Executive Summary  |   Portfolio  |   Guru Analysis  |   Watch List

Executive Summary December 23, 2011

The Economy

While the world continues to focus on and speculate about how Europe will deal with its debt crisis, the U.S. economy continues to plug along with improvement in some major areas.

Perhaps the biggest may be the employment market. New claims for unemployment have fallen sharply over the past two weeks, reaching their lowest level since April 2008. Continuing claims, meanwhile, have fallen to levels not seen since before Lehman Brothers collapsed in September 2008. As we head into 2012, new claims are 14% lower than they were a year ago, and 45% lower than they were at their March 2009 high. Continuing claims are 13% lower than they were a year ago, and 46% below their recessionary high. In other words, both new and continuing claims for unemployment are close to half of what they were during the height of the Great Recession.

Retail sales are also continuing to improve. New Commerce Department data showed that retail and food service sales increased 0.2% in November, the sixth straight month that they've risen. They thus reached another new all-time high, and stand nearly 7% higher than they were a year ago. That shows that Americans are not as tapped out as many have believed, a good sign for a country whose economy is driven by consumer spending. There is some reason for caution, however, as the personal savings rate is down to 3.5%, as of October (the latest month for which data is available). That's down from 5.2% at the beginning of 2011, though it's still significantly higher than it was when we entered into recession in late 2007. That figure will definitely be one to keep an eye on in the first few months of 2012.

Some negative news came from industrial sector. Industrial production fell 0.2% in November, according to new Federal Reserve data. It marks the first monthly decline since April, though production remains 3.7% above year ago levels. Capacity utilization fell slightly to 77.8%, which remains below the 1972-2010 average of 80.4%.

Some mixed news came from the housing market. The National Association of Realtors said that existing-home sales increased 4% in November, putting them more than 12% higher than they were a year ago. The realtor group did, however, issue revised numbers dating back to 2007, saying that a number of issues had resulted in existing-home sales being overcounted. On average from 2007-2010, the group said that existing-home sales were overstated by 14%. The revisions don't really change the trend of sales over the past five years, but they do mean that the housing market, already known to be weak, has been even weaker than believed.

But there's hope: Housing starts jumped 9.3% in November and are 24.3% above year-ago levels, while building permit issuance for housing rose 5.7%, and is 20.7% above year-ago levels, according to a new government report. And, the National Association of Home Builders/Wells Fargo Housing Market Index increased for the third straight month in December -- the first time that has happened in more than two years -- and showed that homebuilder sentiment is higher than it's been since the spring of 2008. We don't want to jump the gun, but perhaps we are finally seeing the housing turnaround we've waited so long for.

As for Europe, debt crisis news there continues to be the market's main driver, though most of the gyrations are based on speculation. The situation remains murky, and the market will no doubt continue to be riveted to the developments there in the opening weeks of 2012.

Since our last newsletter, the S&P 500 returned 1.6%, while the Hot List returned 0.9%. So far in 2011, the portfolio has returned -16.7% vs. -0.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 124.9% vs. the S&P's 25.3% gain.

Hopeful Signs for the New Year

The year of 2011 has been a tough one for stock investors. With a week left before the end of the year, the S&P 500 is on track to be about flat for the year, and the market has put investors through some major ups and downs over the course of the past 12 months. Most investors continue to shy away from equities. And, as I discussed in our last newsletter, the year has been worse for the Hot List, which is well in the red, though its long-term track record remains exceptional.

While many investors remain skittish as we head into 2012, I see a number of reasons to be optimistic. Here are a few of the main factors that make me feel good about the coming year.

Valuation: There are, of course, a number of ways to value the broader market. But of the myriad of valuation metrics that my models use, the vast majority are showing the market to be either cheap or fairly valued. The exception to that is the ten-year P/E ratio, which for the S&P 500 remains between 20 and 21, higher than its long-term average of about 16. Other than that, however, a variety of metrics paint a positive picture. Trailing-12 month P/E ratios for the S&P 500 are 13.1 using operating earnings, and 14.3 using as-reported earnings, based on S&P data and Wednesday's closing price. Forward-looking P/Es are even better. The S&P's price/sales ratio, meanwhile, is 1.2, according to Morningstar.com. That's below the 1.5 target that my James O'Shaughnessy-based model uses to identify bargains, and it's within the "good value" range (0.75 to 1.5) that my Kenneth Fisher-inspired model uses.

The stock market-to-Gross Domestic Product ratio is also quite reasonable. According to GuruFocus.com, it's at 86.4% (as of December 21), which is within the "fair value" range that was determined by examination of historical data. (Note: for this metric, the site uses the Wilshire Total Market Index as a proxy for "the market".) This ratio is of particular interest to me, because Warren Buffett has cited the stock market-to-Gross National Product ratio (which runs very similar to the stock market/GDP ratio) as possibly being the best measure of where valuations stand at a given moment.

Finally, the market's dividend yield is very attractive, particularly when compared to the near-record-low Treasury bond yields currently available. As of December 20, the S&P's dividend yield was 2.53%. Compare that to the 1.94% yield on the 10-year Treasury bond, and stocks lookvery attractive.

Corporate Turnaround: Heading into the financial crisis of 2008 and the accompanying recession, American companies -- especially banks -- were stretched too thin. Financial companies were way overleveraged, and many non-financials had left themselves little wiggle room in the event of a major downturn.

Today, that's much different. Yes, banks are still working off some bad debt, and low interest rates are decreasing lending spreads and hampering earnings. But overall it appears that they are in far better shape than they were in 2008 (thanks in no small measure to the federal government's assistance). In fact, according to Deutsche Bank, the ratio of total U.S. bank assets to cash -- a measure of liquidity -- is near all-time lows. It had climbed to nearly 40-to-1leading up to the financial crisis; now it is below 10-to-1, levels not seen since the early 1980s.

Non-financials, meanwhile, have been stockpiling cash, not wanting to get hit by another major downturn. Cash at companies excluding banks, utilities, truckers, and automakers was a record $998.9 billion last quarter, according to Bloomberg. And there are indications that more companies may be putting their cash to work. This year, shares of the 40 S&P 500 companies that bought back the most of their own stock or offered the biggest dividends climbed an average of 5.7%, Bloomberg reports; the 20 that hoarded the most cash fell an average of 15%. If the laggards are taking notice, that could mean more companies up their buybacks and dividends in 2012, which should help the market.

Improving Economy, Gloomy Sentiment: While many pundits spent most of 2011 predicting recession -- and worse -- for the US economy, positive data has continued to flow in over the last several months. In fact it appears that growth has really accelerated toward the end of the year. But despite that, and despite Corporate America continuing to post strong profits and streamline operations, a sense of doom certainly seems to be hanging over the market.

Some of the fear is merited, with the European debt crisis being a legitimate, serious problem that needs to be dealt with. Still, given the solid, if unspectacular, performance of the U.S. economy and the stellar growth that continues in other parts of the world, Europe and its problems are probably getting a bit more attention than they really deserve. Why? A big reason, no doubt, involves the lingering scars of the 2008 financial crisis, and Great Recession. After going through a crisis and recession that may have been the worse the U.S. has seen since the Great Depression, investors and Americans in general understandably have been left with a sense of foreboding. For many the crisis came on so swiftly and unexpectedly that it has left them with a sort of financial post-traumatic stress disorder. Not wanting to be burned so badly again, investors head for the hills and sell off stocks at the first sign or hint that another crisis is upon us.

All you need to do is read the headlines to get an idea of the fear that is still out there. Recently, I read an article entitled "Five Reasons Why Investing is Dead". The article was rife with short-term thinking, but for now I don't want to get into all the specifics as to why I think it was misguided. Instead, the important point for this discussion is the hyperbole in the headline. Stock investing has been proclaimed dead on several other occasions by prominent news sources, perhaps most notably in 1979, when BusinessWeek ran a cover story entitled "The Death of Equities". The article came at the tail end of a very weak period for stocks, one that lasted over a decade. But within just a few years the market began to surge, remaining in bull market mode for most of the next two decades.

These sorts of articles always come out when things have been going bad for an extended period, because people by nature are inclined to extrapolate the recent past out into the future -- it's what behavioral finance terms "recency bias". But as any investor worth their salt knows, the best time to invest in something usually isn't when the asset has been rising in price for an extended period; it's when prices are cheap and expectations are low. Given that, the current gloom hanging over the market is a positive if you're buying stocks now.

Do I think that the current doom and gloom mindset will change completely in 2012? No. Frankly, I think it will take more than another year for investors and Americans to really feel like they have their feet on solid ground again. But I do think that we'll see gradual improvement in confidence in the coming year; the further and further we get from 2008, the more the pain will fade. What the lingering fears do seem to be doing, however, is putting something of a floor under stock prices. With many investors not only fearing but expecting the worst, some very bad scenarios are already baked into stock prices. That certainly doesn't mean that stocks can't go lower; but it does mean that the downside should be somewhat limited, while the upside should be great. And for value investors, that's a climate that is very attractive.

I hope you all have a wonderful holiday and happy New Year, and we'll see you in 2012.

Editor-in-Chief: John Reese

Validea Capital Management - Private Portfolio Management Based on Strategies of Legends

Are you looking for an alternative to your underperforming mutual funds or financial advisor? Click here to download Validea Capital's investment kit and learn more about the firm's guru-based portfolios.

Get More Information on Validea Capital!

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

The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Kulicke And Soffa Industries Inc. (KLIC), Interpublic Group Of Companies, Inc. (IPG), Astrazeneca Plc (Adr) (AZN) and World Acceptance Corp. (WRLD).

The Keepers

6 stocks remain in the portfolio. They are: Forest Laboratories, Inc. (FRX), Petroleo Brasileiro Sa (Adr) (PBR), Aeropostale, Inc. (ARO), Ternium S.a. (Adr) (TX), Capella Education Company (CPLA) and Bridgepoint Education, Inc. (BPI).

The Newbies

We are adding 4 stocks to the portfolio. These include: Cash America International, Inc. (CSH), Big Lots, Inc. (BIG), Devry Inc. (DV) and Jos. A. Bank Clothiers, Inc. (JOSB).

Portfolio Changes

Newcomers to the Validea Hot List

Cash America International Inc. (CSH): : Cash America operates in more than 1,000 locations in the U.S. and Mexico, providing secured non-recourse loans -- pawn loans. It also offers short-term cash advances and check cashing services. The Fort Worth, Tex.-based firm has a market cap of about $1.3 billion.

Cash America gets strong interest from my James O'Shaughnessy- and Martin Zweig-based models. To read more about the stock, see the "Detailed Stock Analysis" section below.

Jos. A. Bank Clothiers (JOSB): Based in Hampstead, Maryland, Bank is a long-time Hot List favorite. In its most recent stint in the portfolio, the 100-plus-year-old men's clothing retailer gained 17% in just one month (late September to late October). The small-cap ($1.4 billion), has about 500 stores across the U.S.

Bank gets strong interest from my James O'Shaughnessy growth model and my Warren Buffett-based strategy. To find out more about the stock's fundamentals, see the "Detailed Stock Analysis" section below.

DeVry Inc. (DV): This for-profit education stock is based in Illinois. It's the parent of several universities that focus on business, healthcare, and technology, and it also offers programs for middle and high schoolers.

DeVry ($2.5 billion market cap) gets strong interest from my Peter Lynch- and Joel Greenblatt-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

Big Lots, Inc. (BIG): Big Lots offers brand-name closeout and bargain merchandise, including consumables, seasonal products, furniture, housewares, and toys. It operates more than 1,400 retail stores across 48 states.

Ohio-based Big Lots gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. To read more about it, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Capella Eduation Company (CPLA): Capella has approved a $50 million increase to its share repurchase program, the firm announced. The increase is in addition to the $35 million that was remaining under the program as of Sept. 30, 2011.

AstraZeneca PLC (AZN): AstraZeneca said it is abandoning plans to develop a new anti-ovarian cancer drug, and also said a planned antidepressant has underperformed in tests, the Associated Press reported. The drugmaker said it would take a one-time pre-tax loss of $285 million on the ovarian cancer drug and another $96.5 million pre-tax loss on the antidepressant. The Hot List is selling the stock, which as of Thursday was up about 7% since joining the portfolio last month, on today's rebalancing.

The Next Issue

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

Current Portfolio

Detailed Stock Analysis

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

BPI   |   FRX   |   ARO   |   TX   |   CPLA   |   PBR   |   BIG   |   JOSB   |   CSH   |   DV   |  

Bridgepoint Education, Inc. (Bridgepoint) is a provider of postsecondary education services. The Company's wholly owned subsidiaries, Ashford University and the University of the Rockies, are regionally accredited academic institutions that offer associate's, bachelor's, master's and doctoral programs in the disciplines of business, education, psychology, social sciences and health sciences. These institutions deliver programs online, as well as at its traditional campuses located in Clinton, Iowa, and Colorado Springs, Colorado. As of December 31, 2010, it offered approximately 1,345 courses, 71 degree programs and 134 specializations. As of December 31, 2010, it had 77,892 students enrolled in its institutions, 99% of whom were attending classes online.

Forest Laboratories, Inc. (Forest) develops, manufactures and sells branded forms of ethical drug products, most of which requires a physician's prescription. The Company also focuses on the development and introduction of new products, including products developed in collaboration with licensing partners. Its products include those developed by the Company and those acquired from other pharmaceutical companies and integrated into its marketing and distribution systems. The Company's principal products include Lexapro, Namenda, Bystolic, Savella and Teflaro. On April 13, 2011, the Company acquired Clinical Data Inc. (Clinical Data), a specialty pharmaceutical company.

Aeropostale, Inc. is a mall-based, specialty retailer of casual apparel and accessories, principally targeting 14 to 17 year-old young women and men through its Aeropostale stores and 7 to 12 year-old kids through its P.S. from Aeropostale stores. The Company designs, sources, markets and sells all of its own merchandise. P.S. from Aeropostale products can be purchased in P.S. from Aeropostale stores, in certain Aeropostale stores, including its new Times Square store in New York City and online at www.ps4u.com. As of January 29, 2011, it operated 965 Aeropostale stores, consisting of 906 stores in 49 states and Puerto Rico, 59 stores in Canada, as well as 47 P.S. from Aeropostale stores in 13 states. In addition, pursuant to a Licensing Agreement, one of its international licensees operated 10 Aeropostale stores in the United Arab Emirates as of January 29, 2011. During March 2011, it announced that it had signed a second licensing agreement.

Ternium SA is a steel company in Latin America that manufactures and processes flat and long steel products for the construction, home appliances, capital goods, container, food, energy and automotive industries. The Company operates in three segments: Flat Steel Products, comprising the manufacturing and marketing of hot rolled coils and sheets, cold rolled coils and sheets, tin plate, welded pipes, hot dipped galvanized and electro-galvanized sheets and pre-painted sheets; Long Steel Products, comprising the manufacturing and marketing of billets (steel in its basic, semi-finished state), wire rod and bars; Others, comprising mainly pig iron, pellets and pre-engineered metal buildings. During the year ended December 31, 2010, Flat Steel Products accounted to 86% of the Company's overall revenues. Approximately 57% of Ternium's sales were generated in North America and 41% in South and Central America.

Capella Education Company is an online postsecondary education services company. Through its wholly owned subsidiary, Capella University, the Company offers a range of doctoral, master's and bachelor's programs. As December 31, 2010, it offered over 1,250 online courses and 43 academic programs with 136 specializations to over 39,000 learners. It also offers certificate programs, which consist of a series of courses focused on a particular area of study. In addition, Capella Education Company also offers academic services, such as new learner orientation, technical support, academic advising, research services (particularly for doctoral degree candidates), writing services and online tutoring. It also provides appropriate educational accommodations to learners with documented disabilities through its disability support services team. During the year ended December 31, 2010, it formed the joint-venture Sophia Learning, LLC, as majority owner.

Petroleo Brasileiro SA Petrobras (Petrobras) is a Brazilian integrated oil and gas company. It operates in five segments: exploration and production; refining, commercialization and transport of oil and natural gas; petrochemicals; distribution of derivatives, electrical energy, biofuels and other renewable energy sources. Directly or through its subsidiaries, Petrobras is engaged in the research, extraction, refining, processing, commercialization and transport of oil from wells, shales and other rocks, its derivatives, natural gas and other liquid hydrocarbons, as well as in activities related to energy, promoting research, development, production, transport, distribution and commercialization of all forms of energy. As of December 31, 2010, it had 132 production platforms, 16 refineries, 291 vessels, 29,398 kilometers of pipelines, six biofuel plants, 16 thermoelectric plants, one pilot wind farm, 8,477 service stations and two fertilizer plants, as well as presence in 30 countries.

Big Lots, Inc. is a closeout retailer. The Company's merchandising categories include Consumables, Furniture, Home, Hardlines, Seasonal, and Other. The Consumables category includes the food, health and beauty, plastics, paper, chemical, and pet departments. The Furniture category includes the upholstery, mattresses, ready-to-assemble, and case goods departments. Case goods consist of bedroom, dining room, and occasional furniture. The Home category includes the domestics, stationery, and home decorative departments. The Hardlines category includes the electronics, appliances, tools, and home maintenance departments. The Seasonal category includes the lawn and garden, Christmas, summer, and other holiday departments. The Other category includes the toy, jewelry, infant accessories, and apparel departments. At January 29, 2011, it operated a total of 1,398 stores in 48 states. In July 2011, the Company acquired Liquidation World Inc.

Jos. A. Bank Clothiers, Inc. (Jos. A. Bank) is a designer, manufacturer, retailer and direct marketer of men's tailored and casual clothing and accessories and is a retailer of tuxedo rental products. It sells substantially all of its products exclusively under the Jos. A. Bank label through its 506 retail stores (as of January 29, 2011, which includes 12 outlet and factory stores and 14 franchise stores) located throughout 42 states and the District of Columbia in the United States, as well as through the Company's nationwide catalog and Internet (www.josbank.com) operations. It sources substantially all of its merchandise from suppliers and manufacturers or through buying agents using Jos. A. Bank designs and specifications. The Company operates in two segments: Stores and Direct Marketing. The Stores segment consists of all Company-owned stores, excluding outlet and factory stores (full-line stores). The Direct Marketing segment consists of its Internet and catalog operations.

Cash America International, Inc. provides specialty financial services to individuals through retail services locations and through electronic distribution platforms known as e-commerce activities. These services include secured non-recourse loans, commonly referred to as pawn loans and unsecured consumer loans. The Company's consumer loan portfolio includes short-term single payment loans, longer-term multi-payment installment loans, credit services and participation interests purchased from third parties in the micro line of credit (MLOC) services channel. Through the Credit Services Organization program (the CSO program), it provides a third-party lender's consumer loan product in some markets by acting as a credit services organization on behalf of consumers. As of December 31, 2010, it operated in two segments: retail services and e-commerce. During the year ended December 31, 2010, the Company renamed its Internet Services Division as the E-Commerce Division.

DeVry Inc. (DeVry) is a provider of educational services and the parent organization of Advanced Academics, Becker Professional Education, Carrington College and Carrington College California, Chamberlain College of Nursing, DeVry Brasil, DeVry University, and Ross University. These institutions offer a range of programs in business, healthcare and technology and serve students in middle school through postsecondary education, as well as accounting and finance professionals. In August 2011, the Company acquired the business operations of privately held American University of the Caribbean.

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.