditions also improved in the service sector, according to ISM, with 27% of service sector respondents reporting an increase in employment and only 12% reporting a decrease. ISM's overall service sector activity index showed increasing activity in the sector for the 19th straight month in June.

New claims for unemployment also declined slightly in the most recent week (ending July 2), falling a little more than 3%. Still, the number of new claims remains on the high side. Today's monthly unemployment report from the Labor Department will, as always, be watched closely by investors. In what hopefully was a preview of the Labor Department's report, job-tracking firm ADP said this week that the private sector added nearly 160,000 jobs in June, rebounding strongly from May's lackluster increase.

The housing market, meanwhile, remains wobbly, though we've received some decent news since our last newsletter. Pending-home sales, a forward-looking indicator of activity, rose 8.2% in May, the National Association of Realtors reported, the strongest increase since last November. It was also the first time in over a year that the monthly figure was higher than the year-ago figure, the group said. The S&P/Case-Shiller home price indices rose in April (there is a few months lag time in the data) for the first time in eight months, though they were basically flat when seasonal fluctuations are accounted for.

The market took the latest round of economic news quite well over the past fortnight. Since our last newsletter, the S&P 500 returned 5.4%, while the Hot List returned 6.5%. So far in 2011, the portfolio has returned 10.0% vs. 7.6% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 197.0% vs. the S&P's 35.3% gain.

Movers and Shakers

The Hot List is switching out four of its ten holdings on today's rebalancing, with all of the departing stocks having been big movers. Three of the four have made impressive gains: Ancestry.com was up about 13% in just one month; GameStop had increased about 44% since joining the portfolio last September; and GT Solar International surged some 35% in a one-month stint in the portfolio, on the strength of higher-than-expected earnings guidance and its receipt of two new orders totaling more than $80 million from Asia. On the negative side, the portfolio is selling Research in Motion, which tumbled about 35% in two months after some disappointing earnings and sales guidance updates (all figures through Wednesday).

Last newsletter, I looked at the issue of portfolio size. I discussed why we've found that focused stock portfolios like the Hot List can provide enough diversification over the long haul, even though its big movers have a much bigger impact than big movers do within typical mutual fund portfolios, which can hold well over 100 stocks. As Joel Greenblatt -- the hedge fund guru whose approach forms the basis of one of my best-performing Guru Strategies -- noted in a recent piece written for RegisteredRep.com, many funds have to invest in dozens, if not hundreds, of stocks because of their size. He also said many fund managers hold so many stocks that they end up essentially mirroring their benchmarks, because deviating too far from the benchmark on the downside for a year or two -- which is likely to happen at some point if you hold a more concentrated portfolio, no matter how good your strategy -- can be a career killer, since most investors are very short-sighted. If you want to beat the market, you can't simply own it, however, and we believe the Hot List's concentrated nature has played a big role in its long-term outperformance.

This week, I'd like to take a look at two more factors that Greenblatt says keep funds -- and fund investors -- from outperforming the broader market (some studies show that upwards of 75% of managers fail to beat the S&P 500), and the reasons we think the Hot List is well-equipped to avoid those problems.

Size Matters: From 1927 through 2009, according to the data of Dartmouth College professor and noted stock researcher Kenneth French, small-cap value stocks averaged a 14.17-per-cent return per year, beating large-cap value plays by nearly 3 percentage points per year and large-cap growth plays by more than 5 percentage points per year -- a staggering difference when compounded over 82 years. Smaller stocks, Greenblatt notes, are less researched and generate less attention than larger stocks, which can "often mean a greater opportunity to find bargain-priced stocks among these lesser-followed small-capitalization companies".

But many mutual funds -- especially those that have success -- are forced to buy larger stocks and shun small caps. The goal of mutual funds is to accumulate assets -- more assets means more fees, and more fees means more profits. But when a fund has hundreds of millions or billions of dollars under management, it is forced toward larger stocks. A $10 billion fund isn't going to be able to buy up enough shares of a $300-million-market-cap stock to impact its returns in a big way. And, the better a fund does, the more investors tend to flock to it. That means smaller funds that can take advantage of smaller stocks will likely be forced out of small-caps if their success continues, which threatens their ability to continue to beat the market.

If you're an individual investor using a system like the Hot List, you thus have a big "small" advantage over many of the pros. The Hot List lets you find the best bargains in the market, regardless of size -- small-caps, mid-caps, large-caps, all are on the table. And, over the years, we've found some great bargains in small-caps or smaller mid-caps. Just look at Ancestry.com, or GT Solar. The portfolio's ability to roam free across the various capitalization groups is a big reason for its long-term market-beating performance.

Discipine and Long-Term Thinking: "Most investors have no idea why or how an active manager chooses the stocks in his portfolio," Greenblatt says, and, unfortunately, he's probably right. Most investors look at one thing: recent performance. They'll chase hot funds and hot managers and, just as is the case with hot stocks, that's no recipe for long-term success. Greenblatt cites a couple of studies that look at how institutional investors -- professional investors, that is -- selected and fired managers. Most managers were hired due to good recent performance. Most managers that were fired, he notes, had recently underperformed the market. But in the years following hire and fire decisions, the recently fired managers significantly outperformed the market; recently hired managers, meanwhile, failed to outperform the market.

With the Hot List, we don't measure success or failure by short-term performance. And we don't let short-term performance dictate our approach. The strategies we run have long track records of success, both for us and for the gurus who originally developed them. Peter Lynch, Warren Buffett, John Neff, Benjamin Graham -- these great investors weren't flashes in the pan. They produced long track records of market-beating returns, and our implementation of their approaches has served to verify those track records, and lend credence to the value-focused principles on which the strategies are based.

Looking ahead, we'll continue to stick to our disciplined, long-term approach. And I'm confident that by doing so, we'll continue to succeed where the vast majority of fund managers have failed.
Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Gt Solar International, Inc. (SOLR), Gamestop Corp. (GME), Ancestry.com Inc (ACOM) and Research In Motion Limited (Usa) (RIMM).

The Keepers

6 stocks remain in the portfolio. They are: Amtech Systems, Inc. (ASYS), Skechers Usa, Inc. (SKX), Sanofi Sa (Adr) (SNY), At&t Inc. (T), Dollar Tree, Inc. (DLTR) and Bridgepoint Education, Inc. (BPI).

The Newbies

We are adding 4 stocks to the portfolio. These include: Astrazeneca Plc (Adr) (AZN), Coinstar, Inc. (CSTR), Lincoln Educational Services Corporation (LINC) and Rue21, Inc. (RUE).

Portfolio Changes

Newcomers to the Validea Hot List

AstraZeneca PLC (AZN): Based in London, AstraZeneca is one of the world's largest drugmakers. The $69-billion-market-cap firm is active in more than 100 countries, and makes a variety of well-known medications, including Crestor, Symbicort, and Nexium.

AstraZeneca gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. See the "Detailed Stock Analysis" section below to learn more about the stock.

Lincoln Educational Services Corporation (LINC): Lincoln offers high school graduates and working adults various degree and diploma programs. The New Jersey-based small-cap ($420 million) has seen its earnings surge in recent years, as the weak jobs market has sent many job-seekers back to school for more education or training.

For-profit education firms have come under a lot of scrutiny in the past year, but three of my models -- those I base on the writings of Kenneth Fisher, Joel Greenblatt, and Peter Lynch -- think it's a bargain at this price. See the "Detailed Stock Analysis" section below for more on the stock.

Coinstar Inc. (CSTR): You may have seen this Washington-State-based firm's kiosks in grocery stores and other retail shops. Its automated coin-counting machines allow users to turn their spare change into cash or credit for a fee, while its automated redbox DVD kiosks let customers rent DVDs. The company has a $1.8 billion market cap, and has a total of close to 50,000 kiosks.

Coinstar gets strong interest from my Martin Zweig- and James O'Shaughnessy-based models. Scroll down to the "Detailed Stock Analysis" section below to read more about it.

rue21, inc. (RUE): This trendy Pennsylvania-based specialty apparel retailer caters to 11- to 17-year-olds. It recently opened its 700th store in the U.S., operating in 46 states. It's a small-cap ($836 million).

rue21 gets approval from my Peter Lynch- and James O'Shaughnessy-based models. To read more about it, scroll down to the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Sanofi-Aventis (SNY): Sanofi said it is stopping a clinical trial designed to see whether its Multaq drug, which is approved to help people with temporary irregular heartbeats, was effective in people with a permanent version of the condition, Reuters reported on July 7. The firm said it made the decision after seeing a "significant increase in cardiovascular events" in the group of patients taking Multaq.

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

ASYS   |   BPI   |   LINC   |   DLTR   |   T   |   SNY   |   AZN   |   SKX   |   CSTR   |   RUE   |  

Amtech Systems, Inc. (Amtech), incorporated in October 1981, through its wholly owned subsidiaries, supplies horizontal diffusion furnace systems used for solar (photovoltaic) cell and semiconductor manufacturing. The Company provides products and services to two industries: the solar industry and the semiconductor industry. The Company's solar and semiconductor equipment is sold under brand names of Tempress Systems and Bruce Technologies, which have customers in both the solar industry and the semiconductor industry. Within the solar industry, its provide diffusion and automation equipment to solar cell manufacturers and it also offers plasma enhanced chemical vapor deposition (PECVD) and phosphocilicate glass (PSG) equipment. Within the semiconductor industry, it provides equipment to manufacturers of analog, power, automotive and microcontroller chips with geometries greater than 0.3 micron.

Bridgepoint Education, Inc. (Bridgepoint) is a accredited provider of postsecondary education services. The Company offers associate's, bachelor's, master's and doctoral programs in the disciplines of business, education, psychology, social sciences and health sciences. It delivers its programs online, as well as at its traditional campuses located in Clinton, Iowa, and Colorado Springs, Colorado. As of December 31, 2009, it offered approximately 1,150 courses, 60 degree programs and 125 specializations and concentrations. As of December 31, 2009, it had 53,688 students enrolled in its institutions, 99% of whom were attending classes online.

Lincoln Educational Services Corporation is a provider of career-oriented post-secondary education. As of December 31, 2009, the Company operated 43 campuses in 17 states. It offers recent high school graduates and working adults degree and diploma programs in five areas of study health sciences, automotive technology, skilled trades, hospitality services and business and information technology. For the year ended December 31, 2009, the Company's health science program, its automotive technology program, its skilled trades program, its hospitality services program and its business and information technology program accounted for approximately 37%, 31%, 13%, 10%, and 9%, respectively, of its average enrollment. The Company had 29,340 students enrolled as of December 31, 2009 and its average enrollment for the year ended December 31, 2009 was 27,808 students.

Dollar Tree, Inc. is an operator of discount variety stores offering merchandise at the fixed price of $1. At January 29, 2011, the Company operated 4,101 discount variety retail stores. Its stores operate under the names of Dollar Tree, Deal$, Dollar Tree Deal$, Dollar Giant and Dollar Bills. Approximately 3,935 of these stores sell substantially all items for $1 or less in the United States and $1.25 or less in Canada. Substantially all of the remaining stores, operating as Deal$, sell items for $1 or less but also sell items for more than $1. The Company's optimal store is between 8,000 and 10,000 selling square feet. This store size provides the appropriate amount of space for its merchandise offerings while allowing it to provide service. At January 29, 2011, it operated 4,015 stores in 48 states and the District of Columbia, as well as 86 stores in Canada. In November 2010, it acquired 86 Dollar Giant stores based in Vancouver, British Columbia.

AT&T Inc. is a holding company. The Company is a provider of telecommunications services in the United States and worldwide. These include wireless communications, local exchange services, long-distance services, data/broadband and Internet services, video services, managed networking, wholesale services and directory advertising and publishing. It operates in four segments: wireless, which provides both wireless voice and data communications services across the United States and, through roaming agreements, in foreign countries; wireline, which provides landline voice and data communication services, AT&T U-Verse TV, broadband and voice services (U-Verse) and managed networking to business customers; advertising solutions, which publishes Yellow and White Pages directories and sells directory advertising and Internet-based advertising and local search, and other, which provides results from customer information services and all corporate and other operations.

Sanofi, formerly Sanofi-Aventis, is a global and diversified healthcare company. The Company discovers, develops and distributes therapeutic solutions focused on patients' needs. Sanofi focuses on the field of healthcare with seven growth platforms: diabetes solutions, human vaccines, innovative drugs, rare diseases, consumer healthcare, emerging markets and animal health. As of February 2011, Sanofi portfolio comprised 55 projects in clinical development, of which 13 were in Phase III or had been submitted to the health authorities for approval. Sanofi has a portfolio of prescription drugs, vaccines, generics and consumer healthcare products. Its prescription medicines include Lantus, which is an insulin band. The range of products in the field of diabetes also include Apidra and Amaryl. Its human vaccines for Polio/Pertussis include Pentacel and Pentaxim along with influenza vaccines (Vaxigrip et Fluzone). Its animal health products include Frontline and Heartgard.

AstraZeneca PLC (AstraZeneca) is a global biopharmaceutical company. AstraZeneca discovers, develops and commercializes prescription medicines for six areas of healthcare: Cardiovascular, Gastrointestinal, Infection, Neuroscience, Oncology, and Respiratory and Inflammation. It has a range of medicines that includes treatments for illnesses, such as its antibiotic, Merrem/Meronem and Losec/Prilosec for acid related diseases. AstraZeneca's products include Crestor, Seloken/Toprol-XL, Atacand, Nexium, Synagis, Seroquel IR, Seroquel XR, Arimidex, Zoladex and Symbicort. The Company owns and operates a range of research and development (R&D), production and marketing facilities worldwide. AstraZeneca operates in over 100 countries, including China, Mexico, Brazil and Russia. On March 3, 2010, AstraZeneca completed the acquisition of Novexel S.A. Novexel is a France-based research company focused on the infection therapy area.

Skechers U.S.A., Inc. (Skechers) design and market Skechers-branded contemporary footwear for men, women and children under several lines. addition to Skechers-branded lines, the Company also offers several designer, fashion and street-focused footwear lines for men, women and children. These lines are branded and marketed separately from Skechers and appeal to specific audiences. Its brands are sold through department stores, specialty stores, athletic retailers, and boutiques as well as catalog and Internet retailers. Along with wholesale distribution, its footwear is available at its e-commerce Website and its own retail stores. Skechers operates 90 concept stores, 92 factory outlet stores and 37 warehouse outlet stores in the United States, and 22 concept stores and five factory outlets internationally. The Company operates in four reportable segments: domestic wholesale sales, international wholesale sales, retail sales, and e-commerce sales.

Coinstar, Inc. (Coinstar) is a provider of automated retail solutions. Coinstar's core offerings in automated retail include its digital video disk (DVD) business, where consumers can rent or purchase movies from self-service kiosks (DVD Services segment), and its Coin business, where consumers can convert their coin to cash or stored value products at coin-counting self-service kiosks (Coin Services segment). As of December 31, 2010, the Company had approximately 30,200 DVD kiosks in 26,100 locations and 18,900 coin-counting kiosks in 18,700 locations (approximately 12,100 of which offer a variety of stored value products to customers) in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants. On May 25, 2010, the Company sold its subsidiaries consisting of its E-Pay Business to InComm Holdings, Inc. and InComm Europe Limited (collectively InComm).

rue21, inc. (rue21) is a specialty apparel retailer offering the newest fashion trends for girls and guys. As of January 30, 2010, the Company operated 535 stores in 43 states throughout the United States. The Company's merchandise is designed to appeal to 11 to 17 year olds who aspire to be 21 and adults who want to look and feel 21. In addition, it offers its own brands, such as rue21 etc!, Carbon, tarea and rueKicks, to create merchandise excitement and differentiation in its stores.

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.

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.