|Executive Summary | Portfolio | Guru Analysis | Watch List|
|Executive Summary||August 3, 2012|
While Europe's debt woes have again been spooking investors, the U.S. economy continues to show some signs of solid -- albeit unspectacular -- improvement.
New unemployment claims, for example, have made a nice dip since our last newsletter, and are now 9% below year-ago levels. Continuing claims (which lag new claims by a week) also fell slightly since our last Hot List. They are now 12% below year-ago levels. The July unemployment report from the Labor Department is due out today, and as always it will be closely watched, particularly considering the relatively weak numbers we've seen in the past few monthly reports.
Good news also continued to come from the housing sector -- and boy is it good to be able to say those words after housing's horrible troubles over the past several years. Home prices rose in May by 2.2%, according to the S&P/Case-Shiller Home Price Indices, building on the 1.3% gains seen the previous month. Even when seasonal factors are taken into account, prices rose nearly a full percentage point in May. Prices are still 0.7% below where they were a year-ago, according to the group's 20-city index, but the trend is encouraging.
Real estate firm Zillow also said that home prices rose 0.2% in the second quarter (vs. 2011's second quarter), the first quarterly gain since 2007. "After four months with rising home values and increasingly positive forecast data, it seems clear that the country has hit a bottom in home values," the firm's Chief Economist Stan Humphries said. "The housing recovery is holding together despite lower-than-expected job growth, indicating that it has some organic strength of its own."
The National Association of Realtors, meanwhile, said its Pending Home Sales Index fell 1.4% in June (seasonally adjusted), but was still more than 8% above where it was a year ago.
Another good sign: Personal income rose 0.5% in June and disposable personal income rose 0.4%, according to the Commerce Department. Consumers pocketed the gains, as personal consumption expenditures were about flat and the personal savings rate rose to 4.4% (up from 4.0% in May), the Commerce Department said. That means Americans are saving the most they've saved in a year.
Europe's debt troubles continue to weigh on the market, however. After having said the European Central Bank would do whatever it takes to save the euro last week, ECB President Mario Draghi said this week that the ECB would start buying Italian and Spanish government bonds only after individual governments in the euro zone approved the move, the Wall Street Journal reported. Given how hard it has been to get individual eurozone countries to agree on any sort of major action, investors weren't heartened by the news.
Since our last newsletter, the S&P 500 returned -0.8%, while the Hot List returned -2.7%. So far in 2012, the portfolio has returned 6.5% vs. 8.5% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 140.8% vs. the S&P's 36.4% gain.
The Hot List has hit some road bumps over the past few weeks, with a couple holdings posting fairly big losses. One was Apollo Group, which through Wednesday was down about 27% since the portfolio scooped it up a month ago. Much of the decline seems to have been driven not by Apollo's performance, but by broader fears surrounding the for-profit education industry -- Ashford University, owned by Bridgepoint Education, was denied an accreditation by a regional accreditation group, which seems to have renewed fears about the industry and sent shares of other companies within it tumbling. Apollo's fundamentals remain solid, however -- while earnings are expected to decline this year and next, it is so cheap (7.5 times projected 12-month EPS, less than 0.7 times trailing 12-month sales) that the Hot List thinks it is a good candidate for a bounce-back over the longer term. The portfolio is thus holding onto the stock on today's rebalancing.
Another Hot List holding, network management software maker SolarWinds, helped offset some of Apollo's losses. It announced second quarter profit of $19.43 million or $0.26 per share, up sharply from $13.55 million or $0.18 per share a year ago, RTTNews reported. Adjusted earnings were up 50% to $0.33 per share, well outpacing Thomson Reuters analysts estimates of $0.27 per share. Total revenues rose 40%, and the firm upped its full-year forecast. The result: Shares jumped nearly 28% over a two-day period.
Stamps.com took a tumble though. While earnings per share declined in the second quarter, the company said, the results were better than expected. Still, a weaker outlook caused shares to fall 16% on July 26. The firm's fundamentals deteriorated a bit, which caused its score on my strategies to fall, and the portfolio is selling the stock this rebalancing.
All in all, the Hot List is selling four stocks this rebalancing and replacing them with four others. The newcomers are an interesting bunch of value picks: Autoliv, a Swedish auto safety product maker; GameStop Corp., the video game seller that was a big winner for the portfolio not too long ago, gaining more than 40% from September 2010 to July 2011; Main Street Capital, a small-cap investment company that has been hit by the financial sector turmoil, but whose fundamentals are strong; and Marathon Petroleum Corp., an energy sector pick whose shares have been kept down by global economic concerns.
I expect these types of value stocks to help the Hot List continue its long-term performance, which has been quite good. In fact, the portfolio last month hit its nine-year birthday, and since its July 2003 inception it has now gained more than 140% (all returns here and below are through Aug. 1), nearly four times the S&P 500's 37.5% gain. That's annualized returns of 10.2% in a nine-plus-year period in which the S&P has returned just 3.5% annualized.
Given that the Hot List recently hit the nine-year mark, I thought it would be a good time to look back and see what has worked -- and what hasn't -- for the portfolio and the individual strategies that drive its picks over that time.
For the Hot List, the best full-year we've seen so far was 2009 -- a year that many thought was going to spell doom for America and the stock market -- when the portfolio gained 47.0%. (In the partial 2003 year, the portfolio actually gained more -- 56.9% -- but that was only a five-and-a-half-month span.) In addition to being the best year in terms of raw return, 2009 was also the portfolio's best year in terms of outperformance of the broader market. It beat the S&P 500 (which returned 23.5%) by 23.5 percentage points that year.
The portfolio's worst year, meanwhile, came in 2008, when it fell 35.0% amid the financial crisis and Great Recession. It did, however, beat the S&P that year by 3.5 percentage points. In terms of relative underperformance to the broader market, the Hot List's worst year was last year. It declined 16.2% while the S&P was flat.
Including its 2003 and 2012 partial years, the Hot List has beaten the S&P in six years, or 60% of the time. It has been more volatile than the index, with a beta of about 1.2; that's also clear from the fact that the portfolio has had three years when it has produced negative returns (2007, 2008, and 2011), while the S&P has had just one (2008). Of course, when you look at the portfolio's long-term returns, the additional volatility has been well worth it.
So, which of the strategies that go into the Hot List have done particularly well, and which have not? Well, the top overall performer has been the strategy I based on the writings of Motley Fool creators Tom and David Gardner. A 10-stock portfolio picked using this model is up nearly 200% since its inception (also July 15, 2003), or 12.8% annualized (versus that 3.6% S&P figure I mentioned above).While The Fool-based strategy is lagging the market this year, it has put together a remarkable run, beating the S&P in every year of its existence. You would think that a small-cap growth strategy would tend to be more volatile, but the Fool strategy has been successful in large part by limiting losses. Several other portfolios have had significantly better individual years, but the Fool portfolio has had only one negative year -- and that was 2008, when it still beat the S&P by more than 13 percentage points.
Another top performer has been my Benjamin Graham-inspired strategy. My 10-stock Graham-based portfolio has gained more than 170% since its July 15, 2003 inception. That's 11.7% annualized, versus that same 3.6% figure for the S&P. The portfolio was my best performer during the horrible 2008 year, losing just 14.1% while the broader market tumbled nearly 3 times that much. It has lagged the index in only two years, one of which was last year, its worst overall year -- the portfolio loss about 19%. All in all though, the strategy -- which Graham outlined more than six decades ago -- has been an exceptional performer.
Two other big winners have been my Kenneth Fisher-and James O'Shaughnessy-inspired approaches. The 10-stock Fisher portfolio has gained 10.6% annualized since its inception, while the O'Shaughnessy counterpart is up 9.9% annualized since inception (both inceptions were July 15, 2003.
Our other individual guru 10-stock portfolios aren't quite at those double-digit annualized return levels, but nearly every one has beaten the S&P since inception. In fact the lone laggard at this point is the John Neff-inspired portfolio. Since its 2004 inception, it's up 1.4% annualized while the S&P is up 2.5%. I suspect that over the long haul it will come out on top of the index, given that the strategy looks at a number of factors that are used by other successful strategies -- price-earnings ratio, earnings growth, sales growth, and dividend yield, to name a few. Time, of course, will tell.
I thought one interesting way to look at all of these portfolios was by assessing how they've done during strong years for the broader market, and during weak years for the broader market. Since 2003, we've had four years that have featured weak returns for the market: 2005 (3%); 2007 (3.5%); 2008 (-38.5%); and 2011 (0%).The other years have all featured games of at least 9%, which I think it's fair to classify it as strong years.
We'll start with the weak years. The figures are the average (mean) return for the four weak years:
Portfolio Based On
Momentum Investor: 6.65%
Motley Fool: 2.23%
James O'Shaughnessy: -3.73%
Kenneth Fisher: -6.33
Benjamin Graham: -7.70%
Martin Zweig: -8.95%
Joel Greenblatt: -10.83%
John Neff: -11.43%
Warren Buffett: -11.60%
Hot List: -12.08%
Joseph Piotroski: -14.40%
David Dreman: -15.53%
Peter Lynch: -17.48%
S&P 500: -8.00%
Now, here's how the same strategies performed in the strong years. Figures are the average (mean) return for the six strong years (including the two partial years):
Hot List: 29.07%
Motley Fool: 20.13%
S&P 500: 13.23%
The data shows some things that have played out as you'd expect. For example, during the weaker years, the top two performers have both been growth strategies, while several of the worst performers were deeper value strategies. That makes sense, as, during tough times investors tend to gravitate towards stocks with better, more consistent earnings growth and away from deeper value stocks, which often have some sort of problems or are the subject of fears that make them cheap, but riskier, in the short term. Conversely, during good times, when investors are taking on more risk, the top performers have included several deep value strategies and the worst performer has been the momentum strategy.
But the data also shows numerous exceptions. The Peter Lynch strategy has been the worst performer during weak years, for example, despite focusing quite a bit on earnings growth. And, while it has been the best performer during weak years, the Momentum portfolio significantly lagged the market during 2008, when it lost 45%. It's also been the worst performer during strong years, but it nevertheless gained more than 30% in the strong partial 2003 year. The hybrid O'Shaughnessy growth/value model produced very good years during tough times for the broader market in 2005 and 2011, but it lagged the market during 2008 by more than 8 percentage points. It also produced exceptional returns in 2003, 2006, 2009, and 2010, when the market was strong, but just 1% in 2004, another strong year for stocks.
So, at the end of the day, even if you knew what the broader market climate would be, it's very hard to say which strategies are more likely to be the best performers. There are a likely a few reasons for that. One is that while the portfolios are in most cases nine years old, the sample size is still relatively small for strong and weak years. Another is that, while they may tilt one way or the other, almost the strategies that go into the Hot List include both growth and value components, making it difficult to classify them as exclusively a growth or value approach. And, markets are strong or weak for different reasons at different times. The 2008 market was crushed by financial stocks, so a strategy like the Graham approach -- whose rigid balance sheet requirements make it all but impossible for a financial stock to make its way into the portfolio (since financials carry a lot of debt due to the nature of their businesses) -- benefited.
There thus doesn't seem to be a clear conclusion on which strategies perform best during different environments. But I think that, combined with the long-term success of almost all of these approaches, that does lead to another more general conclusion that is critical to understand: All strategies -- even the best ones -- have ups and downs, and you never know exactly when those ups and downs are coming (particularly when you are using a more focused portfolio like the Hot List, where stock-specific issues have a much bigger impact than they do on a portfolio with, say, 100 stocks). And, as Greenblatt and O'Shaughnessy and other top strategists have stressed, that means you need to stay very disciplined. Jumping from hot strategy to hot strategy while bailing on approaches that have short-term hiccups is a recipe for trouble.
Good strategies work over time -- if you let them do their job. The hard part is understanding that good strategies will have short-term underperformance, and not overreacting to those periods, which will cause you to sell low. As Greenblatt has pointed out, his approach has had even three year periods where it has struggled. But over the long haul, he has produced exceptional returns. In the end, there are simply too many factors to take into account to beat the market every week or month or year. But over the longer term, value and fundamental soundness win out, as history has shown. If you have the discipline to stick with a good, fundamental-focused strategy through the market's (and your portfolio's) unpredictable short-term gyrations, you should stay ahead of the game over the longer term.
As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Stamps.com Inc. (STMP), Coinstar, Inc. (CSTR), Tractor Supply Company (TSCO) and Mwi Veterinary Supply, Inc. (MWIV).
6 stocks remain in the portfolio. They are: The Tjx Companies, Inc. (TJX), Apollo Group Inc (APOL), Northrop Grumman Corporation (NOC), Lkq Corporation (LKQ), Solarwinds Inc (SWI) and Altisource Portfolio Solutions S.a. (ASPS).
We are adding 4 stocks to the portfolio. These include: Autoliv Inc. (ALV), Gamestop Corp. (GME), Main Street Capital Corporation (MAIN) and Marathon Petroleum Corp (MPC).
Newcomers to the Validea Hot List
Autoliv Inc. (ALV) : This Sweden-based automotive safety product maker ($5.3 billion market cap) and its joint ventures have more than 80 facilities in 29 countries, and test cars and auto products at more than 20 crash test tracks around the world. The firm gets strong interest from the models I base on the writings of Kenneth Fisher and Peter Lynch. To learn more about it, scroll down to the "Detailed Stock Analysis" section below.
GameStop Corp. (GME): The world's largest multi-channel video game retailer, GameStop offers all sorts of Nintendo, Xbox, and PlayStation games and game units, as well as a variety of computer games and online platforms. The Texas-based company has more than 6,000 stores in the U.S. and 14 other countries, operating under the GameStop, EB Games, and Electronics Boutique names. The firm has a $2.1 billion market cap, and has taken in more than $9 billion in sales over the past 12 months.
GameStop gets approval from my Peter Lynch- and Joel Greenblatt-based strategies. To find out more about the stock's fundamentals, see the "Detailed Stock Analysis" section below.
Main Street Capital Corporation (MAIN): This Houston-based investment firm offers long-term debt and equity capital to lower middle-market companies (usually those with annual revenues between $10 million and $150 million) and debt capital to middle-market firms. Its investments usually support management buyouts, recapitalizations, growth financings, refinancings and acquisitions of companies that operate in diverse industry sectors. Being a small-cap financial ($670 million market cap), it is more susceptible to volatility, particularly in today's environment. But the stock trades for just 7.6 times trailing 12-month earnings, and comes with a handsome 7% dividend yield. It gets approval from my Peter Lynch-based model, and from the model I base on the writings of Tom and David Gardner of The Motley Fool. To read more about it, see the "Detailed Stock Analysis" section below.
Marathon Petroleum Corp. (MPC): This Ohio-based firm was spun off from Marathon Oil about a year ago, and is the nation's fifth-largest transportation fuels refiner. Its gasoline is sold at more than 5,000 retail gas outlets in the U.S., and its subsidiary Speedway LLC owns and operates the nation's fourth-largest convenience store chain. Marathon has a $16 billion market cap and has taken in more than $80 billion in sales over the past year.
Marathon gets strong interest from my Peter Lynch- and Joel Greenblatt-based models. For more information on the stock scroll down to the "Detailed Stock Analysis" section below.
News about Validea Hot List Stocks
SolarWinds Inc. (SWI): SolarWinds' shares jumped nearly 28% over a two-day period after it announced second quarter profit of $19.43 million or $0.26 per share, up sharply from $13.55 million or $0.18 per share a year ago, RTTNews reported. Adjusted earnings were up 50% to $0.33 per share, well outpacing Thomson Reuters analysts estimates of $0.27 per share. Total revenues rose 40%, and the firm upped its full-year forecast..
Stamps.com Inc. (STMP): The firm reported that earnings per share declined in the second quarter, but the results were better than expected. Still, a weaker outlook caused shares to fall 16% on July 26 on the news, The Wall Street Journal reported. The firm's fundamentals deteriorated a bit, and the portfolio is selling the stock this rebalancing.
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 email@example.com.
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