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Executive Summary November 26, 2010

The Economy

After another fortnight of solid economic data, the U.S. economy is showing signs of improvement that even the bears shouldn't be able to ignore.

For starters, new claims for unemployment fell almost 8% in the week ending Nov. 20, hitting the lowest level since mid-July of 2008. Continuing claims also fell by more than 3% in the most recent week data is available for them (ending Nov. 13), hitting their lowest level since November of 2008, according to the Labor Department.

As a reminder of how far we've come, new claims are 15% lower than they were a year ago; continuing claims are 24% lower.

With fewer Americans out of work, spending is on the rise. Retail sales rose 1.2% in October, according to the Census Bureau, reaching their highest level since August 2008. It was the fourth straight monthly increase.

The latest revisions to the third-quarter GDP report also showed a U.S. consumer who is more willing to spend than many had thought. Real consumer spending jumped by 2.8%, the fastest pace in almost four years. Overall, GDP growth was revised upward for the quarter, to a respectable 2.5%.

The latest industrial production report also showed positive signs. While overall production was level in October, according to the Federal Reserve, the decline was largely due to unseasonably warm weather, which reduced demand for heating and impacted output in the utility sector. Manufacturing production actually rose by 0.5%, while business equipment output rose 1.1%.

There are still plenty of issues that remain. The housing market's status and future are very uncertain. Existing-home sales fell 2.2% in October, and a couple issues -- including foreclosure stoppage in certain states and inflated year-ago comparisons that involve periods in which buyers were rushing to meet tax credit deadlines -- continue to make is hard to tell exactly what to make of the housing market.

The U.S.'s huge deficit spending and debt burden also continue to be a source of concern. But for now, while the Fed's latest quantitative easing program has upped inflation fears, the dollar has actually been showing some signs of strength, gaining against the Euro, Yen, Canadian dollar, and Pound in the past couple weeks.

Corporate America, meanwhile, continues to make big strides. In October, 196 companies increased profit expectations above analysts' estimates vs. 130 that decreased expectations. That's the widest gap since Bloomberg started tracking the figures in 1999.

Overall, the generally positive economic news in the U.S. was countered by fear of the Irish debt crisis, and concerns that China is going to take steps to curb its dramatic growth so its economy doesn't overheat. Overall for the fortnight, the S&P 500 returned -1.7%, while the Hot List returned -2.2%. For the year, the portfolio is up 9.7% vs. 7.5% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 164.5% vs. the S&P's 19.8% gain.

Looking Past the Fear

Back in late summer, most "experts" were saying that the economic recovery was in serious jeopardy, and that the market was headed for trouble. We'd had our stimulus sugar high, they said; now it was fading fast.

Since then, retail sales have increased in each of the past three months, rising a total of nearly 3% and reaching post-financial-crisis levels. The manufacturing sector has also continued its expansion, stretching its streak to 15 straight months of growth. The service sector has kept expanding, pushing its streak to 10 straight months. New claims for unemployment have fallen by 19.2% since mid-August, and continuing claims are down more than 11% since early July. And, the market has bounced back, with the S&P 500 up more than 10% since Sept. 1, and the Nasdaq Composite posting gains in the 15% range.

But despite significant improvement from the economy -- including improvement in two areas expected to be its downfall (unemployment and consumer spending) -- the overall mood about the economy and stock market is one of pessimism.

All you need to do is read the papers to see how much fear is out there. Just last week, an article from Reuters said that "what's clear is that whatever love affair many Americans may have had with stocks is over, at least for the moment". It featured interviews with several individual investors who said they'd had enough of the stock market, after dealing with two crashes in the past decade.

And the numbers continue to bear out the notion that individual investors are sour on stocks -- particularly U.S. stocks. According to the Investment Company Institute, since the end of September, investors have pulled close to $14 billion out of U.S. equity mutual funds. They've been much less pessimistic on non-U.S. equities, putting more than $11 billion into foreign equity mutual funds in the same period. But that's still a net negative flow into equity funds -- in a period in which investors were pumping more than $28 billion into bond mutual funds, according to ICI.

I think they're making a mistake. With so many expecting so little from the economy -- even as we continue to see significant signs of continued recovery -- valuations are quite attractive. Stocks are trading for about 12 times 2011 projected earnings, according to recent Thomson Reuters data, and many individual companies' shares are even more attractive. Of the 10 stocks in the Hot List, only two have trailing 12-month price/earnings ratio greater than 11 -- despite the fact that they've been producing exceptional growth, and the fact that only two have debt that is more than 23% of their equity.

In a climate in which pessimism continues to reign, good stock-pickers should be particularly rewarded. Signs of strong growth will likely be prized even more than usual, with companies that show an ability to grow sales and profits likely to capture the attention of investors.

The Hot List picked up a quintet of such stocks in today's rebalancing. Several have managed to post very strong growth in a very tough environment over the past couple years. Millicom Cellular, which provides phone service to underserved parts of the world, grew sales by almost 30% and earnings per share by about 17% in 2008, when many firms were struggling to survive. It then went on to increase both sales and EPS in 2009, and it's on pace to do so again this year.

Another newcomer, Aeropostale, grew EPS by 28% and sales by 19% in 2008, a terrible year for most retailers. Then last year, it upped EPS by more than 50% while growing sales by close to 20%. This year it's been more of the same.

lululemon athletica, which sells specialized athletic apparel, largely for yoga, dance, and running, has also excelled. The firm increased sales by more than 30% in 2008 and close to 30% in 2009, while upping EPS from $0.46 to $0.82 over that two-year period. This year, sales and EPS have continued to skyrocket.

Fidelity fund manager Anthony Bolton, whose exceptional long-term track record as a fund manager makes him something of a British Peter Lynch, recently said that he thinks the bull market has entered a second phase. In the first phase, "junk"-type stocks that were hit hardest during the financial crisis fared best. Now, Bolton says, we're in a phase in which investors, clamoring for growth, will focus on companies that can deliver it. The theory makes sense (in fact, it's typical of post-recession rebounds), and the Hot List is focusing on just those sort of companies. The portfolio's ten holdings sport long-term growth rates as high as 150%, and no lower than 18% -- and those growth rates have been compiled over a period that included the worst recession in decades, and the supposedly "tepid" recovery that has followed

Just as importantly, these stocks are selling at attractive valuations -- in many cases, extremely attractive valuations. Despite its rapid growth, for example, Millicom's shares trade for only about six times trailing 12-month earnings. Aeropostale's shares trade for just 11 times trailing 12-month earnings, despite the fact the firm has proven it can produce excellent growth in even the darkest of times.

Keying on stocks like these have helped the Hot List stay ahead of the broader market this year, building on its exceptional long-term track record even while many investors continue to wait on the sidelines. They won't stay there forever, especially with bonds so pricey and yields so low. And as more and more return to stocks, the portfolio should benefit even more.
Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 5 stocks leave our portfolio. These include: Eli Lilly & Co. (LLY), Western Digital Corp. (WDC), World Acceptance Corp. (WRLD), China Automotive Systems, Inc. (CAAS) and Healthspring, Inc (HS).

The Keepers

5 stocks remain in the portfolio. They are: Sanofi-aventis Sa (Adr) (SNY), Gamestop Corp. (GME), Dollar Tree, Inc. (DLTR), China Mediaexpress Holdings Inc (CCME) and L&l Energy, Inc. (LLEN).

The Newbies

We are adding 5 stocks to the portfolio. These include: Telefonica S.a. (Adr) (TEF), Millicom International Cellular Sa (Usa) (MICC), Raytheon Company (RTN), Aeropostale, Inc. (ARO) and Lululemon Athletica Inc. (LULU).

Portfolio Changes

Newcomers to the Validea Hot List

Aeropostale, Inc. (ARO): Headquartered in New York, this mall-based clothing retailer targets youngsters age 14 to age 17 through more than 900 stores in 49 states, Puerto Rico, and Canada. Its new P.S. from Aeropostale stores are aimed at 7- to 12-year-olds.

Aeropostale, which gained more than 36% while in the Hot List from Nov. 27, 2009 to July 9 of this year, has a market cap of about $2.5 billion. It gets approval from my Peter Lynch-, Warren Buffett-, James O'Shaughnessy-, and Joel Greenblatt-based models. To read more about the stock, see the "Detailed Stock Analysis" section below.

Telefonica S.A.(TEF): This Spain-based telecom giant ($105 billion market cap) has major operations in both Europe and Latin America. Over the past year, it has taken in almost $80 billion in sales. Telefonica gets approval from my James O'Shaughnessy-based growth model. To read more about it, check out the "Detailed Stock Analysis" section below.

Raytheon Company (RTN): This Massachusetts-based aerospace & defense firm provides state-of-the-art electronics, products, and services in a variety of areas, including integrated defense systems, missile systems, space and airborne systems, and intelligence and information systems. It also provides a variety of mission support services. It has a market cap of about $17 billion, and has taken in almost $25 billion in sales in the past year.

Raytheon gets approval from my Joel Greenblatt-, Peter Lynch- and Kenneth Fisher-based models. The "Detailed Stock Analysis" section below has more on the firm.

lululemon athletica inc. (LULU): This Vancouver-based firm makes clothing for a variety of athletics, focusing largely on technical athletic apparel for yoga, running, and dancing. It has more than 100 stores across Canada, the U.S., Australia, and Hong Kong.

lululemon, which has a market cap of about $3.8 billion, gets strong interest from the model I base on the writings of Tom and David Gardner, the creators of The Motley Fool investment web site. The "Detailed Stock Analysis" section below has more on the stock.

Millicom International Cellular SA (MICC): Based in Luxembourg, Millicom provides prepaid cellular telephone services to more than 30 million customers in 13 emerging markets in Latin America and Africa. It provides that service in areas where the basic telephone service is often inadequate to handle increasing demand that has resulted from economic development and rising personal income levels.

Millicom gets strong interest from my Joel Greenblatt-inspired strategy. To read more about it, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

China MediaExpress Holdings (CCME): China MediaExpress, which operates a television advertising network on Chinese buses, announced on Nov. 23 that it has signed two new long-term agreements that will add a total of 2,067 inter-city buses to its network. One deal gives the firm exclusive rights to provide advertising and entertainment programming on 635 inter-city express buses originating from the province of Henan. The deal starts on Dec. 1, and runs for five years. The other gives it the exclusive rights to provide programming and advertising on l1,432 inter-city express buses originating from the province of Hunan. It starts Jan. 1and runs five years.

Aeropostale Inc. (ARO): Aeropostale announced on Nov. 15 that its Board of Directors has authorized a $300 million increase to its share repurchase program. The company now has about $364 million of repurchase authorization remaining under its repurchase program (as of November 12).

The Next Issue

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

Current Portfolio

Detailed Stock Analysis

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

ARO   |   MICC   |   TEF   |   RTN   |   LULU   |   CCME   |   LLEN   |   SNY   |   GME   |   DLTR   |  

Aeropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. The Company designs, markets and sells its own brand of merchandise principally targeting 14 to 17 year-old young women and young men. The Company also sells Aropostale merchandise through its e-commerce Website, www.aeropostale.com. During the fiscal year ended January 30, 2010 (fiscal 2009), the Company launched P.S. from Aeropostale, which offers casual clothing and accessories focused on elementary school children between the ages of 7 and 12. During fiscal 2009, the Company completed the closure of its 14 store Jimmy'Z concept. Jimmy'Z Surf Co., Inc., a wholly owned subsidiary of Aeropostale, Inc., was a contemporary lifestyle brand targeting young women and men aged 18 to 25.

Millicom International Cellular S.A. (Millicom) is a global mobile telecommunications operator. The Company also operates fixed telephony, cable and broadband businesses in five countries in Central America. As of December 31, 2009, the Company had 14 mobile operations in 14 countries focusing on emerging markets in Central America, South America, Africa and Asia. Millicom operates its mobile businesses in El Salvador, Guatemala and Honduras in Central America; in Bolivia, Colombia and Paraguay in South America; in Chad, the Democratic Republic of Congo, Ghana, Mauritius, Rwanda, Senegal and Tanzania in Africa; and in Laos in Asia. In November 2009, the Company announced that it has completed the sale of its Cambodian operations to The Royal Group. In October 2009, the Company announced the sale of Tigo (Private) Limited, its Sri Lanka operation, to Etisalat.

Telefonica S.A. (Telefonica) together with its subsidiaries and investees operates in the telecommunications, media and contact center industries. Telefonica basic purpose is the provision of all manner of public or private telecommunications services, including ancillary or complementary telecommunications services or related services. The Company operates in three business areas: Telefonica Spain, Telefonica Latin America and Telefonica Europe. During the year ended December 31, 2009, Telefonica Moviles Espana, S.A.U., a wholly owned subsidiary of the Company completed the sale of its 32.18% stake in Medi Telecom, S.A. In January 2010, the Telefonica Group, through its wholly owned subsidiary, Telef=nica Europe plc completed the acquisition of JAJAH.

Raytheon Company, together with its subsidiaries, develops products, services and solutions in defense markets; sensing, effects, command, control, communications and intelligence (C3I), and mission support, as well as the cybersecurity and homeland security markets. The Company serves both domestic and international customers, principally as a prime contractor on a portfolio of defense and related programs for government customers. It operates in six business segments Integrated Defense Systems (IDS), Intelligence and Information Systems (IIS), Missile Systems (MS), Network Centric Systems (NCS), Space and Airborne Systems (SAS) and Technical Services (TS). In October 2009, the Company acquired BBN Technologies Corp. and related entities. In November 2010, the Company acquired Trusted Computer Solutions, a company that delivers a portfolio of cross-domain, operating system and network security solutions.

lululemon athletica inc. is a designer and retailer of technical athletic apparel primarily in North America. Its yoga-inspired apparel is marketed under the lululemon athletica brand name. The Company offers a line of apparel and accessories, including fitness pants, shorts, tops and jackets designed for athletic pursuits, such as yoga, running and general fitness. As of January 31, 2010, its branded apparel was principally sold through 124 stores that are primarily located in Canada and the United States. As of January 31, 2010, its retail footprint included 45 stores in Canada, 70 stores in the United States and nine franchise stores in Australia.

China MediaExpress Holdings, Inc. (CME), through contractual arrangements with Fujian Fenzhong Media Co., Ltd. (Fujian Fenzhong), operates the television advertising network on inter-city express buses in China. The Company and its subsidiaries and variable interest entity (VIE) are engaged in the operation of mobile television advertising networks on passenger buses travelling on highways in the People's Republic of China. The Company does not conduct any substantive operations of its own, but conducts it primary business operations through Fujian Fenzhong, a VIE of a wholly owned subsidiary, Fujian Across Express Information Technology Co, Ltd. (Across Express). On October 15, 2009, CME acquired all of the issued and outstanding capital stock of Hong Kong Mandefu Holding Limited (the HKMDF), its subsidiary and VIE, and as a result, HKMDF became its direct wholly owned subsidiary.

L & L Energy, Inc. (L & L) is engaged in the businesses of coal mining, coal washing, coal coking and coal wholesaling. The Company's operations are conducted in Yunnan and Guizhou provinces in the southwest region of the People's Republic of China. As of April 30, 2010, the Company had three operating subsidiaries: KMC, which has coal wholesale operations and Ping Yi Coal Mine (mining operations PYC); two coal mining operations (DaPuAn Mine and SuTsong Mine), including DaPuAn's coal washing operations (the 2 Mines or LLC), and L&L Yunnan Tianneng Industry Co. Ltd. (including Hong Xing coal washing and ZoneLin coking operations) (TNI).

Sanofi-Aventis is a pharmaceutical group engaged in the research, development, manufacture and marketing of healthcare products. The Company's business includes two main activities: pharmaceuticals and human vaccines through sanofi pasteur. The Company is also present in animal health products through Merial Limited (Merial). In its pharmaceutical activity, the Company specializes in six therapeutic areas: diabetes, oncology, thrombosis and cardiovascular, central nervous system (CNS), and internal medicine. The global portfolio of sanofi-aventis also consists of a range of other pharmaceutical products in Consumer Health Care (CHC) and other prescription drugs, including generics. It offers vaccines in five areas: pediatric combination vaccines, influenza vaccines, adult and adolescent booster vaccines, meningitis vaccines and travel and endemic vaccines. In October 2010, Siegfried Holding AG sold its PulmoJet Inhalation Project to the Company.

GameStop Corp. (GameStop) is a retailer of video game products and personal computer (PC) entertainment software. The Company sells new and used video game hardware, video game software and accessories, as well as PC entertainment software, and related accessories and other merchandise. As of January 30, 2010, the Company operated 6,450 stores in the United States, Australia, Canada and Europe, primarily under the names GameStop and EB Games. GameStop also operates the electronic commerce Website www.gamestop.com and publish Game Informer, a multi-platform video game magazine in the United States based on circulation, with approximately 4 million subscribers. During the fiscal year ended January 30, 2010 (fiscal 2009), GameStop operated its business in four segments: United States, Canada, Australia and Europe.

Dollar Tree, Inc. (Dollar Tree) is an operator of discount variety stores offering merchandise at the fixed price of one dollar. At January 30, 2010, the Company operated 3,806 discount variety retail stores. Approximately 3,650 of these stores sell substantially all items for one dollar or less. The remaining stores, operating as Deal$, sell items for one dollar or less but also sell items for more than one dollar. Dollar Tree's stores operate under the names of Dollar Tree, Deal$ and Dollar Bills.

Watch List

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


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