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Executive Summary November 6, 2015

The Economy

While growth has slowed from earlier in the year, strong performance from the service sector has kept the economy chugging along in recent weeks.

The private sector added 182,000 jobs in October, for example, according to payroll processor ADP. That's on the lower side for 2015, but it is still a pretty solid total. The Labor Department is scheduled to release its October jobs report today, and investors will no doubt be paying close attention to see if its numbers are in line with ADP's.

The service sector continues to excel. It expanded in October for the 69th straight month, according to the Institute for Supply Management. The rate of expansion picked up from September, and was, in fact, the second-highest rate of the past year. New order growth accelerated from September's already strong pace, and employment conditions remained very strong.

The manufacturing sector is a bit of a different story, however. While it expanded for the 34th straight month, according to ISM, it barely kept its head above water, with the group's manufacturing sector index coming in at 50.1 -- a reading of 50 demarcates the line between growth and contraction. New order growth did accelerate, but employment conditions worsened.

Disappointing news also came from the housing market. New home sales fell 11.5% in September, according to the Census Bureau. That put them about 3% below where they were a year ago. Median sales prices rose, however, and are about 13.5% ahead of last year's pace.

Another government report showed that gross domestic product rose at a pace of just 1.5% in the third quarter, well below the second quarter's 3.9% gain. One big reason for the decline was that businesses were working off an inventory glut, and thus did not spend much on restocking their wares. That was believed to cut off about 1.5 percentage points of GDP during the quarter. Consumer spending was solid, rising 3.2%.

Personal income rose just 0.1% in September, meanwhile, its worst showing in several months, according to the Commerce Department. Real disposable personal income rose a decent 0.2%, while real personal consumption expenditures also increased 0.2%. A bit of deflation helped add to those numbers, as the real, after-inflation figures were actually higher than the unadjusted numbers. Amid all of this, the personal savings rate was 4.8%, up slightly from 4.7% in August. That's a pretty healthy level.

Last but not least, gas prices have continued to slide. A gallon of regular unleaded on average cost $2.20 as of November 4, down from $2.29 a month earlier, according to AAA. That's more than 25% below where it was a year ago.

Since our last newsletter, the S&P 500 returned 2.3%, while the Hot List returned 0.9%. So far in 2015, the portfolio has returned 0.7% vs. 2.0% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 225.8% vs. the S&P's 109.9% gain.

Portfolio Update

Overall, it has been a pretty good two weeks for the Hot List, but the performance of our individual holdings has varied wildly. Since our last newsletter, six of our holdings have gained ground and three have been in the red, with another right around break-even. Four of the holdings had gains or losses of about 9% or more. (Performance data as of mid-day trading on November 5.)

The biggest winner was WisdomTree Financial (WETF), which was up more than 13%. The asset management firm reported third-quarter profit of $23.3 million, or 17 cents per share, on revenue of $80.8 million. Analysts surveyed by Zacks Investment Research expected earnings of 17 cents per share on revenue of $79.1 million. Shares of Wisdom Tree had been rising in the two weeks prior to the announcement, and they continued to move higher after.

Our second-biggest winner was also a financial: Eagle Bancorp (EGBN). The Maryland-based small-cap gained about 9% since our last newsletter. Just before joining the portfolio on our last rebalancing, Eagle reported third-quarter earnings of $21.5 million, or 63 cents per share. That beat the 61 cents per share that analysts surveyed by Zacks Investment Research anticipated, and the earnings beat appears to have kept driving Eagle's shares higher over the past two weeks.

Other nice winning positions for the past fortnight have been Sanderson Farms (SAFM) and Apple (AAPL), each of which gained about 5%.

On the downside, however, we had two stocks that posted double-digit losses. Chart Industries (GTLS) tumbled 13% after announcing disappointing earnings. The Ohio-based diversified manufacturer reported third-quarter net income of $4.8 million, or 15 cents per share; when adjusted for non-recurring costs and severance costs earnings were 26 cents per share, according to the Associated Press. Analysts surveyed by Zacks Investment Research had expected earnings of 32 cents per share. Chart's revenue was $264 million for the quarter, beating forecasts of $255.9 million. But the earnings miss and a big decrease in its full-year EPS guidance spooked investors, driving shares much lower.

The other big loser was Universal Insurance (UVE), which was down 10.5%. The Florida-based property and casualty insurer reported third quarter 2015 net income of $30.3 million, an increase of 42.0% over the same period in 2014 and a record in company history. Diluted EPS were $0.84, an increase of 37.7%, and also represented a company record. Total revenues increased by $53.5 million, or 51.7%, to $157.0 million. All that would seem to be very good news, as was the fact that the EPS results beat analysts' expectations by 25%, according to MarketBeat. Nevertheless, shares tumbled for reasons that were unclear. Given all of that, Universal bears watching going forward.

The Hot List has been hovering around breakeven for the 2015 year. Hopefully the gains we've seen over the past few weeks will continue as we move into the final part of the year. We'll be back in two weeks, at which point we will rebalance the portfolio.

 
Editor-in-Chief: John Reese












Guru Spotlight: James O'Shaughnessy

If you have ever invested using a quantitative strategy, you probably owe a debt of gratitude to James O'Shaughnessy. In his 1996 book What Works on Wall Street, O'Shaughnessy helped bring the notion of quantitative strategies to the masses. Through his work with the Compustat database, O'Shaughnessy was able to determine how well or poorly dozens of different quantitative strategies would have fared over the previous four-plus decades, and he provided detailed results in his book.

In subsequent versions of What Works on Wall Street, O'Shaughnessy has expanded on his research, testing more strategies and delving into analysis of specific sectors as well. The most recent version includes data from as far back as the 1920s up through the 2009 financial crisis. At 681 pages, it is chock-full of incredibly valuable information, and any investor would be wise to read it.

This week, let's look briefly at the five strategies that O'Shaughnessy found would have produced the best risk-adjusted returns from 1965 through 2009, and see if there might be any similarities among them. (Spoiler alert: There are!)

Strategy 1: Trending Value
This was the top performer in O'Shaughnessy's study, producing a Sharpe ratio of 0.91. The strategy looks for stocks in the top decile based on a composite value factor that takes into account a stock's price/book, price/earnings, price/sales, EBITDA/enterprise value, and price/cash flow ratios, as well as its shareholder yield. Then, from among that group it buys the stocks with the highest six-month relative strengths.

Strategy 2: Low Price/Book, High Momentum, High Shareholder Yield
The strategy with the second-highest risk-adjusted returns was this approach, which generated a 0.87 Sharpe ratio. The approach looks for stocks that are in the top three deciles based on their price/book ratios; have 3- and 6-month relative strengths above the market average; and have the highest shareholder yields.

Strategy 3: Consumer Staples Plus Utilities
With a Sharpe ratio of 0.86, this combined portfolio came in third. It is made up of the 25 stocks from the Consumer Staples sector with the highest shareholder yield, and the 25 stocks from the Utility sector that score highest on the value composite outlined in Strategy 1.

Strategy 4: Micro-Cap Stocks, Low Price/Book, High Momentum
Also coming in with a Sharpe ratio of 0.86, this approach keys on the market's smallest stocks. It looks for micro-caps that are in the top three deciles based on price/book ratio, and which have 3- and 6-month relative strengths greater than 0. Then from that group it takes the top 50 based on 12-month relative strength.

Strategy 5: Low Price/Book, High Momentum, High Shareholder Yield
The fifth-best performer, this approach had a 0.85 Sharpe ratio. It looks for stocks that were in the top three deciles based on price/book ratio, and which also had 3- and 6-month relative strengths higher than the market average. From that group, it then takes the top 25 according to shareholder yield.

These five strategies are a pretty diverse bunch, ranging from approaches that are size- and industry-specific to those that have free range over the entire market. So what ties them together?

What jumps out at me is that each of these strategies uses both value and momentum components. Yes, value stocks do in and of themselves tend to beat the market over the long haul. But as I've noted in some past newsletters, adding a momentum component to value approach can create a juggernaut of a strategy. O'Shaughnessy helped alert me to this notion years ago when I came across his book. His Cornerstone Growth strategy, which is now the basis for my O'Shaughnessy-based growth model, looks for stocks that have increased earnings per share in each of the past five years and which have high 12-month relative strengths. But O'Shaughnessy noted that what really made the strategy work was its combination of momentum with a value component: the price/sales ratio. By purchasing high momentum stocks that are still cheap, you are getting stocks that the market is embracing, but which still have room to run.

Other research has supported O'Shaughnessy's contention about the combination of value and momentum. So, too, has my own experience. Many of my top-performing guru-based portfolios use combinations of momentum and value. The Motley Fool approach looks at 12-month relative strength and the PE-to-growth ratio. The Hot List and our other multi-guru portfolio, the Top 5 Gurus portfolio, both use a myriad of metrics on both the growth/momentum side and the value side.

A strategy that incorporates both momentum and value metrics is no magic bullet. Like any other strategy, such an approach will go through down periods. But by buying stocks with good momentum that are still cheap, you give yourself a great chance of beating the market over the long haul. O'Shaughnessy taught me that years ago, and my own experience has done nothing to make me doubt that belief.



News about Validea Hot List Stocks

WisdomTree Investments (WETF): On Oct. 30, WisdomTree announced it intends to enter the U.S. commodities ETF space through the acquisition of GreenHaven Commodity Services, LLC, the managing owner of the GreenHaven Continuous Commodity Index Fund, and GreenHaven Coal Services, LLC, the sponsor of the GreenHaven Coal Fund. The transaction is subject to approval by the GreenHaven Continuous Commodity Index Fund shareholders and customary closing conditions, and is expected to close in the fourth quarter of 2015. The transaction consideration is $11.75 million in cash. The continuous commodity fund had about $247 million in assets under management and the coal fund about $1 million in assets under management at the time the deal was announced. The financial impact of the transaction will not be material to WisdomTree earnings per share.



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.


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

UVE   |   GTLS   |   AAPL   |   SAFM   |   FL   |   WETF   |   PII   |   PNFP   |   HRTG   |   EGBN   |  



Universal Insurance Holdings, Inc. (UIH), with its wholly owned subsidiaries, is a vertically integrated insurance holding company performing all aspects of insurance underwriting, distribution and claims. The Company's offers homeowners' insurance through the Insurance Entities, Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC). Substantially all aspects of insurance underwriting, distribution and claims processing are performed by the Company's subsidiaries. UPCIC, a wholly owned subsidiary of the Company, is a writer of homeowners insurance in Florida and has commenced its operations in North Carolina, South Carolina, Hawaii, Georgia, Massachusetts, Maryland, Delaware, and Indiana. APPCIC, also a wholly owned subsidiary, writes homeowners multi-peril insurance on Florida homes valued in excess of $1 million, which are limits and coverages currently not targeted through its affiliate UPCIC.





Chart Industries, Inc. (Chart) is a diversified manufacturer of engineered equipment engineered equipment for the industrial gas, energy, and biomedical industries. The Company's equipment and engineered systems are used for low-temperature and cryogenic applications. It operates through three segments: Energy & Chemicals (E&C), Distribution & Storage (D&S) and BioMedical. Its products include vacuum insulated containment vessels, heat exchangers, cold boxes and other cryogenic components. Its E&C and D&S segments manufacture products used in energy-related and 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 medical, biological research and animal breeding industries. The Company, through Thermax, Inc., provides cryogenic fluid vaporizers utilized in industrial gas, petro-chemical and liquefied natural gas applications.





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.





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.





Foot Locker, Inc. is a retailer of shoes and apparel. The Company operates in two segments: Athletic Stores and Direct-to-Customers. The Athletic Stores segment is an athletic footwear and apparel retailer whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction and SIX:02, as well as the retail stores of Runners Point Group, including Runners Point and Sidestep. The Direct-to-Customers segment includes Footlocker.com, Inc. and other affiliates, including Eastbay, Inc., and the direct-to-customer subsidiary of Runners Point Group, which sell to customers through their Internet and mobile sites and catalogs. As of January 31, 2015, the Company operated 3,423 primarily mall-based stores in the United States, Canada, Europe, Australia and New Zealand. As of January 31, 2015, the Company operated a total of 78 franchised stores, of which 31 are in the Middle East, 27 in Germany and Switzerland, and 20 in the Republic of Korea.





WisdomTree Investments, Inc. is an asset management company that focuses on exchange-traded funds (ETFs). The Company's family of ETFs includes fundamentally weighted funds that track its own indexes, funds that track third party indexes and actively managed funds. The Company distributes its ETFs through all major channels within the asset management industry, including brokerage firms, registered investment advisers, institutional investors, private wealth managers and discount brokers. Most of its index-based funds employ a fundamental weighted investment methodology, which weights securities on the basis of factors, such as dividends or earnings, whereas most other ETF industry indexes use a capitalization weighted methodology. In addition, it also offers actively managed ETFs, which are ETFs that are not-based on a particular index but rather are actively managed with complete transparency into the ETF's portfolio on a daily basis.





Polaris Industries Inc. (Polaris) designs, engineers and manufactures off-road vehicles (ORV), including all-terrain vehicles (ATV) and side-by-side vehicles for recreational and utility use, snowmobiles, motorcycles and small vehicles (SV). These products are sold through dealers and distributors located in the United States, Canada and Europe. The Company's ORVs include core ATVs, and RANGER and RZR side-by-side vehicles. The Company produces a range of snowmobiles, consisting of 32 models, ranging from youth models to utility and economy models to performance and competition models. Polaris' Motorcycles division consists of Victory, Indian motorcycles and three-wheel roadster motorcycle, Slingshot. The Company offer products in the light-duty hauling, people mover and urban/suburban commuting sub-sectors of the small vehicles industry. The Company produces or supplies a range of replacement parts and accessories for its product lines.





Pinnacle Financial Partners, Inc. (Pinnacle) is a bank holding company. Pinnacle operates through its wholly owned subsidiary, Pinnacle Bank. The Company operates as a community bank primarily in the urban markets of Nashville and Knoxville, Tennessee. As an urban community bank, Pinnacle provides the personalized service associated with small community banks, while seeking to offer the products and services, such as investments and treasury management, offered by large regional and national banks. Pinnacle Bank offers an array of convenience-centered products and services, including 24-hour telephone and internet banking, mobile banking, debit and credit cards, direct deposit, remote deposit and cash management services for small- to medium-sized businesses. In addition, Pinnacle Bank is associated with a network of automated teller machines of other financial institutions that its clients are able to use throughout Tennessee and other regions across the nation.





Heritage Insurance Holdings, Inc. (Heritage Insurance), formerly Heritage Insurance Holdings, LLC, is a property and casualty insurance holding company. The Company is engaged in providing personal and commercial residential insurance. Through Its subsidiary, Heritage Property & Casualty Insurance Company (Heritage P&C), it provides personal residential insurance for single-family homeowners and condominium owners, rental property insurance and commercial residential insurance in the state of Florida. The Company is vertically integrated and control or manage all aspects of insurance underwriting, actulato analysis, distribution and claims processing, and adjusting. It has approximately 207,000 personal residential policies in force and approximately 2,400 commercial residential policies in force.





Eagle Bancorp, Inc. is a bank holding company for EagleBank (the Bank). The Bank is the Company's principal operating subsidiary. The Bank is a chartered commercial bank. The Bank operates twenty two banking offices: seven in Montgomery County, Maryland; five located in the District of Columbia, and ten in Northern Virginia. The Bank offers a range of commercial banking services to its business and professional clients, as well as consumer banking services to individuals living or working in the service area. The Bank also provides commercial banking services to sole proprietorships, small, medium and large-sized businesses, partnerships, corporations, non-profit organizations and associations, and investors. The Bank offers a range of retail banking services to accommodate the individual needs of both corporate customers as well as the community the Bank serves. The Bank also offers online banking, mobile banking and a remote deposit service.





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.





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.