Executive Summary  |   Portfolio  |   Guru Analysis  |   Watch List

Executive Summary October 2, 2009

The Economy

The latest economic data is continuing to paint the picture of an economy in recovery, though questions abound about just how fast and far that recovery will run.

Some of the good recent news has come from the housing sector. The bursting of the housing bubble did major damage to homeowners and was a crucial factor in the credit crisis of 2008, as the mortgage-backed securities banks binged on plummeted in value. But the housing market is now showing signs of a sustained recovery, as pending home sales rose in August for the seventh straight month, according to the National Association of Realtors. The group's pending home sales index jumped 6.4% from its July level, and is now at its highest level since March of 2007.

In addition, home prices are on the rise. The S&P/Case-Shiller home-price index rose 1.2% in July, according to data released this week -- its biggest gain since October 2005. Yale economist Robert Shiller -- co-creator of the index and one of the few to predict the housing crisis -- told The Wall Street Journal that with the July figures marking the third straight monthly gain, "it looks like a major turnaround. We have some concern that it could be an aberration and temporary. But, at this point, it seems to be evident in just about every city in the U.S. That suggests it's real."

Still, there's reason for caution in the housing market. The NAR said that not all contracts are turning into closed sales within an expected timeframe, because of long delays related to short sales, and issues regarding complex new appraisal rules. In addition, there may be some double counting because buyers whose contracts fall through then go on to find and sign contracts for other homes, the group said. And Shiller said he now expects the housing market to move sideways for the next five years or so.

The broader economy also continues to give signs that a recovery is in progress. The Commerce Department reported this week that gross domestic product actually decreased at an annualized rate of just 0.7% in the second quarter, better than the 1.0% decline previously reported. While still indicating a contraction, the better-than-expected results appear to give credence to the belief that we'll see growth in the third quarter for the first time since the second quarter of 2008.

Consumer spending also jumped in August, according to a new Commerce Department report, rising 1.3% -- the largest increase in almost eight years. It was the fourth straight month the figure increased, an encouraging sign given that consumer spending makes up about two-thirds of the U.S. economy.

There are, however, caveats to the GDP and spending numbers. First, the big increase in spending appears to have been driven in large part by the government's now-complete "Cash for Clunkers" auto rebate plan -- though spending on non-durable goods and services did also increase slightly.

Second, unemployment remains high, with no signs of waning. New first-time claims for unemployment benefits rose last week, and ADP's employment report estimated that about a quarter of a million jobs were cut in the U.S. private sector in September. The Labor Department is slated to announce today the national unemployment rate for September, and the market will surely be watching.

Elsewhere, the manufacturing sector continued to expand in September -- though at a slower-than-expected pace -- with the Institute for Supply Management's manufacturing index coming in at 52.6. (Anything above 50 indicates an expansion.) It was the second straight month of expansion after a year-and-a-half of monthly contractions.

The mixed economic news led to an up-and-down fortnight for the stock market, with Thursday's rough day leaving the S&P 500 down 3.3% since our last newsletter. The Hot List, meanwhile, fell 4.0%. For the year, the portfolio remains well ahead of the S&P, having gained 37.3% compared to the index's 14.0%. And since its inception in July 2003, the Hot List is far outpacing the broader market, having gained 125.2% vs. the S&P's 2.9% gain.

Looking South

This rebalancing, the Hot List is making a pretty significant overhaul of the portfolio, saying goodbye to half of its holdings and replacing them with five new stocks that now rate higher using my Guru Strategies.

Four of the five departing firms -- Capella Education, Tower Group, General Dynamics, and Sturm, Ruger & Company -- have made either one- or two-month stints in the portfolio, ending up with relatively minor gains or losses. The fifth -- Jos. A. Bank Clothiers -- is a different story. Bank joined the Hot List back in February when it was trading at $23.85 a share and the retail picture was bleak. It has since surged over $40 a share, and the Hot List is now taking the profits on an 85% or so gainer. Bank was a great example of how sticking to a strategy that rewards fundamentals is critical -- even when negative headlines are everywhere.

To replace the five departing stocks, the Hot List is heading below the Equator, to South America, where three of the five newbies are headquartered. Its journey down south comes at a time when several top strategists are also looking to emerging markets. Mark Mobius, Robin Geffen (one of the U.K.'s most successful managers), Jeremy Grantham, and Marc Faber have all recently said they see strong potential in emerging or "frontier" markets.

There are two main reasons for the emerging market optimism. One is that, in part because they are still in the earlier stages of development and in part because they were not as impacted by the subprime crisis as the developed world, emerging market nations are expected to be strong engines of global growth moving forward. The other factor is that they offer a currency hedge against potential inflation in the U.S. and other developed nations that have used big stimulus packages and low interest rates to try to jumpstart their economies.

As a fundamental-based system, the Hot List is focused more on the former than the latter, and the new additions to the portfolio reflect that. For example, take MercadoLibre, an Argentina-based online commerce platform that is one of the portfolio's new additions this rebalancing. In its most recent quarter (Q2 of this year), the firm's sales jumped 20%, and its profit more than doubled. Profits also more than doubled in 2009's first quarter, and that was after nearly doubling in the full 2008 year. Similarly, another of the new additions, Peru-based financial firm Credicorp, increased EPS slightly in 2008 while many other financials around the globe were hammered. Its EPS also jumped more than 50% in its most recent quarter.

What's important to remember about emerging markets, however, is that high-growth regions don't mean high profit growth for all. In any economy, some businesses will thrive, others will plug along, and others will fail, and haphazardly adding companies from attractive regions to your portfolio is a good way to lose money. As with all of the stocks in the Hot List, the three South American firms have solid fundamentals and businesses that have proven they can grow even through tough environments -- that, not their location, is what really makes them attractive plays.

Fund Flaws

The other issue I'd like to touch on this week involves mutual fund performance. One of the topics that I covered in my most recent book, The Guru Investor, was the fact that studies show the majority of mutual funds tend to underperform the broader market indices. John Bogle -- the renowned founder of the Vanguard Group -- once told a Congressional committee, for example, that the average equity fund returned 10.5% annually from 1950 through 1970, while the S&P 500 averaged a 12.1% return. From 1983 through 2003, as mutual funds became more popular, the gap widened, according to Bogle: The average equity fund returned 10.3% annually, while the S&P returned 13% per year. Those gaps are bigger than you might think: A $10,000 investment that grows at 13% per year compounded annually, for example, will give you a little more than $115,000 after 20 years; at 10.3% per year, you'd end up with about $71,000.

James O'Shaughnessy, one of the gurus upon whom I base a strategy, found similar results. In his book What Works on Wall Street, he looked at what percentage of equity funds beat the S&P 500 over a series of 10-year periods, beginning with the 10-year period that ended in 1991 and ending with the 10-year period that ended in 2003. According to O'Shaughnessy, "the best 10 years, ending December 31, 1994, saw only 26% of the traditionally managed active mutual funds beating the [S&P] index." And, he noted that these statistics didn't include all the funds that failed to survive a particular 10-year period, meaning that his findings actually overstate the collective performance of equity funds.

In a recent update of its SPIVA Scorecard, Standard & Poor's has highlighted newer information that appears to support Bogle's and O'Shaughnessy's research. S&P looked at the two most recent five-year periods (1999-2003 and 2004-2008) and found that for almost every style box category in those two periods, the majority of actively managed funds lagged their benchmark index. In the 1999-2003 period, 91.36% of mid-cap funds lagged the S&P MidCap 400 index, while 69.38% of small-cap funds lagged the S&P SmallCap 600 index. Large-cap funds fared better, but 53.41% of them still lagged the S&P 500.

From 2004-2008, the numbers for actively managed funds were worse, with 71.90% of large-cap funds lagging their benchmark; 79.06% of mid-cap funds lagging their benchmark; and 85.45% of small-cap funds lagging their benchmark.

There are several reasons the majority of funds struggle to beat broader market indices -- among them are high fees and the career risk managers take when they don't follow the crowd (and to beat the market, you have to sometimes go against the crowd). But the bottom line is that if you want to beat the market, mutual funds are generally not the place to be.

That's the lesson I learned that the hard way when I started investing years and years ago, and it's what led me to create the guru-based computer models that drive the Hot List. Since their inceptions (most of which were in July of 2003), all 12 of the 10-stock individual-guru-based portfolios I track are beating the S&P 500, and 11 are doing so by more than 3.5 percentage points per year. And the Hot List is beating the S&P by more than 15 percentage points per year.

To me, that's proof that individual investors can beat the market on their own, without the help (or, more often, hindrance) of fund managers. But to give yourself the best chance to do so, you have to stick to proven strategies that reward solid, fundamentally sound stocks -- and you have to stay disciplined, even when the market seems terrifying, like it did last year. If you have the stomach to do that, you have what you need to leave most mutual funds in the dust.
Editor-in-Chief: John Reese

Hot List Editor John Reese Announces Publication of New Book

The Guru Investor shows you how to implement the strategies of Wall Street legends like Warren Buffett, Peter Lynch and Benjamin Graham in your own portfolio.

Buy Your Copy Now!

The Fallen

As we rebalance the Validea Hot List, 5 stocks leave our portfolio. These include: General Dynamics Corporation (GD), Jos. A. Bank Clothiers, Inc. (JOSB), Sturm, Ruger & Company (RGR), Tower Group, Inc. (TWGP) and Capella Education Company (CPLA).

The Keepers

5 stocks remain in the portfolio. They are: Frontier Oil Corporation (FTO), World Fuel Services Corporation (INT), Chevron Corporation (CVX), Aeropostale, Inc. (ARO) and Vanceinfo Technologies Inc. (VIT).

The Newbies

We are adding 5 stocks to the portfolio. These include: Humana Inc. (HUM), Reliance Steel & Aluminum (RS), Credicorp Ltd. (Usa) (BAP), Brasil Telecom Participacoes Sa (Adr) (BRP) and Mercadolibre, Inc. (MELI).

Portfolio Changes

Newcomers to the Validea Hot List

Credicorp Ltd. (BAP): Peru's leading financial holding company, Credicorp's businesses include commercial banking, insurance, and investment banking, with its largest holding being Banco de Credito del Peru. Credicorp has a $6.2 billion market cap, and has taken in about $1.4 billion in sales in the past 12 months.

Credicorp gets strong interest from both my Peter Lynch-based model and my Momentum Investor strategy. To find out why, see the "Detailed Stock Analysis" section below.

Humana Inc. (HUM): Based in Louisville, Ky., Humana is a health and supplemental benefits company that has over 10 million medical members and almost 7 million specialty members. The $6.3-billion-market-cap firm offers a variety of plans for employer groups, government programs, and individuals, and has taken in more than $30 billion in sales in the past year.

My Peter Lynch-based model has strong interest in Humana. Find out why in the "Detailed Stock Analysis" section below.

MercadoLibre, Inc. (MELI): This Argentina-based firm hosts online commerce and payment platforms in Latin America, allowing users to buy and sell a wide variety of merchandise through their site. It is a market leader in Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay and Venezuela, based on unique visitors and page views, and has also recently launched online trading platforms in Costa Rica, the Dominican Republic and Panama. The firm has a $1.7 billion market cap, and has taken in about $150 million in sales over the past year.

MercadoLibre gets approval from two of my growth models, my Momentum Investor approach and my Motley Fool-based strategy. The "Detailed Stock Analysis" section below explains why.

Reliance Steel & Aluminum Co. (RS): One of the largest metals service center firms in the U.S., Reliance makes over 100,000 metal products that range from stainless steel to aluminum to brass to copper and beyond. Based in Los Angeles, it has a $3.1 billion market cap, and has taken in more than $7.5 billion in sales in the past year.

Reliance gets strong interest from my Benjamin Graham-, Peter Lynch-, and James O'Shaughnessy-based approaches. To find out why, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Chevron Corp. (CVX): This week, Chevron announced that Vice Chairman John Watson will succeed retiring David O'Reilly as chairman and chief executive officer at the end of the year, MarketWatch reported. Watson, 52, now oversees strategic planning; business development; policy, government and public affairs; major capital projects support; procurement, and corporate compliance.

Reliance Steel & Aluminum Co. (RS): On Sept. 29, Reliance said it expects third-quarter profit will be 40 to 45 cents per share, far ahead of analysts' estimates of 31 cents, the Associated Press reported. The higher guidance figures reflect improving gross profit margins, increased shipping volumes, and higher prices, AP said.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will examine one of my individual Guru Strategies in greater depth. If you have any questions, please feel free to contact us at hotlist@validea.com.

Current Portfolio

Detailed Stock Analysis

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

INT   |   VIT   |   FTO   |   RS   |   ARO   |   MELI   |   BAP   |   BRP   |   HUM   |   CVX   |  

World Fuel Services Corporation is engaged in the marketing and sale of marine, aviation and land fuel products and related services on a worldwide basis. The Company operates in three segments: marine, aviation and land. In its marine segment it offers fuel and related services to maritime customers, including international container and tanker fleets, commercial cruise lines and time-charter operators. In its aviation segment, it offers fuel and related services to major commercial airlines, second and third-tier airlines, cargo carriers, regional and low-cost carriers, corporate fleets, fractional operators, private aircraft, military fleets. In its land segment, it offers fuel and related services to petroleum distributors operating in the land transportation market. In June 2008, it acquired certain assets of Texor Petroleum Company, Inc. In April 2009, the Company acquired the Henty Oil Group of Companies.

VanceInfo Technologies Inc. is an information technology (IT) service provider and one of the offshore software development companies in China. The Company's range of IT services includes research and development services (R&D services), enterprise solutions, application development and maintenance (ADM), quality assurance and testing, as well as globalization and localization. It provides these services primarily to corporations headquartered in the United States, Europe, Japan and China, targeting industries, such as technology, telecommunications, financial services, manufacturing, retail and distribution. The Company operates a range of offshore development centers in China (CDCs). Its major clients include Microsoft, IBM, Huawei, TIBCO, and a European mobile handset manufacturer. In July 2009, the Company acquired the operating subsidiaries of TP Corporation Limited (TP), a provider of customer relationship management (CRM) solutions and call center services.

Frontier Oil Corporation (Frontier) is an independent energy company engaged in crude oil refining and the wholesale marketing of refined petroleum products. The Company operates refineries (the Refineries) in Cheyenne, Wyoming and El Dorado, Kansas with a total annual average crude oil capacity of approximately 182,000 barrels per day (bpd). Frontier's Cheyenne Refinery has a permitted crude oil capacity of 52,000 bpd on a 12-month average. The Company markets its refined products primarily in the eastern slope of the Rocky Mountain region, which encompasses eastern Colorado (including the Denver metropolitan area), eastern Wyoming and western Nebraska (the Eastern Slope). The Cheyenne Refinery has a coking unit, which allows the refinery to process amounts of heavy crude oil for use as a feedstock. During the year ended December 31, 2008, heavy crude oil constituted approximately 76% of the Cheyenne Refinery's total crude oil charge.

Reliance Steel & Aluminum Co. is a metals service center company. The Company's network of metals service centers operates more than 200 locations in 38 states, Belgium, Canada, China, Mexico, Singapore, South Korea and the United Kingdom. Through this network, it provides metals processing services and distributes a line of more than 100,000 metal products, including alloy, aluminum, brass, copper, carbon steel, titanium, stainless steel and specialty steel products, to more than 125,000 customers in a range of industries. Many of the Company's metals service centers process and distribute only specialty metals. Reliance Steel & Aluminum Co. delivers products from facilities located across the United States and Canada. In March 2009, New Wave Holdings Ltd. completed the sale of the entire 30% interest in Reliance Pan Pacific Pte. Ltd. (RPP) held by its wholly owned subsidiary, Manufacturing Network Pte Ltd, to the Company.

Aeropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. The Company designs, markets and sells its own brand of merchandise principally targeting 14 to 17 year-old young women and young men. The Company also sells Aeropostale merchandise through its e-commerce Website, www.aeropostale.com. As of January 31, 2009, it operated 914 stores, consisting of 874 Aeropostale stores in 48 states and Puerto Rico, 29 Aeropostale stores in Canada, and 11 Jimmy'Z stores in 10 states. The Company locates its stores primarily in shopping malls, outlet centers and, to a much lesser degree, lifestyle and off-mall shopping centers. The Company has developed a new retail store concept called P.S. from Aeropostale, which will offer casual clothing and accessories focusing on elementary school children between the ages of seven and 12. It offers a focused collection of apparel, including graphic t-shirts, tops, bottoms, sweaters, jeans, outerwear and accessories.

MercadoLibre, Inc. hosts an online platform in Latin America, called MercadoLibre and located at www.mercadolibre.com. The Company has e-commerce operations in Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay and Venezuela. In addition, it also operates online trading platforms in Costa Rica, the Dominican Republic and Panama. MercadoLibre has two principal services: The MercadoLibre marketplace and The MercadoPago online payments solution. The MercadoLibre marketplace is a fully automated, topically arranged online trading service. The MercadoPago online payments solution is an integrated online payments solution. During the year ended December 31, 2008, visitors to its Website were able to browse an average of over 2.5 million total listings on any given day in over 2,000 different product categories. At December 31, 2008, the Company had over 33.7 million confirmed registered MercadoLibre users.

Credicorp Ltd. (Credicorp) is a financial services holding company. The Company operates primarily through its four principal subsidiaries: Banco de Credito del Peru (BCP), Atlantic Security Holding Corporation (ASHC), El Pacifico-Peruano Suiza Compania de Seguros y Reaseguros (PPS) and Grupo Credito S.A (Grupo Credito). Credicorp is engaged principally in commercial banking (including trade finance, corporate finance and leasing services), insurance (including commercial property, transportation and marine hull, automobile, life, health and pension fund underwriting insurance) and investment banking (including brokerage services, asset management, and trust, custody and securitization services, and trading and investment). The Company conducts its commercial banking and investment banking activities primarily through BCP, ASHC and its pension fund business through Prima AFP. Credicorp's insurance activities are conducted through PPS.

Brasil Telecom Participacoes S.A. is a provider of telecommunications services in Region II in Brazil. The Company offers integrated telecommunications services, which includes fixed-line and mobile telecommunications services, data transmission services (including broadband access services), Internet service provider (ISP) services and other services, for residential customers, small, medium and large companies, and governmental agencies. The Company provided services, which include Fixed-Line Telecommunications Services, Mobile Telecommunications Services, Data Transmission Services and other services.

Humana Inc. (Humana) is a health and supplemental benefits company. The Company is a full-service benefits solutions company, offering an array of health and supplemental benefit plans for employer groups, government benefit programs and individuals. The Company operates in two segments: Government and Commercial. The Government segment consists of beneficiaries of government benefit programs, and includes three lines of business: Medicare, Military and Medicaid. The Commercial segment consists of members enrolled in its medical and specialty products marketed to employer groups and individuals. On October 31, 2008, the Company acquired PHP Companies, Inc. (doing business as Cariten Healthcare). On August 29, 2008, the Company acquired Metcare Health Plans, Inc. On May 22, 2008, it acquired OSF Health Plans, Inc. On April 30, 2008, the Company acquired UnitedHealth Group's Las Vegas, Nevada individual SecureHorizons Medicare Advantage health maintenance organization (HMO) business.

Chevron Corporation (Chevron) manages its investments in subsidiaries and affiliates, and provides administrative, financial, management and technology support to the United States and International subsidiaries that engage in fully integrated petroleum operations, chemicals operations, mining operations of coal and other minerals, power generation and energy services. Exploration and production (upstream) operations consist of exploring for, developing and producing crude oil and natural gas, and also marketing natural gas. Refining, marketing and transportation (downstream) operations relate to refining crude oil into finished petroleum products; marketing crude oil and the many products derived from petroleum, and transporting crude oil, natural gas and petroleum products by pipeline, marine vessel, motor equipment and rail car. In April 2009, Reliance Industries Limited bought back Chevron Corporation's 5% stake in Reliance Petroleum Limited.

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.


The names of individuals (i.e., the 'gurus') appearing in this report are for identification purposes of his methodology only, as derived by Validea.com from published sources, and are not intended to suggest or imply any affiliation with or endorsement or even agreement with this report personally by such gurus, or any knowledge or approval by such persons of the content of this report. All trademarks, service marks and tradenames appearing in this report are the property of their respective owners, and are likewise used for identification purposes only.

Validea is not registered as a securities broker-dealer or investment advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Validea is not responsible for trades executed by users of this site based on the information included herein. The information presented on this website does not represent a recommendation to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment. The information on this website is generic by nature and is not personalized to the specific situation of any individual. The user therefore bears complete responsibility for their own investment research and should seek the advice of a qualified investment professional prior to making any investment decisions.

Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. Past performance is not necessarily indicative of future results. Individual stocks mentioned throughout this web site may be holdings in the managed portfolios of Validea Capital Management, a separate asset management firm founded by Validea.com founder John Reese. Validea Capital Management, which is a separate legal entity and an SEC registered investment advisory firm, uses, in part, the strategies on the web site to select stocks for its clients.