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Executive Summary March 13, 2015

The Economy

Stellar job growth continues to highlight the US's economic strength, fueling speculation that the Federal Reserve may begin raising interest rates sooner rather than later.

The private sector added 288,000 jobs in February, the Labor Department said, with total nonfarm payrolls rising by 295,000. Wages also pushed higher for the second straight month, with average wages for hourly workers rising 0.3%. The unemployment rate dipped two-tenths of a percentage point to 5.5%, while the broader "U-6" rate (which unlike the headline number takes into account those working part-time who want full-time work, and discouraged workers who have given up looking for a job) fell from 11.3% to 11.0%. On the negative side, the number of people not in the labor force -- which had fallen by 354,000 in January, rose by that same amount in February.

The continued impressive job growth has led many economists to predict that the Fed could raise rates as soon as June. Economists' predictions often miss the mark, and the situation is in flux, so we'll have to wait and see.

Manufacturing growth slowed slightly in February, meanwhile, but the sector still expanded for the 26th straight month, according to the Institute for Supply Management's manufacturing index. The employment and new orders sub-indices also both fell but remained in expansion territory.

ISM's service sector index also indicated that the service sector expanded in February for the 61st straight month, doing so at about the same strong pace that it did in January. The new orders sub-index dipped a bit but remained at a high level, which bodes well for coming months, and the employment sub-index jumped significantly.

The latest consumer data from the Commerce Department showed that personal income rose 0.3% in January. Real disposable personal income surged 0.9%, likely in part because of the plunge in fuel prices, while real personal consumption expenditures rose 0.3%. That helped push the personal savings rate up from 5.0% to a very healthy 5.5%.

Oil and gas prices are continuing to rebound. As of March 9, the average price for a gallon of regular unleaded was $2.45, according to AAA, up from $2.18 a month ago. Still, that's about 30% lower than they were a year ago.

Since our last newsletter, the S&P 500 returned -2.1%, while the Hot List returned -1.3%. So far in 2015, the portfolio has returned 7.9% vs. 0.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 248.9% vs. the S&P's 106.5% gain.

Lessons From The Oracle

As you may know, Warren Buffett recently released his annual letter to Berkshire Hathaway shareholders. Buffett's letters are always filled with valuable pearls of wisdom, and this year's -- which marked the 50th anniversary of Buffett's acquisition of Berkshire -- was particularly flush with insightful advice. Given the impact that Buffett has had on my investment philosophy, I thought I'd take a look at how some of the key points in his letter relate to our approach.

Graham vs. Munger

In his early years, Buffett espoused the "cigar butt" approach of his mentor, the great Benjamin Graham. He bought very cheap shares that he compared to discarded cigar butts. "Though the stub might be ugly and soggy, the puff would be free," Buffett explained. "Once that momentary pleasure was enjoyed, however, no more could be expected."

Buffett would later change his approach to one practiced by his Berkshire partner Charlie Munger. Rather than cigar butts, he started looking for extremely high-quality businesses with durable competitive advantages, even if they were nowhere near as cheap as those cigar butts. But Buffett didn't change strategies because the cigar-butt approach wasn't working. "My cigar-butt strategy worked very well while I was managing small sums," he wrote. "Indeed, the many dozens of free puffs I obtained in the 1950s made that decade by far the best of my life for both relative and absolute investment performance." A big reason for the shift was, instead, that Berkshire was getting too big. "Cigar-butt investing was scalable only to a point," he said. "With large sums, it would never work well."

When a portfolio grows as large as Berkshire's did, opportunities become limited. With billions and billions of dollars to invest, you simply can't move the portfolio's needle by investing in smaller stocks anymore -- and small, less followed stocks are often where the most mispricings occur. Most individual investors are not, however, running multibillion dollar portfolios. That allows them to still make use of Graham's approach. Our 10-stock, monthly rebalanced Graham model portfolio is a great example of that. Since its mid-2003 inception, it has returned 11.7% annualized compared to just 6.3% for the S&P 500. Just as Buffett wrote that the Graham approach helped him generate better returns than the Munger approach, our Graham approach has beaten our Buffett model, which is based on Buffett's more recent Munger-inspired method. The 10-stock Buffett-based portfolio is up 8.6% annualized since its early 2004 inception, vs. 6.0% for the S&P.

The Ballad of Jimmy Ling

Buffett talked in his letter about conglomerate LTV, which enjoyed remarkable success in the late-1960s under the leadership of Jimmy Ling. "Through a lot of corporate razzle-dazzle, Ling had taken LTV from sales of only $36 million in 1965 to number 14 on the Fortune 500 list just two years later," Buffett wrote. "Ling's strategy, which he labeled 'project redeployment,' was to buy a large company and then partially spin off its various divisions. In LTV's 1966 annual report, he explained the magic that would follow: 'Most importantly, acquisitions must meet the test of the 2 plus 2 equals 5 (or 6) formula.' The press, the public and Wall Street loved this sort of talk."

But the success was the result of smoke and mirrors, not good business sense, and before long LTV was a mess and Ling was fired, Buffett says. The lesson here is simple: "Periodically, financial markets will become divorced from reality -- you can count on that. More Jimmy Lings will appear," Buffett writes. "They will look and sound authoritative. The press will hang on their every word. Bankers will fight for their business. What they are saying will recently have 'worked.' Their early followers will be feeling very clever. Our suggestion: Whatever their line, never forget that 2+2 will always equal 4. And when someone tells you how old-fashioned that math is -- zip up your wallet, take a vacation and come back in a few years to buy stocks at cheap prices."

Whether the "housing prices can't go down" mantra of the mid-2000s, or the "new economy" rhetoric of the tech bubble, or the Dutch tulip mania of the 17th century, history is filled with examples of instances in which investors ignored value and rationality in favor of supposed new paradigms. And without fail those paradigms are proven illusory. What works over the long haul is investing in businesses with good fundamentals and reasonably priced shares. End of story.

The Forest for the Trees

Buffett also talked about both Berkshire's and America's long-term prospects, and he sounds quite optimistic on both. "Despite our conservatism, I think we will be able every year to build the underlying per-share earning power of Berkshire," he says. "That does not mean operating earnings will increase each year -- far from it. The U.S. economy will ebb and flow -- though mostly flow -- and, when it weakens, so will our current earnings. But we will continue to achieve organic gains, make bolt-on acquisitions and enter new fields. I believe, therefore, that Berkshire will annually add to its underlying earning power."

"In some years the gains will be substantial, and at other times they will be minor," he added. "Markets, competition, and chance will determine when opportunities come our way. Through it all, Berkshire will keep moving forward, powered by the array of solid businesses we now possess and the new companies we will purchase. In most years, moreover, our country's economy will provide a strong tailwind for business. We are blessed to have the United States as our home field."

These bullish long-term sentiments are nothing new for Buffett, but they're well worth mentioning. The financial headlines are filled with reason after reason to worry. Turn on any financial news channel or go to any financial website, and you're likely to find some headline that makes you think twice about owning stocks. Recently we've heard about weak retail sales, rising oil stockpiles that could trigger a collapse in oil prices, and the "danger" of interest rate hikes. Before that it was valuations, before that it was Europe's woes, before that it was ... well, you get the idea.

If you want a reason to ditch stocks, you'll always be able to find one. But history has shown that doing so will likely lead to more trouble than profit. Stocks have been the best investment vehicle over the long term, and America is still the best place in the world to do business. Buffett knows this. He lets others fret about each and every economic report, each and every speculation about interest rate policy, and other shorter-term issues. In fact, he probably welcomes their fretting -- it allows him to swoop in and pick up shares of great companies at good prices when others turn pessimistic.

The reality is that, whatever happens in the short term, there will always be good businesses (if ever there aren't, we'll likely have bigger problems than your portfolio), and some of those businesses' shares will always be trading at attractive valuations (sometimes there will be more than others). Ebbs and flows in the economic strength of the US and movements of the stock market are inevitable -- and unpredictable. But if you focus on the long-term and shut out as much of the day-to-day noise as you can, you should be rewarded over the long haul.

The Bottom Line

While financial commentators of all sorts -- including myself -- have been dissecting and digesting Buffett's letter, it's important to remember that the "Oracle of Omaha" isn't perfect. In fact, Buffett spent much of this year's letter talking about mistakes he's made over the course of his stellar career -- including the purchase of Berkshire itself (he says he would've been better off buying an insurance company to start his conglomerate rather than a textile mill). And, to be clear, while I always listen carefully to what Buffett has to say, our investing styles do differ significantly in many ways, in part because of circumstance and in part because of preference. But when it comes to the broad principles, Buffett's advice is both priceless and timeless, and I try to incorporate it in our investment approach. The ability to think long-term, the discipline to keep emotion at bay, the belief that sticking to solid, proven investment principles wins out over fads and flavor-of-the-month strategies -- these are all principles that Buffett has built his empire and reputation on. I think any investor would be wise to embrace them, whatever the specifics of their own strategy.

Editor-in-Chief: John Reese

The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Starwood Property Trust, Inc. (STWD), Hibbett Sports, Inc. (HIBB), Amtrust Financial Services Inc (AFSI) and Middleby Corp (MIDD).

The Keepers

6 stocks remain in the portfolio. They are: Apple Inc. (AAPL), Sasol Limited (Adr) (SSL), Sanderson Farms, Inc. (SAFM), Jones Lang Lasalle Inc (JLL), Lannett Company, Inc. (LCI) and Zumiez Inc. (ZUMZ).

The Newbies

We are adding 4 stocks to the portfolio. These include: Credit Acceptance Corp. (CACC), Universal Insurance Holdings, Inc. (UVE), Chart Industries, Inc. (GTLS) and Sodastream International Ltd (SODA).

Portfolio Changes

Newcomers to the Validea Hot List

Credit Acceptance Corp. (CACC): An indirect auto finance company, Credit Acceptance works with car dealers nationwide to enable them to sell cars to consumers on credit regardless of their credit history. The firm has a $4 billion market cap.

Credit Acceptance is a favorite of my Warren Buffett- and Peter Lynch-inspired Guru Strategies, and my Momentum Investor model. To read more about it, scroll down to the "Detailed Stock Analysis" section.

Chart Industries, Inc. (GTLS): Chart ($1 billion market cap) makes highly engineered equipment used in the production, storage and end-use of hydrocarbon and industrial gases. It has taken in $1.2 billion in sales over the past year.

Chart gets strong interest from my Peter Lynch- and Benjamin Graham-inspired strategies. To read more about it, scroll down to the "Detailed Stock Analysis" section.

Universal Insurance Holdings, Inc. (UVE): Universal is a vertically integrated insurance holding company involved in insurance underwriting, distribution and claims. Its subsidiaries offer homeowners insurance in Florida, North Carolina, South Carolina, Hawaii, Georgia, Massachusetts and Maryland.

Universal ($850 million market cap) gets strong interest from my Motley Fool- and Peter Lynch-based models. To read more about it, see the "Detailed Stock Analysis" section below.

Sodastream (SODA): While it has become a big name in recent years, this firm began introducing solutions to the beverage market in 1903 with a system that enabled consumers to carbonate water at home. Today, it is the world's largest manufacturer, distributor and marketer of home carbonation systems with machines being sold in over 60,000 retail stores, in 45 countries worldwide.

Sodastream ($365 million market cap) gets strong interest from my Benjamin Graham- and Peter Lynch-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Sasol Ltd. (SSL): Sasol announced that net profit rose 54% to 19.54 billion rand ($1.62 billion) in the second half of 2014, with revenue rising 1.6% to 99.83 billion rand. But the firm said that it has cut 1,500 jobs -- with more cuts to come -- and is decreasing its dividend amid the plunge in oil prices, The Wall Street Journal reported. The dividend will be cut by 13% to seven rand ($0.58) per share. Sasol has suspended exploration and extraction activity indefinitely to generate more savings, with the exception being a gas-plant project in Mozambique, the Journal reported.

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

SODA   |   UVE   |   GTLS   |   SAFM   |   ZUMZ   |   LCI   |   CACC   |   AAPL   |   JLL   |   SSL   |  

SodaStream International Ltd., formerly Soda-Club Holdings Ltd., along with its subsidiaries, is engaged in developing, manufacturing and marketing home beverage carbonation systems and related products. The Company's operational activities are managed by Soda-Club International BV (SCBV), wholly owned subsidiary of Soda-Club Enterprises N.V. (SCNV), whch is the wholly owned subsidiary of the Company. SodaStream manufactures home beverage carbonation systems, which enable consumers to transform ordinary tap water into carbonated soft drinks and sparkling water. The Company's products include soda makers, CO2 refills, flavors and carbonation bottles. In October 2011, the Company acquired CEM Industries S.R.L.

Universal Insurance Holdings, Inc. (UIH) is a vertically integrated insurance holding company. The Company's insurance products are offered to its customers through Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC), (collectively the Insurance Entities). Substantially all aspects of insurance underwriting, distribution and claims processing are covered through the Company's subsidiaries. Blue Atlantic Reinsurance Corporation (BARC), a wholly owned subsidiary of UIH, is a reinsurance intermediary broker. The Insurance Entities generate revenues primarily from the collection of premiums. Universal Risk Advisors, Inc. (URA), the Company's managing general agent, generates revenue through policy fee income and other administrative fees from the marketing of the Insurance Entities' insurance products through its distribution network of independent agents.

Chart Industries, Inc., is an independent global manufacturer of engineered equipment used in the production, storage and end-use of hydrocarbon and industrial gases. The Company supplies engineered equipment used throughout the global liquid gas supply chain. It operates in three segments: energy and chemicals (E&C), distribution and storage or (D&S), and biomedical. The E&C and D&S segments manufacture products used primarily in energy-related and general industrial applications, such as the separation, liquefaction, distribution and storage of hydrocarbon and industrial gases. Through its BioMedical segment, it supplies cryogenic and other equipment used in the storage and distribution of biological materials and oxygen, used primarily in the medical, biological research and animal breeding industries. In May 2014, Chart Industries Inc completed its acquisition of the brazed aluminum heat exchanger (BAHX) business of Wuxi City Zhongbo Heat Exchanger Co., Ltd.

Sanderson Farms, Inc. is a poultry processing company which is engaged in the production, processing, marketing and distribution of fresh and frozen chicken and other prepared chicken items. In addition, the Company is engaged in the processing, marketing and distribution of prepared chicken through its wholly owned subsidiary, Sanderson Farms, Inc. (Foods Division). It produces a range of processed chicken products and prepared chicken items. It sells ice pack, chill pack, bulk pack and frozen chicken, in whole, cut-up and boneless form, under the Sanderson Farms brand name to retailers, distributors, and casual dining operators in the south-eastern, south-western, north-eastern and western United States and to customers who resell frozen chicken into export markets. During the fiscal year ended October 31, 2013 (fiscal 2013), it processed 452 million chickens, or over 3.0 billion dressed pounds.

Zumiez Inc. is a multi-channel specialty retailer of action sports related apparel, footwear, accessories and hardgoods, focusing on skateboarding, snowboarding, surfing, motocross and bicycle motocross for young men and women. The Company operates under the names Zumiez and Blue Tomato. The Company operates ecommerce Websites at www.zumiez.com and www.blue-tomato.com. Its apparel offerings include tops, bottoms, outerwear and accessories, such as caps, bags and backpacks, belts, jewelry and sunglasses. Zumiez's footwear offerings primarily consist of action sports related athletic shoes and sandals. Its equipment offerings, or hardgoods, include skateboards, snowboards and ancillary gear, such as boots and bindings. The Company sources its private label merchandise from primarily foreign manufacturers around the world.

Lannett Company, Inc. develops, manufactures, packages, markets and distributes solid oral (tablets and capsules), extended release, topical and oral solution finished dosage forms of drugs. The Company also manufactures active pharmaceutical ingredients through its Cody Laboratories, Inc. (Cody Labs) subsidiary. The Company operates pharmaceutical manufacturing plants in Philadelphia, Pennsylvania and Cody, Wyoming. Customers of the Company's pharmaceutical products include generic pharmaceutical distributors, drug wholesalers, chain drug stores, private label distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups, Governmental entities and health maintenance organizations. The Company's products include Levothyroxine Sodium tablets, Digoxin tablets, Butalbital, Cocaine Topical Solution and Morphine Sulfate Oral Solution.

Credit Acceptance Corporation is a provider of financing programs to automobile dealers that enable them to sell vehicles to consumers, regardless of their credit history. The Company's financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing; from repeat and referral sales generated by these same customers; and from sales to customers responding to advertisements. Credit Acceptance has two programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, it advances money to Dealer-Partners (referred to as a Dealer Loan) in exchange for the right to service the underlying Consumer Loans. Under the Purchase Program, Credit Acceptance buys the Consumer Loans from the Dealer-Partners (referred to as a Purchased Loan) and keeps all amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans.

Apple Inc. designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players and sells a variety of related software, services, peripherals, networking solutions and third-party digital content and applications. The Company's products and services include iPhone, iPad, Mac, iPod, Apple TV, a portfolio of consumer and professional software applications, the iOS and OS X operating systems, iCloud and a variety of accessory, service and support offerings. The Company offers a range of mobile communication and media devices, personal computing products and portable digital music players, as well as a variety of related software, services, peripherals, networking solutions and third-party hardware and software products. The Company's primary products include iPhone, iPad, Mac, iPod, iTunes, Mac App Store, iCloud, Operating System Software, Application Software and Other Application Software.

Jones Lang LaSalle Incorporated (Jones Lang LaSalle), is a financial and professional services firm specializing in real estate. Jones Lang LaSalle has over 200 corporate offices worldwide and operations in more than 1,000 locations in 70 countries. The Company offers integrated real estate and investment management services on a local, regional and global basis to owner, occupier and investor clients. It delivers an array of Real Estate Services (RES) across its three geographic business segments: the Americas, Europe, Middle East and Africa (EMEA), and Asia Pacific. LaSalle Investment Management, a wholly owned member of the Jones Lang LaSalle group that consists of its fourth business segment, is a diversified real estate investment management company. In July 2014, Jones Lang LaSalle Inc acquired CLEO Construction Management (CLEO), a construction project management services firm that specializes in medical facilities.

Sasol Limited (Sasol) is an integrated energy and chemicals company. Sasol mines coal in South Africa and produce natural gas and condensate in Mozambique, oil in Gabon and shale gas in Canada. In South Africa it refines imported crude oil and retail liquid fuels. It has chemical manufacturing and marketing operations in South Africa, Europe, the Middle East, Asia and the Americas. It operates in four segments: South African energy cluster, International Energy Cluster, Chemical Cluster and Other businesses. Effective March 31, 2013, Sasol Olefins & Surfactants sold G.D. Portbury Ltd. On 16 August 2013, Sasol Investment Company (Pty) Limited, a wholly owned subsidiary of Sasol, entered into a definitive sale and share purchase agreement pursuant to which Main Street 1095 (Pty) Limited, completed the acquisition of 100% of the interest of SPI International (Pty) Limited (SPII). SPII is the indirect owner of a 50% interest in the Iranian joint venture, Arya Sasol Polymer Company.

Watch List

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


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