The Economy

Nonfarm payrolls up 156,000 compared to the markets expectation of 170K. Private sector gains were stronger than expected at 167,000. The unemployment rate in the US now stands at 5.0%. Average hourly earnings rose 0.2% from the previous month and were up 2.6% from a year earlier.

The minutes from the Federal Reserve's latest meeting were released on Oct. 12th. The transcript shows some divergences in the minds of Fed officials. On one side are those who think the Fed should be moving interest rates higher in an effort to normalize rates. However, others think rates should remain lower for longer in an effort drive inflation higher towards the Fed's 2% target. The minutes show that the Fed thinks a short term interest rate increase will happen "relatively soon" and most experts are predicting a December rate hike.

Corelogic estimates that insured losses from Hurricane Matthew will come in between $4-$6 billion compared to an estimated $20 billion prior to the storm's impact. This number does not include the loss of economic activity from business and commerce shutting down pre and post storm, but the actual losses are looking like they will come in far less than most experts predicted before the storm hit the Florida and Carolina coast lines.

Jobless claims in the US came in at 246,000 in the week ended Oct. 8. This is the lowest level of Americans applying for first-time unemployment since 1973, indicating the job market in America still looks pretty healthy.

The University of Michigan Consumer Sentiment Index fell in September to 87.9, which was the lowest level since September of 2015 and the second lowest reading in the past 24 months. Most of the decline came in households making less than $75,000 in income. According to Advisor Perspectives, "The Michigan average since its inception is 85.4. During non-recessionary years the average is 87.6. The average during the five recessions is 69.3. So the latest sentiment number puts us 18.6 points above the average recession mindset and 0.3 points above the non-recession average."

Overseas, the British Pound continued its descent vs. the dollar. The pound has been under significant pressure as impact from the Brexit vote continues to create uncertainty around the UK economy. The positive of a declining currency is that it's made British exports cheaper, which will help the economy, but import prices are up for citizens of England.

Corporate earnings have been nicely beating expectations so far this earnings season. FactSet has some interesting early data - 76% of the reporting companies have beaten earnings expectations and 62% have beaten on sales. So far for the quarter, earnings up about 0.5% and revenues are up about 2% for the quarter. The "earnings recession" in US business seems to be coming to an end, but the growth coming off the trough appears somewhat muted still at this point.

Performance Update

Since our last newsletter, the S&P 500 returned -0.9%, while the Hot List returned -4.4%. So far in 2016, the portfolio has returned 2.8% vs. 4.8% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 189.6% vs. the S&P's 114.0% gain.

A Guru Primer

As uncertainty continues to loom in the economic realm, an equity investor's approach to the stock market should be anything but uncertain. On the contrary, it should be built on a firm foundation of information and executed in a disciplined way. It only makes sense, then, for an investor to glean as much knowledge as possible from history's most notable and successful investors. This, however, can be a daunting process. When developing the stock screening models used to guide our portfolio management, I researched and incorporated the tenets of those investing gurus with verifiable, long-term track records of success, whose strategies were publicly disclosed and primarily quantitative in nature. These strategies have been tried, true and successful over the long term, and can offer investors the tools necessary to build a strong investment portfolio while guarding against misguided, knee-jerk reactions and decisions.

One such guru is the late Benjamin Graham, investing sage and mentor to Warren Buffett, who drove the point home using a parable in his book The Intelligent Investor:

If you are a prudent investor or a sensible businessman, will you let Mr. Market's daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in the case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial condition.

That is precisely what we set out to do with our guru-based stock screening models; to use concrete metrics derived from a company's operations to make an informed investment decision. And while we always substantiate our stock picks with detailed information about the individual models, we don't often address them collectively. Here's an overview of the guru-based strategies and their core calculations:

The Benjamin Graham-based Strategy explicitly eschews technology stocks (which Graham found too risky), and implicitly avoids financial firms (thanks to its stringent debt requirements). The model requires that a company have at least as much net current assets as it does long-term debt, and that it have a current ratio (current assets/current liabilities) of at least 2.0. Graham was known as the "Father of Value Investing", so it also looks for cheap stocks. Neither the stock's trailing 12-month price/earnings ratio nor its P/E based on three-year average earnings can be over 15, and the product of its P/E and price/book ratios can't be more than 22.

The Warren Buffett-based Strategy: targets high-quality companies trading at reasonable valuations. My Buffett-based model is derived from the book Buffettology, written by Buffett's former daughter-in-law Mary Buffett, with whom he worked closely. It looks back a full decade into a firm's fundamentals and financials, targeting companies that have grown earnings-per-share on a consistent basis over the past 10 years, and which have averaged returns on equity of at least 15% over that same 10-year span -- a sign of the "durable competitive advantage" that Buffett is known to seek in his investments. The model also likes companies that are conservatively financed, looking for those that have enough annual earnings that they could, if need be, pay off all of their long-term debt within five years (and preferably two). It also looks for companies with a positive free cash flow, and a decade long return on retained earnings of at least 12%. In terms of value, the stock doesn't need to be dirt-cheap, but it does need to have an earnings yield greater than the yield on a long-term Treasury bond.

The Motley Fool-based Strategy: is based on the philosophies disclosed by brothers Tom and David Gardner (the creators of the Motley Fool web site). The Fool portfolio targets small-cap growth stocks, looking for companies with high profit margins, strong sales and earnings growth, high relative strengths, low debt, and low P/E/Growth ratios. It also takes into consideration several other factors, including price and volume levels, and a company's income tax level.

The Kenneth Fisher-based Strategy: incorporates the methodology that Fisher (a longtime Forbes columnist, money manager, and author) unveiled in his 1984 classic Super Stocks, and focuses on a metric Fisher pioneered: the price/sales ratio (PSR). While investors for decades relied heavily on the P/E ratio, Fisher found that earnings -- even the earnings of good companies -- can fluctuate greatly from year to year as firms replace equipment or facilities in one year rather than in another, use money for new research that will help the company reap profits later on, or change accounting methods. Sales, however, are much more consistent, and the PSR can thus find strong firms that are going through earnings "glitches" that have driven their stocks down to bargain levels. Fisher also looked at a variety of other metrics, including the debt/equity ratio, profit margins, and earnings growth.

The James O'Shaughnessy-based Strategy: actually uses two models -- one growth and one value. The growth model targets companies with high relative strengths and PSRs below 1.5, a combination O'Shaughnessy found would identify stocks that were being embraced by the market, but which hadn't gotten too pricey. It also looks for firms that have upped earnings per share in each year of the past half-decade, without regard to the magnitude of the increases. The value approach, meanwhile, targets big firms (those with sales at least 1.5 times the market mean) with better-than-average cash flows per share and high dividend yields.

The Peter Lynch-based Strategy: Just as Fisher pioneered the use of the PSR, Lynch, one of the most successful mutual fund managers of all time, made the P/E/Growth ratio a popular stock investing tool. By dividing a firm's P/E ratio by its historical growth rate, Lynch found good growth firms selling on the cheap. The rationale: The faster a company is growing, the higher the valuation you should be willing to pay for its earnings. P/E/Gs below 1.0 are acceptable to this model, with those under 0.5 the best case. The Lynch-based approach also looks at factors like the debt/equity ratio, inventory/sales ratio, and, for financial firms, the equity/assets ratio and return on assets rate.

The David Dreman-based Strategy: A great student of investor psychology, Dreman found that investors are prone to overreaction. This meant solid companies going through short-term troubles could have their shares beaten down far more than they deserved. Then, when the short-term problems were rectified, the stocks often bounced back very strong. To find these types of unloved stocks, Dreman looked for firms with price/earnings, price/cash flow, price/book, or price/dividend ratios in the bottom 20% of the market. Dreman conceded, however, that a stock can be cheap because it's simply a losing proposition. So to separate the unfairly beaten down firms from the dogs, Dreman applied a variety of financial tests that zeroed in on debt levels, profit margins, returns on equity, and several other factors.

The Martin Zweig-based Strategy: Zweig, who put up an exceptional long-term track record with his investment newsletter, was something of a conservative growth investor. He dissected a firm's earnings from a variety of angles, looking not just for high growth rates, but also for growth that was accelerating. He also wanted that growth to be driven by sales, not one-time cost-cutting efforts, and he didn't want earnings to be amped up by high leverage. He also thought there was a limit to how much one should pay for growth -- this approach targets stocks with P/E ratios no greater than three times the market average, and never more than 43 regardless of what the market average is. Zweig also didn't want P/Es to be too low, because that could be the sign of a dog. The model I base on his writings uses a minimum P/E of 5.

The John Neff-based Strategy: Given his longevity, Neff belongs in the conversation about who is the greatest fund manager of all time. Over a remarkable three-decade run that began in 1964, he guided the Windsor fund to a 13.7% average annual return, easily outpacing the S&P 500's 10.6% return during that time with his value based approach. Neff looked for unloved stocks using the price/earnings ratio, seeking stocks with P/Es that were between 40% and 60% of the market average. From this group, he looked for firms with steady, sustainable EPS growth (between 7% and 20% per year, and driven by sales growth), as well as positive free cash flows. He also used what he called the "total return/PE" ratio, which combined a stock's growth rate and dividend yield and divided that by its P/E ratio to find good values. The variable underscored Neff's belief that strong dividends were an often-overlooked part of how investors could beat the market.

The Joel Greenblatt-based Strategy: In his Little Book That Beats the Market, hedge fund manager Greenblatt laid out a stunningly simple way to beat the market using two -- and only two -- fundamental variables: return on capital and earnings yield. To be fair, it's actually a bit more complicated than that; his "Magic Formula" (as he dubbed it) and our Greenblatt-based model don't use a simple earnings yield (that is, a simple earnings/price ratio). Instead, they use earnings before interest and taxes and divide by enterprise value, which includes not only the price of the company's shares, but also the amount of debt it uses to generate earnings. Similarly, for return on capital, the strategy divides a firm's earnings before interest and taxes by its tangible capital employed, which is equal to net working capital plus net fixed assets. So while the approach uses just two variables, those variables encompass quite a bit and provide a pretty well-rounded look at a stock.

The Joseph Piotroski-based Strategy: This little-known accounting professor wrote a highly influential paper that laid out an accounting-based value investing method that produced 23% average annual back-tested returns over a two-decade period. The strategy starts by looking for stocks trading in the top 20% of the market based on their book/market ratios (or, conversely, the bottom 20% of the market based on price/book ratios). Then, it applies a series of additional tests of financial strength to separate the high book/market firms that are dogs from those that are good prospects. Return on assets, current ratio, cash flow from operations, change in gross margin, and long-term debt/assets are all among the variables it examines.

The Momentum Investor Portfolio: A customized approach based on the writings of some top momentum strategists, this strategy looks for stocks in leading industries with strong recent earnings growth (18% or more in the most recent quarter vs. the year-ago quarter), and strong relative price performance. It also likes high returns on equity and low (or declining) debt/equity ratios.

Benefits of Combining Investment Strategies

As events continue to unfold in the form of monetary policy, geo-political movements, the tumultuous road to the presidential election, earnings reports and the like, we stand by the disciplined, methodical investment strategies we have developed. These methodologies, however, afford us more than just a unilateral focus on underlying business fundamentals. Because they are varied (some target deep value, others growth, and still others a hybrid growth/value approach) and encompass a wide spectrum of criteria used (over 300 stock- and company-specific variables), a very small portion of stocks pass through more than one of these models. When they do, such as those in our Consensus and Hot List portfolios, they are typically strong across a number of different criteria and tend to outperform over the long haul.

The diversity among models also serves as a built-in buffer against market volatility (which can eat away at returns). To return to Graham's parable, it would be reasonable to say that Mr. Market is a fickle sort. There are times when he prefers growth over value, other times when value is more favored. There is no single strategy that will always work well and, as we've seen, hopping from one strategy to the other in pursuit of higher returns will often result in an investor buying high and selling low. If, as an investor, you apply a two-pronged approach that includes a growth-focused strategy and a value-focused strategy, you will see less volatility in your portfolio. Your highs might not be quite as high, but you'll suffer smaller losses during down times. Also, since gains are compounded (you earn money not only on your initial investment but on whatever you had at the end of the previous year) a down year can have long term effects because it reduces the base amount that you're earning on.

Another important impetus to reduce volatility: you'll be less inclined to cut and run when times get tough. While we like to think that our arguments for staying the course are compelling enough to guard against this, the reality is that when investment dollars start disappearing, emotions can run high and lead panicky investors to jump ship. Blending strategies and avoiding wide swings in performance (up or down) is a good way to keep things on an even keel.

Blending strategies can also maximize returns over the long run. For example, the Hot List includes stocks that get the most combined interest from our strategies, but it also gives greater weight to the strategies with the most historical success, so that its picks are fundamentally strong on a number of levels and get interest from strategies that have been very successful over the long term. This doesn't mean that the blended-strategy portfolios (Hot List and Consensus) don't have off years. Our Hot List (10-stock) portfolio, which has outperformed the S&P 500 by 83.5% since its inception in 2003, suffered dips in 2011 and over the last two years. Year-to-date, however, it has outperformed.

So, while an individual guru model may outperform the Hot List in a given period, we believe that over the longer term a blended approach will achieve the best results because it limits downside risk when an individual strategy is facing a rough patch of road.

Blended strategies also afford investors that are new to our system the opportunity to benefit from a combination of approaches, removing both guesswork and legwork as they figure out which strategy they may feel most aligned with.


The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Smith & Wesson Holding Corp (SWHC), Lgi Homes Inc (LGIH), Trex Company Inc (TREX) and American Woodmark Corporation (AMWD).

The Keepers

6 stocks remain in the portfolio. They are: Valero Energy Corporation (VLO), Insteel Industries Inc (IIIN), Tractor Supply Company (TSCO), Grupo Financiero Galicia S.a. (Adr) (GGAL), Banco Macro Sa (Adr) (BMA) and Amtrust Financial Services Inc (AFSI).

The New Additions

We are adding 4 stocks to the portfolio. These include: Drew Industries, Inc. (DW), John B. Sanfilippo & Son, Inc. (JBSS), Wabash National Corporation (WNC) and Jones Lang Lasalle Inc (JLL).

Latest Changes

Additions  
DREW INDUSTRIES, INC. DW
JOHN B. SANFILIPPO & SON, INC. JBSS
WABASH NATIONAL CORPORATION WNC
JONES LANG LASALLE INC JLL
Deletions  
SMITH & WESSON HOLDING CORP SWHC
LGI HOMES INC LGIH
TREX COMPANY INC TREX
AMERICAN WOODMARK CORPORATION AMWD

Newcomers to the Validea Hot List

Drew Industries (DW):
Drew Industries supplies an array of components in the United States and abroad for the manufacturers of recreational vehicles (RVs) and manufactured homes. It passes the tests of my strategies based on James O'Shaughnessy, Peter Lynch and Martin Zweig. Full Details

John Sanfilippo and Sons (JBSS):
John B. Sanfilippo & Son, Inc. is a processor and distributor of peanuts, pecans, cashews, walnuts, almonds and other nuts. It meets the tests of my strategies based on James O'Shaughnessy, Peter Lynch and Kenneth Fisher. Full Details

Jones Lang Lasalle (JLL):
Jones Lang LaSalle Incorporated (JLL) is a financial and professional services firm specializing in real estate. It receives approval from my strategies based on Peter Lynch and Kenneth Fisher. Full Details

Wabash National Corporation (WNC):
Wabash National Corporation is engaged in designing, manufacturing and marketing standard and customized truck and tank trailers, intermodal equipment and transportation related products. It passes the tests of my strategies based on Peter Lynch and Joel Greenblatt. Full Details

News About the Hot List Stocks

Tractor Supply (TSCO): On October 19th, Tractor Supply reported EPS of 67 cents per share, which was up 4.7% from the previous year. The results slightly exceeded analyst estimates. Gross margin remained steady from the previous quarter at 35%. Same store sales fell slightly by .6% compared to the previous quarter.

Insteel Industries (IIIN): On October 20th, Insteel reported fiscal fourth-quarter earnings of 51 cents per share and $1.95 per share for the full fiscal year. Revenue for the quarter was $103.1 million.

The Next Issue

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

Portfolio Holdings
Ticker Date Added Return
GGAL 8/26/2016 5.8%
BMA 7/1/2016 7.8%
VLO 6/3/2016 -0.7%
IIIN 9/23/2016 -21.6%
AFSI 8/26/2016 1.9%
TSCO 9/23/2016 -4.9%
DW 10/21/2016 TBD
JLL 10/21/2016 TBD
JBSS 10/21/2016 TBD
WNC 10/21/2016 TBD


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

GGAL   |   BMA   |   VLO   |   IIIN   |   AFSI   |   TSCO   |   DW   |   JLL   |   JBSS   |   WNC   |  

GRUPO FINANCIERO GALICIA S.A. (ADR)

Strategy: Contrarian Investor
Based on: David Dreman

Grupo Financiero Galicia S.A. (Grupo Financiero Galicia) is a financial services holding company. The Company's segments include Banking, Regional Credit Cards, CFA, Insurance and Other Grupo Galicia Businesses. Banco de Galicia y Buenos Aires S.A. (Banco Galicia) is a subsidiary of the Company. Its banking business segment represents Banco Galicia consolidated line by line with Banco Galicia Uruguay S.A. (Galicia Uruguay). It operates the regional credit cards segment through Tarjetas Regionales S.A. and its subsidiaries. Its CFA business segment extends unsecured personal loans to low and middle-income segments of the Argentine population. The Company operates the insurance segment through Sudamericana Holding S.A. and its subsidiaries. Its Other Grupo Galicia Businesses segment includes the results of Galicia Warrants S.A., Galicia Administradora de Fondos S.A. Sociedad Gerente de Fondos Comunes de Inversion and Net Investment S.A.

MARKET CAP: PASS

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. GGAL has a market cap of $3,245 million, therefore passing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. GGAL's EPS for the past 2 quarters, (from earliest to most recent quarter) 0.07, 0.70 have been increasing, and therefore the company passes this test.


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: PASS

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. GGAL passes this test as its EPS growth rate over the past 6 months (900.00%) has beaten that of the S&P (17.35%). GGAL's estimated EPS growth for the current year is (1,227.27%), which indicates the company is expected to experience positive earnings growth. As a result, GGAL passes this test.


This methodology would utilize four separate criteria to determine if GGAL is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. GGAL's P/E of 12.22, based on trailing 12 month earnings, meets the bottom 20% criterion (below 12.36), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: FAIL

The P/CF of a company should be in the bottom 20% of the overall market. GGAL's P/CF of 7.53 does not meet the bottom 20% criterion (below 7.24), and therefore fails this test.


PRICE/BOOK (P/B) VALUE: FAIL

The P/B value of a company should be in the bottom 20% of the overall market. GGAL's P/B is currently 3.69, which does not meet the bottom 20% criterion (below 0.97), and it therefore fails this test.


PRICE/DIVIDEND (P/D) RATIO: FAIL

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). GGAL's P/D of 384.62 does not meet the bottom 20% criterion (below 20.00), and it therefore fails this test.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


PAYOUT RATIO: PASS

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for GGAL is 0.00%. Unfortunately, its historical payout ratio is not available. Nonetheless it passes the payout criterion, as this is a very low payout.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 16.04%, and would consider anything over 27% to be staggering. The ROE for GGAL of 35.42% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: PASS

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. GGAL's pre-tax profit margin is 25.66%, thus passing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. GGAL's current yield is 0.26%, while the market yield is 2.76%. GGAL fails this test.

BANCO MACRO SA (ADR)

Strategy: Contrarian Investor
Based on: David Dreman

Banco Macro S.A. offers traditional bank products and services to companies, including those operating in regional economies, as well as to individuals. In addition, the Bank performs certain transactions through its subsidiaries, including mainly Banco del Tucuman, Macro Bank Limited, Macro Securities S.A., Macro Fiducia S.A. and Macro Fondos S.G.F.C.I. S.A. It has approximately two categories of customers, such as retail customers, including individuals and entrepreneurs and corporate customers, which include small, medium and large companies and major corporations. In addition, it provides services to over four provincial governments. It provides its corporate customers with traditional banking products and services, such as deposits, lending (including overdraft facilities), check cashing advances and factoring, guaranteed loans and credit lines for financing foreign trade and cash management services.

MARKET CAP: PASS

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. BMA has a market cap of $4,697 million, therefore passing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. BMA's EPS for the past 2 quarters, (from earliest to most recent quarter) 0.21, 2.04 have been increasing, and therefore the company passes this test.


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: PASS

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. BMA passes this test as its EPS growth rate over the past 6 months (1,175.00%) has beaten that of the S&P (17.35%). BMA's estimated EPS growth for the current year is (1,156.90%), which indicates the company is expected to experience positive earnings growth. As a result, BMA passes this test.


This methodology would utilize four separate criteria to determine if BMA is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. BMA's P/E of 11.27, based on trailing 12 month earnings, meets the bottom 20% criterion (below 12.36), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: FAIL

The P/CF of a company should be in the bottom 20% of the overall market. BMA's P/CF of 10.70 does not meet the bottom 20% criterion (below 7.24), and therefore fails this test.


PRICE/BOOK (P/B) VALUE: FAIL

The P/B value of a company should be in the bottom 20% of the overall market. BMA's P/B is currently 3.77, which does not meet the bottom 20% criterion (below 0.97), and it therefore fails this test.


PRICE/DIVIDEND (P/D) RATIO: FAIL

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). BMA's P/D of 107.53 does not meet the bottom 20% criterion (below 20.00), and it therefore fails this test.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


PAYOUT RATIO: FAIL

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for BMA is 10.23%, while its historical payout ratio has been 9.75%. Therefore, it fails the payout criterion.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 16.04%, and would consider anything over 27% to be staggering. The ROE for BMA of 39.80% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: PASS

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. BMA's pre-tax profit margin is 43.92%, thus passing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. BMA's current yield is 0.93%, while the market yield is 2.76%. BMA fails this test.

VALERO ENERGY CORPORATION

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Valero Energy Corporation (Valero), through Valero Energy Partners LP (VLP), owns, operates, develops and acquires crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets. The Company operates in two segments: refining and ethanol. Its refining segment includes refining and marketing operations in the United States, Canada, the United Kingdom, Aruba and Ireland. Its ethanol segment includes ethanol and marketing operations in the United States. VLP's assets include crude oil and refined petroleum products pipeline and terminal systems in the United States Gulf Coast and the United States Mid-Continent regions. Its refineries can produce conventional gasolines, premium gasolines, gasoline meeting the specifications of the California Air Resources Board (CARB), diesel, low-sulfur diesel, ultra-low-sulfur diesel, CARB diesel, other distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratios below 0.75 are tremendous values and should be sought. VLO's P/S of 0.33 based on trailing 12 month sales, is below 0.75 which is considered quite attractive. It passes this methodology's P/S ratio test with flying colors.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. VLO's Debt/Equity of 36.50% is acceptable, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. VLO is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in VLO At this Point

Is VLO a "Super Stock"? NO


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical(non-Smokestack) companies with Price/Sales ratios below .75 are tremendous values and should be sought.VLO's P/S ratio of 0.33 is below .75 which is considered extremely attractive. It passes this methodology's P/S ratio test with flying colors.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. VLO's inflation adjusted EPS growth rate of 21.41% passes the test.


FREE CASH PER SHARE: PASS

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. VLO's free cash per share of 6.29 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: FAIL

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. VLO, whose three year net profit margin averages 3.09%, fails this evaluation.

INSTEEL INDUSTRIES INC

Strategy: P/E/Growth Investor
Based on: Peter Lynch

Insteel Industries, Inc. (Insteel) is a manufacturer of steel wire reinforcing products for concrete construction applications. The Company manufactures and markets PC strand and welded wire reinforcement (WWR), including Engineered Structural Mesh (ESM), concrete pipe reinforcement (CPR) and standard welded wire reinforcement (SWWR). The Company's products are sold to manufacturers of concrete products that are used in nonresidential construction. Insteel has two wholly owned subsidiaries, Insteel Wire Products Company (IWP), an operating subsidiary, and Intercontinental Metals Corporation, an inactive subsidiary. The Company's concrete reinforcing products consist of PC strand and WWR. PC strand provides reinforcement for bridges, parking decks, buildings and other concrete structures. Welded Wire Reinforcement produces engineered reinforcing product for use in nonresidential and residential construction.


DETERMINE THE CLASSIFICATION:

This methodology would consider IIIN a "fast-grower".


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (14.21) relative to the growth rate (77.55%), based on the average of the 3 and 4 year historical eps growth rates, for a company. This is a quick way of determining the fairness of the price. In this particular case, the P/E/G ratio for IIIN (0.18) is very favorable.


SALES AND P/E RATIO: NEUTRAL

For companies with sales greater than $1 billion, this methodology likes to see that the P/E ratio remain below 40. Large companies can have a difficult time maintaining a growth rate high enough to support a P/E above this threshold. IIIN, whose sales are $418.6 million, is not considered large enough to apply the P/E ratio analysis. However, an investor can analyze the P/E ratio relative to the EPS growth rate.


INVENTORY TO SALES: PASS

When inventories increase faster than sales, it is a red flag. However an increase of up to 5% is considered bearable if all other ratios appear attractive. Inventory to sales for IIIN was 14.75% last year, while for this year it is 17.01%. Since inventory has been rising, this methodology would not look favorably at the stock but would not completely eliminate it from consideration as the inventory increase (2.26%) is below 5%.


EPS GROWTH RATE: FAIL

This methodology favors companies that have several years of fast earnings growth, as these companies have a proven formula for growth that in many cases can continue many more years. This methodology likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for IIIN is 77.5%, based on the average of the 3 and 4 year historical eps growth rates, which is considered too fast.


TOTAL DEBT/EQUITY RATIO: PASS

This methodology would consider the Debt/Equity ratio for IIIN (0.00%) to be wonderfully low (equity is at least ten times debt). This ratio is one quick way to determine the financial strength of the company.


FREE CASH FLOW: NEUTRAL

The Free Cash Flow/Price ratio, though not a requirement, is considered a bonus if it is above 35%. A positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology prefers not to invest in companies that rely heavily on capital spending. This ratio for IIIN (3.93%) is too low to add to the attractiveness of the stock. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.


NET CASH POSITION: NEUTRAL

Another bonus for a company is having a Net Cash/Price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for IIIN (11.17%) is too low to add to the attractiveness of this company. Keep in mind, however, that it does not adversely affect the company as it is a bonus criteria.

AMTRUST FINANCIAL SERVICES INC

Strategy: Patient Investor
Based on: Warren Buffett

Amtrust Financial Services, Inc. (AmTrust) is an insurance holding company. The Company, through its subsidiaries, provides specialty property and casualty insurance focusing on workers' compensation and commercial package coverage for small business, specialty risk and extended warranty coverage, and property and casualty coverage for middle market business. Its segments include Small Commercial Business, Specialty Risk and Extended Warranty, and Specialty Program. The Small Commercial Business segment is engaged in providing workers' compensation, commercial package and other commercial insurance lines produced by wholesale agents, retail agents and brokers in the United States. The Specialty Risk and Extended Warranty segment is engaged in providing coverage for consumer and commercial goods and custom designed coverages. The Specialty Program segment is engaged in writing commercial insurance for defined classes of insureds through general and other wholesale agents.

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

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


LOOK FOR EARNINGS PREDICTABILITY: PASS

Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 0.39, 0.68, 0.62, 0.78, 0.97, 1.14, 1.17, 1.78, 2.72, 2.80. Buffett would consider AFSI's earnings predictable, although earnings have declined 1 time(s) in the past seven years, with the most recent decline 8 years ago. The dips have totaled 8.8%. AFSI's long term historical EPS growth rate is 22.8%, based on the 10 year average EPS growth rate, and it is expected to grow earnings 12.0% per year in the future, based on the analysts' consensus estimated long term growth rate. For the purposes of our analysis, we will use the more conservative of the two EPS growth numbers.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: PASS

Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for AFSI, over the last ten years, is 18.3%, which is high enough to pass. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 15.2%, 22.8%, 20.9%, 17.9%, 17.8%, 17.0%, 15.1%, 18.5%, 20.8%, 16.9%, and the average ROE over the last 3 years is 18.7%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON ASSETS: PASS

Buffett also requires, for financial companies, that the average Return On Assets (ROA) be at least 1% and consistent. Return On Assets is defined as the net earnings of the business divided by the total assets of the business. The average ROA for AFSI, over the last ten years, is 3.0%, which is high enough to pass. It is not enough that the average be at least 1%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROA must be at least 1% for Buffett to feel comfortable that the ROA is consistent. The ROA for the last 10 years, from earliest to latest, is 4.2%, 3.8%, 2.6%, 3.0%, 3.1%, 2.6%, 2.3%, 2.4%, 3.1%, 2.9%, thus passing this criterion.


LOOK AT CAPITAL EXPENDITURES: PASS

Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. AFSI's free cash flow per share of $4.20 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.


LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: PASS

Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $11.11 and compares it to the gain in EPS over the same period of $2.41. AFSI's management has proven it can earn shareholders a 21.7% return on the earnings they kept. This return is more than acceptable to Buffett. Essentially, management is doing a great job putting the retained earnings to work.


HAS THE COMPANY BEEN BUYING BACK SHARES: BONUS PASS

Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. AFSI's shares outstanding have fallen in the current year from 175,919,998 to 173,000,000, thus passing this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

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

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


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

Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $2.80 and divide it by the current market price of $26.41. An investor, purchasing AFSI, could expect to receive a 10.60% initial rate of return. Furthermore, he or she could expect the rate to increase 12.0% per year, based on the analysts' consensus estimated long term growth rate, as this is how fast earnings are growing.


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

Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.25%. Compare this with AFSI's initial yield of 10.60%, which will expand at an annual rate of 12.0%, based on the analysts' consensus estimated long term growth rate. The company is the better choice, as the initial rate of return is close to or above the long term bond yield and is expanding.


CALCULATE THE FUTURE EPS: [No Pass/Fail]

AFSI currently has a book value of $15.09. It is safe to say that if AFSI can preserve its average rate of return on equity of 18.3% and continues to retain 83.82% of its earnings, it will be able to sustain an earnings growth rate of 15.3% and it will have a book value of $62.83 in ten years. If it can still earn 18.3% on equity in ten years, then expected EPS will be $11.49.


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

Now take the expected future EPS of $11.49 and multiply them by the lower of the 5 year average P/E ratio (10.2) or current P/E ratio (current P/E in this case), which is 9.4 and you get AFSI's projected future stock price of $108.24.


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

Now add in the total expected dividend pool to be paid over the next ten years, which is $8.90. This gives you a total dollar amount of $117.15. These numbers indicate that one could expect to make a 16.1% average annual return on AFSI's stock at the present time. Buffett would consider this a great return.


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

If you take the EPS growth of 12.0%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $8.70. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (10.2) or current P/E ratio (current P/E in this case), which is 9.4. This equals the future stock price of $81.92. Add in the total expected dividend pool of $8.90 to get a total dollar amount of $90.82.


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

Now you can figure out your expected return based on a current price of $26.41 and the future expected stock price, including the dividend pool, of $90.82. If you were to invest in AFSI at this time, you could expect a 13.15% average annual return on your money. Buffett likes to see a 15% return, but nonetheless would accept this return.


LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: PASS

Based on the two different methods, you could expect an annual compounding rate of return somewhere between 13.1% and 16.1%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 14.6% on AFSI stock for the next ten years, based on the current fundamentals. Buffett likes to see a 15% return, but nonetheless would accept this return, thus passing the criterion.

TRACTOR SUPPLY COMPANY

Strategy: Patient Investor
Based on: Warren Buffett

Tractor Supply Company is an operator of rural lifestyle retail stores in the United States. The Company operates in the retail sale of products that support the rural lifestyle segment. The Company focuses on supplying the lifestyle needs of recreational farmers and ranchers, as well as tradesmen and small businesses. It operates over 1,490 retail stores in over 50 states under the names Tractor Supply Company, Del's Feed & Farm Supply and HomeTown Pet. It also operates a Website under the name TractorSupply.com. The Company's stores offer merchandise, which includes equine, livestock, pet and small animal products; hardware, truck, towing and tool products; seasonal products, including heating, lawn and garden items, power equipment, gifts and toys; work/recreational clothing and footwear, and maintenance products for agricultural and rural use. The Company's products are offered under various brands, which include 4health, Blue Mountain and Countyline.

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

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


LOOK FOR EARNINGS PREDICTABILITY: PASS

Buffett likes companies to have solid, stable earnings that are continually expanding. This allows him to accurately predict future earnings. Annual earnings per share from earliest to most recent were 0.58, 0.62, 0.72, 0.82, 1.12, 1.51, 1.90, 2.32, 2.66, 3.00. Buffett would consider TSCO's earnings predictable. In fact EPS have increased every year. TSCO's long term historical EPS growth rate is 18.9%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 12.5% per year in the future, based on the analysts' consensus estimated long term growth rate. For the purposes of our analysis, we will use the more conservative of the two EPS growth numbers.


LOOK AT THE ABILITY TO PAY OFF DEBT PASS

Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. TSCO has a debt of 310.0 million and earnings of 423.4 million, which could be used to pay off the debt in less than two years, which is considered exceptional.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON EQUITY: PASS

Buffett likes companies with above average return on equity of at least 15% or better, as this is an indicator that the company has a durable competitive advantage. US corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for TSCO, over the last ten years, is 21.2%, which is high enough to pass. It is not enough that the average be at least 15%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROE must be at least 10% for Buffett to feel comfortable that the ROE is consistent. In addition, the average ROE over the last 3 years must also exceed 15%. The ROE for the last 10 years, from earliest to latest, is 15.5%, 16.4%, 17.1%, 15.1%, 17.6%, 21.3%, 25.8%, 25.9%, 28.0%, 28.9%, and the average ROE over the last 3 years is 27.6%, thus passing this criterion.


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

Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for TSCO, over the last ten years, is 20.7% and the average ROTC over the past 3 years is 26.6%, which is high enough to pass. It is not enough that the average be at least 12%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROTC must be at least 9% for Buffett to feel comfortable that the ROTC is consistent. The ROTC for the last 10 years, from earliest to latest, is 15.5%, 14.9%, 17.0%, 15.1%, 17.5%, 21.3%, 25.7%, 25.9%, 27.9%, 25.8%, thus passing this criterion.


LOOK AT CAPITAL EXPENDITURES: PASS

Buffett likes companies that do not have major capital expenditures. That is, he looks for companies that do not need to spend a ton of money on major upgrades of plant and equipment or on research and development to stay competitive. TSCO's free cash flow per share of $0.66 is positive, indicating that the company is generating more cash that it is consuming. This is a favorable sign, and so the company passes this criterion.


LOOK AT MANAGEMENT'S USE OF RETAINED EARNINGS: PASS

Buffett likes to see if management has spent retained earnings in a way that benefits shareholders. To figure this out, Buffett takes the total amount of retained earnings over the previous ten years of $12.71 and compares it to the gain in EPS over the same period of $2.42. TSCO's management has proven it can earn shareholders a 19.0% return on the earnings they kept. This return is more than acceptable to Buffett. Essentially, management is doing a great job putting the retained earnings to work.


HAS THE COMPANY BEEN BUYING BACK SHARES: BONUS PASS

Buffett likes to see falling shares outstanding, which indicates that the company has been repurchasing shares. This indicates that management has been using excess capital to increase shareholder value. TSCO's shares outstanding have fallen over the past five years from 142,529,999 to 134,000,000, thus passing this criterion. This is a bonus criterion and will not adversely affect the ability of a stock to pass the strategy as a whole if it is failed.

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

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


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

Buffett compares his type of stocks to bonds, and likes to see what a company's initial rate of return is. To calculate the initial rate of return, take the trailing 12-month EPS of $3.16 and divide it by the current market price of $64.99. An investor, purchasing TSCO, could expect to receive a 4.86% initial rate of return. Furthermore, he or she could expect the rate to increase 12.5% per year, based on the analysts' consensus estimated long term growth rate, as this is how fast earnings are growing.


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

Buffett favors companies in which the initial rate of return is around the long-term treasury yield. Nonetheless, he has invested in companies with low initial rates of return, as long as the yield is expected to expand rapidly. Currently, the long-term treasury yield is about 2.25%. Compare this with TSCO's initial yield of 4.86%, which will expand at an annual rate of 12.5%, based on the analysts' consensus estimated long term growth rate. The company is the better choice, as the initial rate of return is close to or above the long term bond yield and is expanding.


CALCULATE THE FUTURE EPS: [No Pass/Fail]

TSCO currently has a book value of $10.96. It is safe to say that if TSCO can preserve its average rate of return on equity of 21.2% and continues to retain 81.79% of its earnings, it will be able to sustain an earnings growth rate of 17.3% and it will have a book value of $54.09 in ten years. If it can still earn 21.2% on equity in ten years, then expected EPS will be $11.45.


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

Now take the expected future EPS of $11.45 and multiply them by the lower of the 5 year average P/E ratio (27.9) or current P/E ratio (current P/E in this case), which is 20.6 and you get TSCO's projected future stock price of $235.82.


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

Now add in the total expected dividend pool to be paid over the next ten years, which is $11.61. This gives you a total dollar amount of $247.43. These numbers indicate that one could expect to make a 14.3% average annual return on TSCO's stock at the present time. Although, the return is slightly below the liking of Buffett, the return would still be somewhat acceptable.


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

If you take the EPS growth of 12.5%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $10.23. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (27.9) or current P/E ratio (current P/E in this case), which is 20.6. This equals the future stock price of $210.64. Add in the total expected dividend pool of $11.61 to get a total dollar amount of $222.25.


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

Now you can figure out your expected return based on a current price of $64.99 and the future expected stock price, including the dividend pool, of $222.25. If you were to invest in TSCO at this time, you could expect a 13.08% average annual return on your money. Buffett likes to see a 15% return, but nonetheless would accept this return.


LOOK AT THE RANGE OF EXPECTED RATE OF RETURN: PASS

Based on the two different methods, you could expect an annual compounding rate of return somewhere between 13.1% and 14.3%. To pinpoint the average return a little better, we have taken an average of the two different methods. Investors could expect an average return of 13.7% on TSCO stock for the next ten years, based on the current fundamentals. Buffett likes to see a 15% return, but nonetheless would accept this return, thus passing the criterion.

DREW INDUSTRIES, INC.

Strategy: Growth Investor
Based on: Martin Zweig

Drew Industries Incorporated, through its subsidiaries, supplies an array of components in the United States and abroad for the manufacturers of recreational vehicles (RVs) and manufactured homes. The Company also supplies components for adjacent industries, including buses; trailers used to haul boats, livestock, equipment and other cargo; pontoon boats; modular housing, and mobile office units. It operates in two segments, which include the recreational vehicle products segment (the RV Segment), and the manufactured housing products segment (the MH Segment). RVs are motorized (motorhomes) or towable, such as travel trailers, fifth-wheel travel trailers, folding camping trailers and truck campers. It manufactures and distributes a range of products used primarily in the production of RVs and manufactured homes, such as electronic components, windows, slide-out mechanisms and solutions, furniture and mattresses, chassis components, and thermoformed bath, kitchen and other products.


P/E RATIO: PASS

The P/E of a company must be greater than 5 to eliminate weak companies, but not more than 3 times the current Market P/E because the situation is much too risky, and never greater than 43. DW's P/E is 21.40, based on trailing 12 month earnings, while the current market PE is 14.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: PASS

Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. DW's revenue growth is 18.38%, while it's earnings growth rate is 21.31%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, DW passes this criterion.


SALES GROWTH RATE: PASS

Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (21.7%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (17%) of the current year. Sales growth for the prior must be greater than the latter. For DW this criterion has been met.


The earnings numbers of a company should be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria.


CURRENT QUARTER EARNINGS: PASS

The first of these criteria is that the current EPS be positive. DW's EPS ($1.51) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. DW's EPS for this quarter last year ($0.85) pass this test.


POSITIVE EARNINGS GROWTH RATE FOR CURRENT QUARTER: PASS

The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. DW's growth rate of 77.65% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: FAIL

Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for DW is 10.66%. This should be less than the growth rates for the 3 previous quarters which are 9.38%, 32.65% and 76.83%. DW does not pass this test, which means that it does not have good, reasonably steady earnings.


This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: PASS

If the growth rate of the prior three quarter's earnings, 43.59%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 77.65%, (versus the same quarter one year ago) then the stock passes.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN THE HISTORICAL GROWTH RATE: PASS

The EPS growth rate for the current quarter, 77.65% must be greater than or equal to the historical growth which is 21.31%. DW would therefore pass this test.


EARNINGS PERSISTENCE: PASS

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. DW, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 1.34, 1.64, 2.11, 2.56 and 3.02, passes this test.


LONG-TERM EPS GROWTH: PASS

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. DW's long-term growth rate of 21.31%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: PASS

A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. DW's Debt/Equity (9.93%) is not considered high relative to its industry (10.70%) and passes this test.


INSIDER TRANSACTIONS: PASS

A factor that adds to a stock's attractiveness is if insider buy transactions number 3 or more, while insider sell transactions are zero. Zweig calls this an insider buy signal. For DW, this criterion has not been met (insider sell transactions are 303, while insiders buying number 920). Despite the lack of an insider buy signal, there also is not an insider sell signal, so the stock passes this criterion.

JONES LANG LASALLE INC

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Jones Lang LaSalle Incorporated (JLL) is a financial and professional services firm specializing in real estate. The Company operates through four business segments: Americas; Europe, Middle East and Africa (EMEA); Asia Pacific, and LaSalle. JLL provides real estate services (RES) through three business segments: the Americas, EMEA and Asia Pacific. Its range of real estate services include agency leasing, capital markets, corporate finance, energy and sustainability services, facility management outsourcing (occupiers), investment management, lease administration, logistics and supply-chain management, mortgage origination and servicing, project and development management/construction, property management (investors), real estate investment banking/merchant banking, research, strategic consulting and advisory services, tenant representation, transaction management, valuations and value recovery and receivership services.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratios below 0.75 are tremendous values and should be sought. JLL's P/S of 0.73 based on trailing 12 month sales, is below 0.75 which is considered quite attractive. It passes this methodology's P/S ratio test with flying colors.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. JLL's Debt/Equity of 39.90% is acceptable, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. JLL is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in JLL At this Point

Is JLL a "Super Stock"? YES


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical(non-Smokestack) companies with Price/Sales ratios below .75 are tremendous values and should be sought.JLL's P/S ratio of 0.73 is below .75 which is considered extremely attractive. It passes this methodology's P/S ratio test with flying colors.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. JLL's inflation adjusted EPS growth rate of 23.39% passes the test.


FREE CASH PER SHARE: PASS

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. JLL's free cash per share of 4.43 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: PASS

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. JLL, whose three year net profit margin averages 6.84%, passes this evaluation.

JOHN B. SANFILIPPO & SON, INC.

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

John B. Sanfilippo & Son, Inc. is a processor and distributor of peanuts, pecans, cashews, walnuts, almonds and other nuts. The Company offers nuts under a range of private brands and under the Fisher, Orchard Valley Harvest, Fisher Nut Exactly and Sunshine Country brand names. The Company also markets and distributes a diverse product line of food and snack products, including snack mixes, salad toppings, snacks, snack bites, trail mixes, dried fruit, and chocolate and yogurt coated products under private brands and brand names. The Company's principal products are raw and processed nuts. The Company's nut product line includes black walnuts, English walnuts, macadamia nuts, pistachios, pine nuts, Brazil nuts and filberts. The Company's products are sold through various distribution channels to buyers of nuts, including food retailers, commercial ingredient users, contract packaging customers and international customers.


MARKET CAP: PASS

The first requirement of the Cornerstone Growth Strategy is that the company has a market capitalization of at least $150 million. This will screen out the companies that are too illiquid for most investors, but still include a small growth company. JBSS, with a market cap of $565 million, passes this criterion.


EARNINGS PER SHARE PERSISTENCE: PASS

The Cornerstone Growth methodology looks for companies that show persistent earnings growth without regard to magnitude. To fulfill this requirement, a company's earnings must increase each year for a five year period. JBSS, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 1.58, 1.98, 2.36, 2.60 and 2.68, passes this test.


PRICE/SALES RATIO: PASS

The Price/Sales ratio should be below 1.5. This value criterion, coupled with the growth criterion, identify growth stocks that are still cheap to buy. JBSS's Price/Sales ratio of 0.59, based on trailing 12 month sales, passes this criterion.


RELATIVE STRENGTH: PASS

The final criterion for the Cornerstone Growth Strategy requires that the Relative Strength of the company be among the top 50 of the stocks screened using the previous criterion. This gives you the opportunity to buy the growth stocks you are searching for just as the market is embracing them. JBSS, whose relative strength is 61, is in the top 50 and would pass this last criterion.

WABASH NATIONAL CORPORATION

Strategy: Growth Investor
Based on: Martin Zweig

Wabash National Corporation is engaged in designing, manufacturing and marketing standard and customized truck and tank trailers, intermodal equipment and transportation related products. The Company's segments include Commercial Trailer Products, Diversified Products, Retail, and Corporate and Eliminations. The Commercial Trailer Products segment manufactures standard and customized van and platform trailers. The Commercial Trailer Products segment produces and sells new trailers to the Retail segment and to customers who purchase trailers directly from the Company or through independent dealers. The Diversified Products segment focuses to expand its customer base, and diversify its product offerings and revenues. The Retail segment includes the sale of new and used trailers, as well as the sale of after-market parts and service, through its retail branch network. It offers products under the brand names, including Walker Transport, Brenner Tank, DuraPlate and Beall Trailers.


P/E RATIO: PASS

The P/E of a company must be greater than 5 to eliminate weak companies, but not more than 3 times the current Market P/E because the situation is much too risky, and never greater than 43. WNC's P/E is 7.07, based on trailing 12 month earnings, while the current market PE is 14.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

Revenue Growth must not be substantially less than earnings growth. For earnings to continue to grow over time they must be supported by a comparable or better sales growth rate and not just by cost cutting or other non-sales measures. WNC's revenue growth is 12.86%, while it's earnings growth rate is 30.48%, based on the average of the 3 and 4 year historical eps growth rates. Therefore, WNC fails this criterion.


SALES GROWTH RATE: FAIL

Another important issue regarding sales growth is that the rate of quarterly sales growth is rising. To evaluate this, the change from this quarter last year to the present quarter (-8.4%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (2.3%) of the current year. Sales growth for the prior must be greater than the latter. For WNC this criterion has not been met and fails this test.


The earnings numbers of a company should be examined from various different angles. Three of these angles are stability in the trend of earnings, earnings persistence, and earnings acceleration. To evaluate stability, the stock has to pass the following four criteria.


CURRENT QUARTER EARNINGS: PASS

The first of these criteria is that the current EPS be positive. WNC's EPS ($0.53) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. WNC's EPS for this quarter last year ($0.40) pass this test.


POSITIVE EARNINGS GROWTH RATE FOR CURRENT QUARTER: PASS

The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. WNC's growth rate of 32.50% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: PASS

Compare the earnings growth rate of the previous three quarters with long-term EPS growth rate. Earnings growth in the previous 3 quarters should be at least half of the long-term EPS growth rate. Half of the long-term EPS growth rate for WNC is 15.24%. This should be less than the growth rates for the 3 previous quarters, which are 88.00%, 85.19%, and 180.00%. WNC passes this test, which means that it has good, reasonably steady earnings.


This strategy looks at the rate which earnings grow and evaluates this rate of growth from different angles. The 4 tests immediately following are detailed below.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN PRIOR 3 QUARTERS: PASS

If the growth rate of the prior three quarter's earnings, 107.46%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 32.50%, (versus the same quarter one year ago) then the stock fails, with one exception: if the growth rate in earnings between the current quarter and the same quarter one year ago is greater than 30%, then the stock would pass. The growth rate over this period for WNC is 32.5%, and it would therefore pass this test.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN THE HISTORICAL GROWTH RATE: PASS

The EPS growth rate for the current quarter, 32.50% must be greater than or equal to the historical growth which is 30.48%. WNC would therefore pass this test.


EARNINGS PERSISTENCE: FAIL

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. WNC, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.22, 1.53, 0.67, 0.85, and 1.50, fails this test.


LONG-TERM EPS GROWTH: PASS

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. WNC's long-term growth rate of 30.48%, based on the average of the 3 and 4 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: PASS

A final criterion is that a company must not have a high level of debt. A high level of total debt, due to high interest expenses, can have a very negative effect on earnings if business moderately turns down. If a company does have a high level, an investor may want to avoid this stock altogether. WNC's Debt/Equity (58.59%) is not considered high relative to its industry (163.72%) and passes this test.


INSIDER TRANSACTIONS: PASS

A factor that adds to a stock's attractiveness is if insider buy transactions number 3 or more, while insider sell transactions are zero. Zweig calls this an insider buy signal. For WNC, this criterion has not been met (insider sell transactions are 95, while insiders buying number 65). Despite the fact that insider sells out number insider buys for this company, Zweig considers even one insider buy transaction enough to prevent an insider sell signal, therefore there is not an insider sell signal and the stock passes this criterion.


Watch List

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

Ticker Company Name Current
Score
SAFM SANDERSON FARMS, INC. 46%
FIZZ NATIONAL BEVERAGE CORP. 43%
PII POLARIS INDUSTRIES INC. 40%
AGX ARGAN, INC. 40%
LTXB LEGACYTEXAS FINANCIAL GROUP INC 38%
WDR WADDELL & REED FINANCIAL, INC. 37%
UTHR UNITED THERAPEUTICS CORPORATION 37%
GIII G-III APPAREL GROUP, LTD. 36%
SWHC SMITH & WESSON HOLDING CORP 36%
SIMO SILICON MOTION TECHNOLOGY CORP. (ADR) 36%



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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.