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Executive Summary	May 23, 2014

The Economy Economic data has been mixed over past fortnight, with a weak industrial sector report counterbalanced by a nice rebound in the housing market. Industrial production fell 0.6% in April, according to a new Federal Reserve report, with manufacturing production declining 0.4%. Mining output was a bright spot, rising 1.4%. Utility output fell 5.3%, the result of warming temperatures. While disappointing, it's worth noting that March's industrial production gain was revised upward from 0.7% to 0.9%, thanks to manufacturing output being revised from a 0.5% gain to a 0.7% gain. The report noted that production was particularly strong in both February and March, after "severe weather had restrained production early in the quarter." The implication may be that production fell in April as a sort of bounce-back from the strong February and March gains -- we'll see whether May's data provides any clues on that. But while industrial production slipped, housing market activity jumped. Housing starts surged 13.2% in April, according to the Census Bureau, putting them 24.4% above where they were a year ago. Permit issuance for new construction rose 8.0%, and was 4.0% above year-ago levels. Critics noted that almost all of the April increases in starts and permit issuance involved multi-family homes. To be sure, that's worth noting in the overall housing discussion, but it's hard to argue that a big jump in construction activity is anything but a positive. Homebuying activity increased slightly in April, with existing home sales rising 1.3%, according to the National Association of Realtors. Sales were about 7% below where they were last April. Inventory, which has been quite constrained, hurting the market, jumped by about 17%, however, a good sign going forward. The job market, meanwhile, continues to look better than it's looked in a long time. While new claims for unemployment have stayed roughly level since our last newsletter, they are about 6% below their year-ago mark. Continuing claims were also about flat over the past couple weeks, but are 10% below year-ago levels. Retail and food service sales also were close to flat compared to March, rising 0.1%, according to the Commerce Department. But the year-over-year gain accelerated significantly, to close to 5%, a very healthy improvement. Since our last newsletter, the S&P 500 returned 0.9%, while the Hot List returned -1.2%. So far in 2014, the portfolio has returned -13.1% vs. 2.4% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 216.1% vs. the S&P's 89.2% gain. Portfolio Update Stocks have been fairly volatile over the past two weeks, with both the S&P 500 and Nasdaq moving a bit higher overall since our last newsletter (as of mid-afternoon trading on May 22). The Hot List's holdings have had mixed performance, with four of the ten in the black and six in the red. NetEase was leading the way with a 5.5% gain, while Bed Bath and Beyond was up about 1%. Anika Therapeutics and Robert Half International were both up very slightly. On the down side, Drew Industries was the biggest laggard, losing 4.9%, while BofI Holding was down 3.7% and Valero Energy was down 3.6%. Northrop Grumman and AGCO were both down about 2%. While there were significant news events for some of these holdings during the past two weeks (an earnings announcement for NetEase, a dividend increase for Northrop -- see the News section below), the timing of the news events didn't really match up with these stocks' performances. It appears that much of the movement was thus due either to macroeconomic issues, or to simple day to day market noise as the dust settles following the momentum and technology stock downturn we saw earlier this year. Whatever the case, all of these stocks continue to get good scores from my Guru Strategies. We'll see if they'll still have what it takes to remain in the portfolio on our next rebalancing in two weeks.		Editor-in-Chief: John Reese Since Inception   Hot List 216.1% S&P 500 89.2% Accuracy 55.2% Beta 1.2 YTD   Hot List -13.1% S&P 500 2.4% Since Last Issue   Hot List -1.2% S&P 500 0.9% Avg. Fundamentals   Market Cap (mil) $9,137 PE Ratio 15.7 5 Yr EPS Growth 25.9% Yield 0.7% Rel. Strength 71 Portfolio Sectors Services 3 Capital Goods 2 Consumer Cyclical 1 Energy 1 Financial 1 Healthcare 1 Technology 1
Have Your Portfolio Managed Using Validea's Investing System Many users know about our research services but are unaware that money management services based on our system are also offered through a separate registered investment advisory firm, Validea Capital Management. If you are thinking about switching advisors or no longer have the time or inclination to manage your investments yourself, find out more about Validea Capital, its portfolio offerings, and its performance below. Request an Investment Consultation Today! ** Validea Capital Management is a separate investment advisory firm managed by Validea.com founder John Reese. The information above is not intended as personal investment advice and should not be interpreted as such. Guru Spotlight: James O'Shaughnessy To say that James O'Shaughnessy has written the book on quantitative investing strategies might be an exaggeration -- but not much of one. Over the years, O'Shaughnessy has compiled an anthology of research on the historical performance of various stock selection strategies rivaling that of just about anyone. He first published his findings back in 1996, in the first edition of his bestselling What Works on Wall Street, using Standard & Poor's Compustat database to back-test a myriad of quantitative approaches. He has continued to periodically update his findings since then, and today he also serves as a money manager and the manager of several Canadian mutual funds. In addition to finding out how certain strategies had performed in terms of returns over the long term, O'Shaughnessy's study also allowed him to find out how risky or volatile each strategy he examined was. So after looking at all sorts of different approaches, he was thus able to find the one that produced the best risk-adjusted returns -- what he called his "United Cornerstone" strategy. The United Cornerstone approach, the basis for my O'Shaughnessy-based Guru Strategy, is actually a combination of two separate models that O'Shaughnessy tested, one growth-focused and one value-focused. His growth method -- "Cornerstone Growth" -- produced better returns than his "Cornerstone Value" approach, and was a little more risky. The Cornerstone Value strategy, meanwhile, produced returns that were a bit lower, but with less volatility. Together, they formed an exceptional one-two punch, averaging a compound return of 17.1 percent from 1954 through 1996, easily beating the S&P 500s 11.5 percent compound return during that time while maintaining relatively low levels of risk. That 5.6 percent spread is enormous when compounded over 42 years: If you'd invested $10,000 using the United Cornerstone approach on the first day of the period covered by O'Shaughnessy's study, you'd have had almost $7.6 million by the end of 1996 -- more than $6.6 million more than you'd have ended up with if you'd invested $10,000 in the S&P for the same period! That seems powerful evidence that stock prices do not -- as efficient market believers suggest -- move in a "random walk," but instead, as O'Shaughnessy writes, with a "purposeful stride." Two-In-One O'Shaughnessy has revamped his strategies over the years, most recently in his new, updated version of What Works on Wall Street (which I reviewed in the Nov. 25, 2011 edition of the Hot List). I've chosen not to tinker with my O'Shaughnessy-based models, however, given the exceptional performance they've had over the long term. The models discussed here are thus based on O'Shaughnessy's 1996 version of What Works on Wall Street. So, let's start with the value stock strategy. O'Shaughnessy's Cornerstone Value approach targeted "market leaders" -- large, well-known firms with sales well above those of the average company -- because he found that these firms' stocks are considerably less volatile than the broader market. He believed that all investors-even the youngest of the bunch -- should hold some value stocks. To find these firms, O'Shaughnessy required stocks to have a market cap greater than $1 billion, a number of shares outstanding greater than the market mean, and trailing 12-month sales that were at least 1.5 times the market mean. Size and market position weren't enough to make a value stock attractive for O'Shaughnessy, however. Another key factor that was a great predictor of a stock's future, he found, was cash flow. My O'Shaughnessy-based value model calls for companies to have cash flows per share greater than the market average. O'Shaughnessy found that, when it came to market leaders, another criterion was even more important than cash flow: dividend yield. He found that high dividend yields were an excellent predictor of success for large, well-known stocks (though not for smaller stocks); large market-leaders with high dividends tended to outperform during bull markets, and didn't fall as far as other stocks during bear markets. The Cornerstone Value model takes all of the stocks that pass the four aforementioned criteria (market cap, shares outstanding, sales, and cash flow) and ranks them according to dividend yield. The 50 stocks with the highest dividend yields get final approval. The Cornerstone Growth approach, meanwhile, isn't strictly a growth approach. That's because one of the interesting things O'Shaughnessy found in his back-testing was that all of the successful strategies he studied -- even growth approaches -- included at least one value-based criterion. The value component of his Cornerstone Growth strategy was the price/sales ratio, a variable that O'Shaughnessy found -- much to the surprise of Wall Street -- was the single best indication of a stock's value, and predictor of its future. The Cornerstone Growth model allows for smaller stocks, using a market cap minimum of $150 million, and requires stocks to have price/sales ratios below 1.5. To avoid outright dogs, the strategy also looks at a company's last five years of earnings, requiring that its earnings per share have increased each year since the first year of that period. The final criterion of this approach is relative strength, the measure of how a stock has performed compared to all other stocks over the past year. A key part of why the growth stock model works so well, according to O'Shaughnessy, is the combination of high relative strengths and low P/S ratios. By targeting stocks with high relative strengths, you're looking for companies that the market is embracing. But by also making sure that a firm has a low P/S ratio, you're ensuring that you're not getting in too late on these popular stocks, after they've become too expensive. "This strategy will never buy a Netscape or Genentech or Polaroid at 165 times earnings," O'Shaughnessy wrote, referring to some of history's well-known momentum-driven, overpriced stocks. "It forces you to buy stocks just when the market realizes the companies have been overlooked." To apply the RS criterion, the Cornerstone Growth model takes all the stocks that pass the three growth criteria I mentioned (market cap, earnings persistence, P/S ratio) and ranks them by RS. The top 50 stocks then get final approval. The Growth/Value Investor model I base on O'Shaughnessy's two-pronged approach has been a strong performer since its inception back in 2003, with my 10-stock O'Shaughnessy-based portfolio gaining 174.8% (9.8% annualized) since inception, while the S&P 500 has gained just 88.7% (6.0% annualized; figures through May 21). The O'Shaughnessy-based portfolio will pick stocks using both the growth and value methods I described above. It picks whatever the best-rated stocks are at the time, regardless of growth/value distinction, meaning the portions of the portfolio made up of growth and value stocks can vary over time. After leaning strongly to the growth side, the portfolio has shifted back toward a more even balance over the past year or two. Currently six of the ten holdings are growth picks. Here's a look at the portfolio's holdings: COP -- ConocoPhillips (Value) TEO -- Telecom Argentina (Growth) EC -- Ecopetrol SA (Value) NCI -- Navigant Consulting (Growth) LUKOY -- NK Lukoil OAO (Value) DW -- Drew Industries (Growth) HY -- Hyster-Yale Materials Handling, Inc. (Growth) NOC -- Northrop Grumman Corporation (Growth) VLO -- Valero Energy Corporation (Growth) CHL -- China Mobile Limited (Value) Not Just Numbers O'Shaughnessy is a pure quant, but you should be aware that some of his most critical lessons are less about specific criteria and numbers than they are about the general mindset an investor must have. Perhaps more than anything else, O'Shaughnessy believes in picking a good strategy and sticking with it -- no matter what. In What Works on Wall Street, he writes that in order to beat the market, it is crucial that you stay disciplined: "[C]onsistently, patiently, and slavishly stick with a strategy, even when it's performing poorly relative to other methods." The reason involved human emotions, which cause many investors to bail on a good approach and jump onto hot stocks or strategies that are often overhyped and overpriced. "We are a bundle of inconsistencies," he writes, "and while that may make us interesting, it plays havoc with our ability to invest our money successfully. Disciplined implementation of active strategies is the key to performance." Wise words, whether you follow O'Shaughnessy's approach or another proven method. News about Validea Hot List Stocks NetEase (NTES): NetEase announced first quarter results that fell short of expectations, but a deeper look at the numbers showed reason for optimism. Total revenue was $380.5 million, below the consensus estimate of $392 million, Barron's reported. Earnings per share were $1.38, falling short of the consensus estimate of $1.40. But Barron's noted that the revenue miss was driven by a weaker World of Warcraft contribution in Q1 after a strong Q4. The firm reported solid results from its in-house games, however. Northrop Grumman (NOC): Grumman announced it is upping its quarterly dividend to $0.70 per share, a 15 percent increase from the prior quarter. It marked the 11th consecutive annual increase in Grumman's quarterly common stock dividend. The dividend is payable June 18, 2014, to shareholders of record as of the close of business June 2, 2014. The Next Issue In two weeks, we will publish another issue of the Hot List, at which time we will rebalance the portfolio. If you have any questions, please feel free to contact us at hotlist@validea.com.

Current Portfolio Ticker Company Name Industry Guru Score ANIK ANIKA THERAPEUTICS, INC. Biotechnology & Drugs 92 AGCO AGCO CORPORATION Constr. & Agric. Machinery 68 SWHC SMITH & WESSON HOLDING CORP Recreational Products 61 VLO VALERO ENERGY CORPORATION Oil & Gas Operations 56 BBBY BED BATH & BEYOND INC. Retail (Specialty) 50 DW DREW INDUSTRIES, INC. Mobile Homes & RVs 46 RHI ROBERT HALF INTERNATIONAL INC. Business Services 42 NOC NORTHROP GRUMMAN CORPORATION Communications Equipment 34 BOFI BOFI HOLDING, INC. Regional Banks 30 NTES NETEASE, INC (ADR) Business Services 28 Ticker Market Cap Date Added Start Price Current Price Return ANIK $671 5/9/2014 $47.62 $46.50 -2.4% AGCO $5,066 12/20/2013 $57.62 $53.94 -6.4% SWHC $837 4/11/2014 $13.91 $15.23 9.5% VLO $29,173 4/11/2014 $50.96 $54.67 7.3% BBBY $12,539 5/9/2014 $61.31 $61.46 0.2% DW $1,116 5/9/2014 $50.29 $47.22 -6.1% RHI $6,201 5/9/2014 $44.62 $45.10 1.1% NOC $25,375 5/9/2014 $121.06 $118.50 -2.1% BOFI $1,102 1/17/2014 $80.22 $77.63 -3.2% NTES $9,288 5/9/2014 $67.15 $71.44 6.4%

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 ANIK   |   AGCO   |   SWHC   |   VLO   |   BBBY   |   DW   |   RHI   |   NOC   |   BOFI   |   NTES   |   ANIKA THERAPEUTICS, INC. Profile Strategy: Small-Cap Growth Investor Based on: Motley Fool Anika Therapeutics, Inc. (Anika) develops, manufactures and commercializes therapeutic products for tissue protection, healing and repair. These products are based on hyaluronic acid (HA), a naturally occurring, biocompatible polymer found throughout the body. As of December 31, 2011, Anika's wholly owned subsidiary, Anika Therapeutics S.r.l., had over 20 products commercialized, primarily in Europe. These products are also all made from hyaluronic acid, based on two technologies: HYAFF, which is a solid form of HA, and ACP gel, an autocross-linked polymer of HA. Analysis Guru Score: 93% PROFIT MARGIN: [PASS] This methodology seeks companies with a minimum trailing 12 month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns. A true test of the quality of a company is that they can sustain this margin. ANIK's profit margin of 34.67% passes this test. RELATIVE STRENGTH: [PASS] The investor must look at the relative strength of the company in question. Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive. Companies whose price has been rising much quicker than the market tend to keep rising. ANIK, with a relative strength of 96, satisfies this test. COMPARE SALES AND EPS GROWTH TO THE SAME PERIOD LAST YEAR: [PASS] Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for ANIK (361.90% for EPS, and 123.02% for Sales) are good enough to pass. INSIDER HOLDINGS: [FAIL] ANIK's insiders should own at least 10% (they own 3.78%) of the company's outstanding shares. This does not satisfy the minimum requirement, and companies that do not pass this criteria are less attractive. CASH FLOW FROM OPERATIONS: [PASS] A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. ANIK's free cash flow of $1.67 per share passes this test. PROFIT MARGIN CONSISTENCY: [PASS] ANIK's profit margin has been consistent or even increasing over the past three years (Current year: 27.41%, Last year: 16.48%, Two years ago: 13.08%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise. R&D AS A PERCENTAGE OF SALES: [PASS] ANIK is either maintaining the same levels of R&D expenditures(currently $7.1 million) or increasing these levels which is a good sign. This allows the company to develop the superior technology and new products that will put everyone else out of business. This criterion is particularly important for high-tech and medical stocks because they are so R&D dependant. CASH AND CASH EQUIVALENTS: [PASS] ANIK's level of cash $63.3 million passes this criteria. If a company is a cash generator, like ANIK, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash. INVENTORY TO SALES: [PASS] This methodology strongly believes that companies, especially small ones, should have tight control over inventory. It's a warning sign if a company's inventory relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Inventory to Sales for ANIK was 11.60% last year, while for this year it is 14.65%. Although the inventory to sales is rising, it is below the max 30% that is allowed. The investor can still consider the stock if all other criteria appear very attractive. ACCOUNT RECEIVABLE TO SALES: [PASS] This methodology wants to make sure that a company's accounts receivable do not get significantly out of line with sales. It's a warning sign if a company's accounts receivable relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Accounts Receivable to Sales for ANIK was 30.07% last year, while for this year it is 24.96%. Since the AR to sales is decreasing by -5.11% the stock passes this criterion. LONG TERM DEBT/EQUITY RATIO: [PASS] ANIK's trailing twelve-month Debt/Equity ratio (0.00%) is at a great level according to this methodology because the superior companies that you are looking for don't need to borrow money in order to grow. "THE FOOL RATIO" (P/E TO GROWTH): [PASS] The "Fool Ratio" is an extremely important aspect of this analysis. If the company has attractive fundamentals and its Fool Ratio is 0.5 or less (ANIK's is 0.46), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. ANIK passes this test. The following criteria for ANIK are less important which means you would place less emphasis on them when making your investment decision using this strategy: AVERAGE SHARES OUTSTANDING: [PASS] ANIK has not been significantly increasing the number of shares outstanding within recent years which is a good sign. ANIK currently has 16.0 million shares outstanding. This means the company is not taking any measures, with regards to the number of shares, that will dilute or devalue the stock. SALES: [PASS] Companies with sales less than $500 million should be chosen. It is among these small-cap stocks that investors can find "an uncut gem", ones that institutions won't be able to buy yet. ANIK's sales of $93.8 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". ANIK passes the sales test. DAILY DOLLAR VOLUME: [PASS] ANIK passes the Daily Dollar Volume (DDV of $23.2 million) test. It is required that this number be less than $25 million because these are the stocks that remain relatively undiscovered by institutions. "You'll be scoring touchdowns against the big guys on your turf." PRICE: [PASS] This is a very insignificant criterion for this methodology. But basically, low prices are chosen because "small numbers multiply more rapidly than large ones" and the potential for big returns expands. ANIK with a price of $46.50 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions. INCOME TAX PERCENTAGE: [PASS] ANIK's income tax paid expressed as a percentage of pretax income this year was (36.64%) and last year (39.78%) are greater than 20% which is an acceptable level. If the tax rate is below 20% this could mean that the earnings that were reported were unrealistically inflated due to the lower level of income tax paid. This is a concern.   AGCO CORPORATION Profile Strategy: P/E/Growth Investor Based on: Peter Lynch AGCO Corporation (AGCO) is a manufacturer and distributor of agricultural equipment and related replacement parts globally. The Company sells a range of agricultural equipment, including tractors, combines, self-propelled sprayers, hay tools, forage equipment and implements. It also manufactures and distributes grain storage and handling equipment systems, as well as protein production systems. Its products are recognized in the agricultural equipment industry and are marketed under a range of brands, including Challenger, Fendt, Massey Ferguson and Valtra. The Company distributes its products through a combination of approximately 3,100 independent dealers and distributors in more than 140 countries. In September 2013, Grain Systems, Inc. (GSI), a global brand of the Company announced that it has purchased Johnson System Inc. (JSI), manufacturer of catwalks, towers and support structures based in Marshall, Michigan. Analysis Guru Score: 93% DETERMINE THE CLASSIFICATION: This methodology would consider AGCO a "fast-grower". P/E/GROWTH RATIO: [PASS] The investor should examine the P/E (9.22) relative to the growth rate (29.73%), based on the average of the 3, 4 and 5 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 AGCO (0.31) is very favorable. SALES AND P/E RATIO: [PASS] 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 high enough to support a P/E above this threshold. AGCO, whose sales are $10,717.2 million, needs to have a P/E below 40 to pass this criterion. AGCO's P/E of (9.22) is considered acceptable. 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 AGCO was 17.10% last year, while for this year it is 18.69%. 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 (1.59%) is below 5%. EPS GROWTH RATE: [PASS] 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 AGCO is 29.7%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable. TOTAL DEBT/EQUITY RATIO: [PASS] This methodology would consider the Debt/Equity ratio for AGCO (33.42%) to be normal (equity is approximately twice debt). 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 AGCO (6.82%) 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 AGCO (0.63%) 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.   SMITH & WESSON HOLDING CORP Profile Strategy: P/E/Growth Investor Based on: Peter Lynch Smith & Wesson Holding Corporation (Smith & Wesson) is a manufacturer of firearms. The Company manufactures a range of handguns, modern sporting rifles, hunting rifles, black powder firearms, handcuffs, and firearm-related products and accessories for sale to a range of customers, including gun enthusiasts, collectors, hunters, sportsmen, competitive shooters, individuals desiring home and personal protection, law enforcement and security agencies and officers, and military agencies in the United States and globally. It sells its products under the Smith & Wesson brand, the M&P brand, the Thompson/Center Arms brand, and the Performance Center brand. The Company manufactures its firearm products at its facilities in Springfield, Massachusetts and Houlton, Maine. In May 2014, the Company through Deep River Plastics LLC, subsidiary purchased substantially all of assets of Tri Town Precision Plastics Inc. Analysis Guru Score: 93% DETERMINE THE CLASSIFICATION: This methodology would consider SWHC a "fast-grower". P/E/GROWTH RATIO: [PASS] The investor should examine the P/E (10.02) relative to the growth rate (44.56%), based on the average of the 3 and 5 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 SWHC (0.22) 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. SWHC, whose sales are $634.9 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 SWHC was 13.42% last year, while for this year it is 10.72%. Since inventory to sales has decreased from last year by -2.70%, SWHC passes this test. EPS GROWTH RATE: [PASS] 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 SWHC is 44.6%, based on the average of the 3 and 5 year historical eps growth rates, which is considered 'OK'. However, it may be difficult to sustain such a high growth rate. TOTAL DEBT/EQUITY RATIO: [PASS] This methodology would consider the Debt/Equity ratio for SWHC (72.54%) to be mediocre. If the Debt/Equity ratio is this high, the other ratios and financial statistics for SWHC should be good enough to compensate. 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 SWHC (5.58%) 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 SWHC (-0.33%) 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.   VALERO ENERGY CORPORATION Profile Strategy: Value Investor Based on: Benjamin Graham Valero Energy Corporation (Valero) is an independent petroleum refining and marketing company. Valero's refineries can produce conventional gasoline's, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products, as well as a slate of premium products, including conventional blendstock for oxygenate blending and reformulated gasoline blendstock for oxygenate blending, gasoline meeting the specifications of the California Air Resources Board, a diesel fuel, and low-sulfur and ultra-low-sulfur diesel fuel. It also owns 10 ethanol plants in the central plains region of the United States with a combined ethanol nameplate production capacity of about 1.1 billion gallons per year. It operates in three business segments: refining, ethanol, and retail. In May 2013, CST Brands Inc announced that the Company which includes Corner Store and Depanneur du Coin, spun off from Valero Energy Corporation. Analysis Guru Score: 71% SECTOR: [PASS] VLO is neither a technology nor financial Company, and therefore this methodology is applicable. SALES: [PASS] The investor must select companies of "adequate size". This includes companies with annual sales greater than $340 million. VLO's sales of $138,263.0 million, based on trailing 12 month sales, pass this test. CURRENT RATIO: [FAIL] The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. VLO's current ratio of 1.47 fails the test. LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: [PASS] For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that meet this criterion display one of the attributes of a financially secure organization. The long-term debt for VLO is $5,860.0 million, while the net current assets are $6,104.0 million. VLO passes this test. LONG-TERM EPS GROWTH: [FAIL] Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. EPS for VLO were negative within the last 5 years and therefore the company fails this criterion. P/E RATIO: [PASS] The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be "moderate", which this methodology states is not greater than 15. Stocks with moderate P/Es are more defensive by nature. VLO's P/E of 13.20 (using the 3 year PE) passes this test. PRICE/BOOK RATIO: [PASS] The Price/Book ratio must also be reasonable. That is, the Price/Book multiplied by P/E cannot be greater than 22. VLO's Price/Book ratio is 1.46, while the P/E is 13.20. VLO passes the Price/Book test.   BED BATH & BEYOND INC. Profile Strategy: Patient Investor Based on: Warren Buffett Bed Bath & Beyond Inc. is a chain of retail stores, operating under the names Bed Bath & Beyond (BBB), Christmas Tree Shops (CTS), Harmon and Harmon Face Values (Harmon), buybuy BABY and World Market or Cost Plus World Market (World Market). In addition, it is a partner in a joint venture, which operates three stores in the Mexico City market under the name Bed Bath & Beyond. The Company sells a range of domestics merchandise and home furnishings. Domestics merchandise includes categories, such as bed linens and related items, bath items and kitchen textiles. Home furnishings include categories, such as kitchen and tabletop items, fine tabletop, basic housewares and general home. During fiscal year ended March 2, 2013 (fiscal 2012), the Company opened a total of 38 stores, including 12 BBB stores throughout the United States and Canada, five CTS stores, one Harmon store and 18 buybuy BABY stores, and six World Market stores throughout the United States and closed one BBB store. Analysis Guru Score: 79% 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 1.65, 1.92, 2.08, 2.10, 1.64, 2.31, 3.07, 4.06, 4.56, 4.79. Buffett would consider BBBY's earnings predictable, although earnings have declined 1 time(s) in the past seven years, with the most recent decline 6 years ago. The dips have totaled 21.9%. BBBY's long term historical EPS growth rate is 13.8%, based on the 10 year average EPS growth rate, and it is expected to grow earnings 9.3% 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. BBBY has no long term debt and therefore would pass this criterion. 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 BBBY, over the last ten years, is 21.3%, 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 22.0%, 23.8%, 21.8%, 21.2%, 14.2%, 16.6%, 19.6%, 24.4%, 24.7%, 25.0%, and the average ROE over the last 3 years is 24.7%, 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 BBBY, over the last ten years, is 21.3% and the average ROTC over the past 3 years is 24.7%, 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 22.0%, 23.8%, 21.8%, 21.2%, 14.2%, 16.6%, 19.6%, 24.4%, 24.7%, 25.0%, 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. BBBY's free cash flow per share of $5.00 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: [FAIL] 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 $28.18 and compares it to the gain in EPS over the same period of $3.14. BBBY's management has earned shareholders a 11.1% return on the earnings they kept. This is unacceptable to Buffett, as management is not profitably allocating retained earnings. Essentially, investors would be better off if the company paid all earnings out to shareholders and let them invest the earnings on their own. 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. BBBY's shares outstanding have fallen over the past five years from 262,899,994 to 208,000,000, 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 BBBY 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 $4.81 and divide it by the current market price of $61.46. An investor, purchasing BBBY, could expect to receive a 7.83% initial rate of return. Furthermore, he or she could expect the rate to increase 9.3% 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 2.75%. Compare this with BBBY's initial yield of 7.83%, which will expand at an annual rate of 9.3%, 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] BBBY currently has a book value of $19.21. It is safe to say that if BBBY can preserve its average rate of return on equity of 21.3% and continues to retain 100.00% of its earnings, it will be able to sustain an earnings growth rate of 21.3% and it will have a book value of $132.78 in ten years. If it can still earn 21.3% on equity in ten years, then expected EPS will be $28.32. CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail] Now take the expected future EPS of $28.32 and multiply them by the lower of the 5 year average P/E ratio (14.6) or current P/E ratio (current P/E in this case), which is 12.8 and you get BBBY's projected future stock price of $361.95. 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 $0.00. This gives you a total dollar amount of $361.95. These numbers indicate that one could expect to make a 19.4% average annual return on BBBY'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 9.3%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $11.75. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (14.6) or current P/E ratio (current P/E in this case), which is 12.8. This equals the future stock price of $150.13. Add in the total expected dividend pool of $0.00 to get a total dollar amount of $150.13. 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 $61.46 and the future expected stock price, including the dividend pool, of $150.13. If you were to invest in BBBY at this time, you could expect a 9.34% average annual return on your money. Buffett likes to see a 15% return, and would even go down to 12%. 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 9.3% and 19.4%. 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 14.4% on BBBY 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. Profile Strategy: Growth/Value Investor Based on: James P. O'Shaughnessy Drew Industries, is a supplier of components for recreational vehicle (RVs) and manufactured housing. The Company operates in two segments: the RV products segment (RV Segment), and the manufactured housing products segment (MH Segment). The Company's operations are conducted through its wholly owned subsidiaries, Lippert Components, Inc. and its subsidiaries (Lippert) and Kinro, Inc. and its subsidiaries (Kinro), each of which has operations in both the RV Segment and the MH Segment. During the year ended December 31, 2012, the RV Segment accounted for 87% of net sales and the MH segment accounted for 13% of net sales. In February 2014, the Company's wholly-owned subsidiary, Lippert Components, Inc has acquired Innovative Design Solutions, Inc. (IDS). In March 2014, the Company's subsidiary Lippert Components, Inc, completed the acquisition of certain assets and the business of Star Design, LLC. Analysis Guru Score: 100% 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. DW, with a market cap of $1,116 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. DW, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were -1.10, 1.26, 1.34, 1.64 and 2.11, 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. DW's Price/Sales ratio of 1.06, 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. DW, whose relative strength is 74, is in the top 50 and would pass this last criterion.   ROBERT HALF INTERNATIONAL INC. Profile Strategy: Growth/Value Investor Based on: James P. O'Shaughnessy Robert Half International Inc. provides specialized staffing and risk consulting services. The Company operates in three segments: temporary and consultant staffing, permanent placement staffing, and risk consulting and internal audit services. The Company, through its Accountemps, Robert Half Finance & Accounting, and Robert Half Management Resources divisions, is a specialized provider of temporary, full-time, and project professionals in the fields of accounting and finance. OfficeTeam specializes in skilled temporary administrative support personnel. Robert Half Technology provides information technology professionals. Robert Half Legal provides temporary, project, and full-time staffing of attorneys and specialized support personnel within law firms and corporate legal departments. The Creative Group provides project staffing in the advertising, marketing, and Web design fields. Protiviti is a global business consulting and internal audit firm. Analysis Guru Score: 100% 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. RHI, with a market cap of $6,201 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. RHI, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 0.24, 0.44, 1.04, 1.50 and 1.83, 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. RHI's Price/Sales ratio of 1.44, 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. RHI, whose relative strength is 71, is in the top 50 and would pass this last criterion.   NORTHROP GRUMMAN CORPORATION Profile Strategy: Growth Investor Based on: Martin Zweig Northrop Grumman Corporation (Northrop Grumman) provides products, services, and integrated solutions in aerospace, electronics, information and services to its global customers. As of December 31, 2011, the Company operated in four segments: Aerospace Systems, Electronic Systems, Information Systems and Technical Services. The Company conducts most of its business with the United States Government, principally the Department of Defense (DoD) and intelligence community. It also conducts business with local, state, and foreign Governments and domestic and international commercial customers. Effective as of March 31, 2011, the company completed the spin-off of Huntington Ingalls Industries, Inc. (HII). HII operates the Company's former shipbuilding business. In September 2012, it acquired M5 Network Security Pty Ltd. In February 2014, Northrop Grumman Corp completed the acquisition of Qantas Defence Services Pty Limited. Analysis Guru Score: 77% 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. NOC's P/E is 13.24, based on trailing 12 month earnings, while the current market PE is 16.00. 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. NOC's revenue growth is -2.57%, while it's earnings growth rate is 16.37%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, NOC fails 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 (-4.2%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (-4.9%) of the current year. Sales growth for the prior must be greater than the latter. For NOC 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. NOC's EPS ($2.63) pass this test. QUARTERLY EARNINGS ONE YEAR AGO: [PASS] The EPS for the quarter one year ago must be positive. NOC's EPS for this quarter last year ($2.03) 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. NOC's growth rate of 29.56% 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 NOC is 8.18%. This should be less than the growth rates for the 3 previous quarters which are 9.57%, 17.58% and -0.47%. NOC 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, 8.39%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 29.56%, (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, 29.56% must be greater than or equal to the historical growth which is 16.37%. NOC 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. NOC, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 4.44, 6.41, 7.41, 7.81 and 8.35, 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. NOC's long-term growth rate of 16.37%, 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. NOC's Debt/Equity (56.08%) is not considered high relative to its industry (73.79%) 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 NOC, this criterion has not been met (insider sell transactions are 207, while insiders buying number 270). Despite the lack of an insider buy signal, there also is not an insider sell signal, so the stock passes this criterion.   BOFI HOLDING, INC. Profile Strategy: Small-Cap Growth Investor Based on: Motley Fool BofI Holding, Inc. is a holding company for BofI Federal Bank, a diversified financial services company. The Bank operate its bank from a single location in San Diego, California, serving approximately 40,000 retail deposit and loan customers across all 50 states. As of June 30, 2012, it had total assets of $2,386.8 million, loans of $1,799.7 million, mortgage-backed and other investment securities of $483.0 million, total deposits of $1,615.1 million and borrowings of $547.2 million. It distributes its deposit products through a range of retail distributions channels, and its deposits consist of demand, savings and time deposits accounts. It distributes its loan products through its retail, correspondent and wholesale channels, and the loans it retains are primarily first mortgages secured by single family real property and by multifamily real property. Analysis Guru Score: 73% PROFIT MARGIN: [PASS] This methodology seeks companies with a minimum trailing 12 month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns. A true test of the quality of a company is that they can sustain this margin. BOFI's profit margin of 32.99% passes this test. RELATIVE STRENGTH: [FAIL] The investor must look at the relative strength of the company in question. Companies whose relative strength is 90 or above (that is, the company outperforms 90% or more of the market for the past year), are considered attractive. Companies whose price has been rising much quicker than the market tend to keep rising. Although BOFI's relative strength of 89 is below the acceptable level, yet it is very close. Keep an eye on the stock as it could move into the acceptable range. COMPARE SALES AND EPS GROWTH TO THE SAME PERIOD LAST YEAR: [FAIL] Companies must demonstrate both revenue and net income growth of at least 25% as compared to the prior year. These growth rates give you the dynamic companies that you are looking for. These rates for BOFI (31.43% for EPS, and 22.82% for Sales) are not good enough to pass. INSIDER HOLDINGS: [FAIL] BOFI's insiders should own at least 10% (they own 9.72%) of the company's outstanding shares. This does not satisfy the minimum requirement, and companies that do not pass this criteria are less attractive. CASH FLOW FROM OPERATIONS: [PASS] A positive cash flow is typically used for internal expansion, acquisitions, dividend payments, etc. A company that generates rather than consumes cash is in much better shape to fund such activities on their own, rather than needing to borrow funds to do so. BOFI's free cash flow of $0.77 per share passes this test. PROFIT MARGIN CONSISTENCY: [PASS] BOFI's profit margin has been consistent or even increasing over the past three years (Current year: 29.70%, Last year: 25.47%, Two years ago: 22.14%), passing the requirement. It is a sign of good management and a healthy and competitive enterprise. R&D AS A PERCENTAGE OF SALES: [NEUTRAL] This criterion is not critically important for companies that are not high-tech or medical stocks because they are not as R&D dependant as companies within those sectors. Not much emphasis should be placed on this test in BOFI's case. CASH AND CASH EQUIVALENTS: [PASS] BOFI's level of cash $196.3 million passes this criteria. If a company is a cash generator, like BOFI, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash. "THE FOOL RATIO" (P/E TO GROWTH): [FAIL] The "Fool Ratio" is an extremely important aspect of this analysis. The methodology says consider holding the shares when the company's Fool Ratio is greater than 0.65 (BOFI's is 0.76), but initial purchases in this range are unfavorable. The following criteria for BOFI are less important which means you would place less emphasis on them when making your investment decision using this strategy: AVERAGE SHARES OUTSTANDING: [PASS] BOFI has not been significantly increasing the number of shares outstanding within recent years which is a good sign. BOFI currently has 14.0 million shares outstanding. This means the company is not taking any measures, with regards to the number of shares, that will dilute or devalue the stock. SALES: [PASS] Companies with sales less than $500 million should be chosen. It is among these small-cap stocks that investors can find "an uncut gem", ones that institutions won't be able to buy yet. BOFI's sales of $148.7 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". BOFI passes the sales test. DAILY DOLLAR VOLUME: [PASS] BOFI passes the Daily Dollar Volume (DDV of $21.6 million) test. It is required that this number be less than $25 million because these are the stocks that remain relatively undiscovered by institutions. "You'll be scoring touchdowns against the big guys on your turf." PRICE: [PASS] This is a very insignificant criterion for this methodology. But basically, low prices are chosen because "small numbers multiply more rapidly than large ones" and the potential for big returns expands. BOFI with a price of $77.63 passes the price test, even though it doesn't fall in the preferred range. The price should be above $7 in order to eliminate penny stocks and below $20 since most stocks in this price range are undiscovered by the institutions. INCOME TAX PERCENTAGE: [PASS] BOFI's income tax paid expressed as a percentage of pretax income this year was (40.92%) and last year (40.49%) are greater than 20% which is an acceptable level. If the tax rate is below 20% this could mean that the earnings that were reported were unrealistically inflated due to the lower level of income tax paid. This is a concern.   NETEASE, INC (ADR) Profile Strategy: Patient Investor Based on: Warren Buffett NetEase, Inc. is a holding company. The Company is an Internet technology company. The Company operates in three segments: Online Game Services, Advertising Services and E-mail, Wireless Value-added Services and Others. The Company provides its Internet and wireless value-added applications, services and technologies and advertising services to Guangzhou NetEase and Guangyitong Advertising and they operate the NetEase Websites and the online advertising business. Guangzhou NetEase has two majority-owned subsidiaries, Youdao Computer (a search business operator) and Wangyibao (the operator of its Wangyibao payment system). Through its subsidiaries and contracts with its affiliates Guangzhou NetEase, Guangyitong Advertising and Shanghai EaseNet and their respective shareholders, it operates an interactive online community in China and is a provider of Chinese language content and services through its online games, Internet portal and wireless value-added services businesses. Analysis Guru Score: 100% 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 0.02, 0.04, 0.06, 0.06, 0.08, 0.09, 0.11, 0.16, 0.18, 0.22. Buffett would consider NTES's earnings predictable. In fact EPS have increased every year. NTES's long term historical EPS growth rate is 24.4%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 11.3% 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. NTES has no long term debt and therefore would pass this criterion. 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 NTES, over the last ten years, is 28.1%, 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 29.3%, 34.0%, 37.9%, 34.0%, 28.6%, 24.7%, 22.9%, 24.6%, 22.8%, 21.9%, and the average ROE over the last 3 years is 23.1%, 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 NTES, over the last ten years, is 25.3% and the average ROTC over the past 3 years is 23.1%, 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 18.2%, 25.5%, 29.9%, 34.0%, 28.6%, 24.7%, 22.9%, 24.6%, 22.8%, 21.9%, 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. NTES's free cash flow per share of $5.17 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 $0.98 and compares it to the gain in EPS over the same period of $0.20. NTES's management has proven it can earn shareholders a 20.4% 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. NTES's shares outstanding have fallen over the past five years from 3,238,020,020 to 131,000,000, 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 NTES 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 $5.54 and divide it by the current market price of $71.44. An investor, purchasing NTES, could expect to receive a 7.75% initial rate of return. Furthermore, he or she could expect the rate to increase 11.3% 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 2.75%. Compare this with NTES's initial yield of 7.75%, which will expand at an annual rate of 11.3%, 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] NTES currently has a book value of $25.15. It is safe to say that if NTES can preserve its average rate of return on equity of 23.1% and continues to retain 98.88% of its earnings, it will be able to sustain an earnings growth rate of 22.9% and it will have a book value of $196.96 in ten years. If it can still earn 23.1% on equity in ten years, then expected EPS will be $45.52. CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail] Now take the expected future EPS of $45.52 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (12.9) (5 year average P/E in this case), which is 12.9 and you get NTES's projected future stock price of $586.28. 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 $1.17. This gives you a total dollar amount of $587.45. These numbers indicate that one could expect to make a 23.5% average annual return on NTES's stock at the present time. Buffett would consider this an absolutely fantastic expected return. CALCULATE THE EXPECTED FUTURE STOCK PRICE BASED ON AVERAGE EPS GROWTH: [No Pass/Fail] If you take the EPS growth of 11.3%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $16.13. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (12.9) (5 year average P/E in this case), which is 12.9. This equals the future stock price of $207.78. Add in the total expected dividend pool of $1.17 to get a total dollar amount of $208.95. 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 $71.44 and the future expected stock price, including the dividend pool, of $208.95. If you were to invest in NTES at this time, you could expect a 11.33% average annual return on your money. Buffett likes to see a 15% return, and would even go down to 12%. 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 11.3% and 23.5%. 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 17.4% on NTES stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.   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. Ticker Company Name Industry Guru Score LQDT LIQUIDITY SERVICES, INC. Retail (Catalog & Mail Order) 100 JLL JONES LANG LASALLE INC Real Estate Operations 57 COH COACH INC Retail (Apparel) 55 USNA USANA HEALTH SCIENCES, INC. Conglomerates 50 HY HYSTER-YALE MATERIALS HANDLING INC Auto & Truck Manufacturers 48 MNST MONSTER BEVERAGE CORP Beverages (Non-Alcoholic) 46 BWLD BUFFALO WILD WINGS Restaurants 44 EC ECOPETROL S.A. (ADR) Oil & Gas Operations 43 FDS FACTSET RESEARCH SYSTEMS INC. Computer Services 42 TJX THE TJX COMPANIES, INC. Retail (Apparel) 41

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