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Executive Summary December 20, 2013

The Economy

At last, the long awaited taper has arrived, with the Federal Reserve announcing that it will begin curtailing its giant bond-buying program by $10 billion (about 12%) a month. And guess what? The stock market didn't implode, as so many had feared.

In fact, on the strength of more good economic news, stocks actually surged higher the day the Fed announced the taper, with the S&P 500 reaching a record level. Part of that was likely due to impressive data from the housing market, as a new government report showed that housing starts jumped 22.7% in November. That put them more than 33% above where they stood a year ago, a sign that the housing recovery still has legs -- very strong legs. Permit issuance for new construction fell 3.1%, but remained 3.2% above year-ago levels.

The housing data was the latest of several reports that have indicated an acceleration in growth. Industrial production, for example, jumped 1.1% in November, the Federal Reserve said. To be fair, that was aided by weather -- utility output jumped 3.9% amid colder-than-average temperatures. But manufacturing output rose a solid 0.6%, and mining output increased by 1.7%. October's overall industrial production figure was also revised upward, from -0.1% to 0.1%.

Retail and food service sales also made significant gains, climbing 0.7% in November, according to the Commerce Department. That put them 4.3% above where they stood a year ago.

On the negative side, new jobless claims have jumped since our last newsletter, rising close to 25% But as I noted in our last Hot List, late November's claims data may have been artificially low because Thanksgiving fell so late this year. It's hard to draw any major conclusions based on the last couple weeks.

As for the Fed, it's hardly abandoning the economy. While Chairman Ben Bernanke said it will likely continue to pare back its asset purchase plan throughout 2014, the group also said that it likely will keep the federal funds rate at near-zero levels "well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the Committee's 2% longer-run goal. "You can bet that had something to do with the market pop the day the taper was announced.

Since our last newsletter, the S&P 500 returned 1.4%, while the Hot List returned -2.1%. So far in 2013, the portfolio has returned 29.9% vs. 26.9% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 252.2% vs. the S&P's 80.9% gain.

The Year In Review

The year is fast drawing to a close, and since this is our last newsletter before the New Year, it's a good time to take a look back at what has worked, and what hasn't, for the Hot List and my other guru-inspired portfolios in 2013.

Overall, it has been a very strong year for the market, and an even better year for my models. Ten of the fourteen 10-stock portfolios we track are beating the market, most by a wide margin. These 14 portfolios have averaged a 35.6% return this year, 8.6 percentage points better than the S&P 500 (all performance figures here and below through Dec. 18). Several of the portfolios have had truly exceptional years, with three returning more than 55% so far and another three returning between 45% and 55%. Leading the way have been the Peter Lynch-inspired portfolio, up 64.1%, and the Martin Zweig-based portfolio, up 60.8%. Only once before has one of our 10-stock, monthly rebalanced portfolios returned more than 60% in a single year (in 2009, the Joel Greenblatt-inspired portfolio). If the Lynch portfolio keeps up its current pace over the last week and a half of the year, that 64.1% return would be the single highest return we've seen.

There have been laggards, of course. The David Dreman-inspired portfolio has been the worst performer so far this year, gaining just 5.2%. Still, it's ahead of the S&P since its 2003 inception. The Joseph Piotroski-based portfolio and James O'Shaughnessy-based portfolio, meanwhile, have both returned between 8% and 9% this year, also lagging well behind the S&P. The O'Shaughnessy model remains far ahead of the market since its inception in 2003. The Piotroski-based portfolio is right in line with the market since its 2004 inception.

For the Hot List, it has by and large been a very solid year. Through December 18, the portfolio was up 29.7%, about three percentage points ahead of the S&P 500. It has been accurate (meaning that it has made money) on 60% of its picks, led by USANA Health Sciences, which joined the portfolio in late December of 2012 and has remained there for the entire year, gaining nearly 125%. The Hot List also found big winners in two other current holdings, property and casualty insurer HCI Group, up 43% since joining the portfolio in June, and Lear Corporation, up 34% since joining in May. In addition, it picked up a number of stocks that produced solid gains over shorter periods, like small-cap trucking firm SAIA Inc., which gained more than 21% while in the portfolio for just one month in parts of April and May.

The Hot List wasn't perfect, however, choosing some stocks that hurt returns. One was Inter Parfums, which lost more than 20% while in the portfolio for just one month in August. Another is Amtrust Financial Services, which had been faring well until running into some recent trouble (see the "News about Hot List Stocks" section below for more on that). The portfolio picked it up in early July, and will be selling it today on our regularly scheduled rebalancing. Through December 18, shares were down 20%.

All in all though, the year has been a good one for the Hot List. If the portfolio keeps up its current pace for the last week and a half of the year, it will have beaten the S&P 500 in eight of its 11 years since inception (including the partial 2003 year). Now let's take a closer look at some of this year's top performers, as well as one of the laggards.

The Peter Lynch-based Portfolio: The Lynch portfolio has been accurate on an exceptional 83.3% of its picks so far this year. The strategy, which looks for conservatively financed, cash-generating firms with low P/E-to-growth ratios, found several huge winners in 2013, three of which are still in the portfolio. HCI Group gained more than 80% after joining the portfolio on April 12; Bridgepoint Education, which joined the portfolio a week and a half before the start of 2013, is up more than 66%; and Green Dot Corporation, a provider of prepaid debit cards, is up 65% since joining in mid-February. Another big winner was Volterra Semiconductor, which gained about 68% while in the portfolio from mid-April to the end of August. It was a beneficiary of the M&A market, with its shares surging after it reached a deal to be acquired by Maxim Integrated in mid-August.

The missteps for the Lynch portfolio have been few and far between. One of the bigger losing positions was small-cap telecom firm IDT Corporation. Since joining the portfolio on November 22, its shares have fallen about 17%. Overall, however, the losers haven't been nearly enough to derail an exceptional year.

The Martin Zweig-based Portfolio: In posting 60%-plus year-to-date returns, the Zweig-inspired portfolio has been accurate on 75% of its picks. The strategy, which looks for companies with strong, accelerating earnings growth, low debt, and shares that haven't gotten too pricey, didn't find as many huge gainers as the Lynch model did, save for USANA Health Sciences, which gained about 67% while in the portfolio from mid February to November 22. But while it didn't have as many huge gainers, it did have a number of stocks that posted strong gains over relatively short periods. Sturm, Ruger & Company has gained 35% since joining the portfolio on August 2; Chinese tech firm NetEase gained over 24% while in the portfolio from mid-February until June 7; and Questcor Pharmaceuticals gained more than 27% while in the portfolio for less than three months in the first half of the year.

The Zweig portfolio did run into a couple significant losers. They included Alliance Fiber Optic Products, which is down more than 27% since joining the portfolio in late October, and Amtrust Financial Services, which is down about 20% since joining in late August. As with the Lynch portfolio, though, the winners far outweighed the losers this year.

The Motley Fool-based Portfolio: Another stellar year from this portfolio, inspired by the writings of Fool co-creators Tom and David Gardner, has helped it climbed to the top position of all my 10-stock monthly rebalanced portfolios on a long-term basis. It's up 55.9% this year and 394.3% since its 2003 inception, generating nearly five times the returns of the S&P 500 over that decade-plus period. That's an annualized gain of more than 16%.

In 2013, the Fool-based portfolio found several big winners, one of which really stood out above the crowd. HCI Group, the property and casualty insurer that helped boost the Lynch portfolio, has done even more for the Fool portfolio. Since joining in mid-February, HCI is up more than 130%. Other big winners include Noah Holdings Limited, a small-cap financial that serves high wealth clients in China. It gained more than 60% while in the Fool portfolio from early August to November 22. Generic pharmaceutical company Lannett Company, meanwhile, gained close to 40% from September 27 through December 18 (it was scheduled to be sold off on today's rebalancing).

The Fool portfolio was accurate on 60% of its picks during the year, so it did also run into a number of losing positions. One of the larger ones: Virtus Investment Partners, which lost about 24% while in the portfolio from May 10 to September 27. Overall, however, the Fool model again showed that you don't have to be right on much more than 50% or 60% of your picks in order to generate very strong returns. In fact, while it's now my best long-term performer, it has been accurate on just 51.9% of its picks over the long haul. When the winners are stocks like HCI Group, though, that can make for exceptional gains.

The David Dreman-based Portfolio: Most years, a 5.2% return would not land you in the basement. But with stocks surging in 2013, the Dreman portfolio is bringing up the rear. It didn't have a big number of disastrous picks. Telecom Corporation of New Zealand lost about 20% during a two-month stay in the portfolio, and Annaly Capital lost 11% in one stint and 13% in another. But its other major losers were barely in double digits. The problem seemed to be that the portfolio was accurate on only about 47% of its picks, and it lacked the huge gainers of some other portfolios. One of its better picks was Brazil energy giant Petrobras, which gained about 26% in a two-month stint.

As I noted earlier, the Dreman portfolio remains ahead of the S&P since its 2003 inception, by a 97% to 81% margin.

A Key Lesson

One of the biggest lessons to take from the 2013 results, I think, has been the importance of discipline. While it has been a juggernaut in 2013, the Lynch portfolio lagged the S&P 500 by about two percentage points in 2012, and had a dreadful 2011 in which it lost 21.4% while the broader market was flat. If you'd given up on the strategy heading into this year, you've missed out on tremendous gains. Similarly, the Zweig portfolio was about flat last year, while the S&P was gaining 13.4%. If you stuck with the strategy, you've been rewarded with 60%-plus year to date gains. Even the Fool portfolio, despite its exceptional long-term track record, came into 2013 on a down note. It had gained just 1% in 2011 and 4.7% in 2012, with the latter ending its streak of having beaten the market every year since its 2003 inception. Rather than a sign that the strategy was losing its effectiveness, however, the subpar performance turned out to be a great buying opportunity.

That's nothing new. If you're a regular Hot List reader, you know that history's best investors (and our guru inspired strategies) often produce exceptional bounce back gains following short-term periods of underperformance. If you can stay disciplined through those short-term hiccups, you can reap the benefits later, as many of our portfolios did this year. It's hard to do, of course, when things are going badly. But it's an approach that we believe wholeheartedly in, having seen just how successful it can be over more than a decade of implementation. That's why we certainly won't give up on 2013 laggards as we head into 2014. While it's no guarantee, it wouldn't surprise me to see the Dreman and portfolio and some of the other laggards from this year bounce back very strong next year.

Happy holidays and have a healthy, happy New Year. We'll see you in 2014.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Bridgepoint Education Inc (BPI), Amtrust Financial Services, Inc. (AFSI), Stamps.com Inc. (STMP) and Papa John's Int'l, Inc. (PZZA).

The Keepers

6 stocks remain in the portfolio. They are: Usana Health Sciences, Inc. (USNA), Chevron Corporation (CVX), Lukoil (Adr) (LUKOY), Lear Corporation (LEA), Hollyfrontier Corp (HFC) and Hci Group Inc (HCI).

The Newbies

We are adding 4 stocks to the portfolio. These include: Agco Corporation (AGCO), The Tjx Companies, Inc. (TJX), Cnooc Limited (Adr) (CEO) and Alliance Fiber Optic Products Inc (AFOP).

Portfolio Changes

Newcomers to the Validea Hot List

Alliance Fiber Optic Products Inc. (AFOP): This California-based firm ($270 million market cap) makes high performance fiber optic components and integrated modules for the optical network equipment market. Its products enable communications equipment manufacturers to deliver optical networking systems to the rapidly growing long-haul, metropolitan and last-mile access segments of the communications network.

Alliance gets strong interest from my Peter Lynch-based strategy, and high scores from a couple of my other growth models as well. To read more about its fundamentals, scroll down to the "Detailed Stock Analysis" section below.

AGCO Corporation (AGCO) ): Based in Deluth, Ga., AGCO makes tractors, combines, hay tools, sprayers, and forage and tillage equipment. Its products are sold through more than 3,100 independent dealers and distributors across more than 140 countries.

AGCO ($5.6 billion market cap) has taken in more than $10 billion in sales over the past 12 months, and gets approval from my Kenneth Fisher- and Peter Lynch-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

CNOOC Limited (CEO): This oil and natural gas operations giant (the Chinese National Offshore Oil Corporation) has lagged this year amid the China slowdown fears. But the firm ($82 billion market cap) has very strong fundamentals. Three of my models -- those I base on the approaches of Peter Lynch, Warren Buffett and David Dreman -- have strong interest in the stock. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

The TJX Companies (TJX): The parent of Marshalls, T.J. Maxx, and HomeGoods, this frequent Hot List favorite offers brand-named clothing and merchandise at discount prices -- making it attractive when times are good or bad. The $44-billion-market-cap firm has taken in about $27 billion in sales in the past year.

TJX gets approval from my Peter Lynch- and Warren Buffett-based models. To read more about the stock, scroll down to the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Amtrust Financial Services (AFSI): It's been a rough fortnight for Amtrust, the legality of whose accounting practices were questioned in a report from GeoInvesting. The firm's CEO said Amtrust's outlook remains positive and its financial position "has never been stronger," and accused GeoInvesting of trying to manipulate Amtrust's stock price because it has a short position in AFSI. Bronstein, Gewirtz & Grossman, LLC is investigating potential claims on behalf of AFSI purchasers. All of this frightened investors, with Amtrust shares tumbling more than 28% since our last newsletter (as of afternoon trading on Dec. 19). The Hot List is selling its stake in AFSI on today's regularly scheduled rebalancing, as its scores on my models have fallen sharply.

The Next Issue

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

Current Portfolio

Detailed Stock Analysis

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

USNA   |   HCI   |   LUKOY   |   LEA   |   HFC   |   CVX   |   AFOP   |   AGCO   |   TJX   |   CEO   |  

USANA Health Sciences, Inc. develops and manufactures science-based nutritional and personal care products. The Company has operations in 15 markets worldwide, where it distributes and sells its products by way of direct selling. The Company reports operations in two geographic regions: North America and Asia Pacific, which is further divided into three sub-regions; Southeast Asia/Pacific, Greater China, and North Asia. North America includes the United States, Canada, Mexico, and direct sales from the United States to the United Kingdom and the Netherlands. Southeast Asia/Pacific includes Australia, New Zealand, Singapore, Malaysia, and the Philippines; Greater China includes Hong Kong, Taiwan and China; and North Asia includes Japan and South Korea. The Company's customer base consists of two types of customers: Associates and Preferred Customers. As of December 31, 2011, the Company had 222,000 active Associates and 64,000 active Preferred Customers worldwide.

HCI Group Inc, formerly Homeowners Choice, Inc., is a holding company. The Company, through its subsidiaries, is engaged in the property and casualty insurance business. Through Homeowners Choice Property & Casualty Insurance Company, Inc. (HCPC) and subsidiaries, primarily Homeowners Choice Managers, Inc. (HCM), Southern Administration, Inc., Claddaugh Casualty Insurance Company, Ltd., and its subsidiary, HCPCI Holdings LLC, it provides property and casualty homeowners' insurance, condominium-owners' insurance and tenants' insurance to individuals owning property in Florida. Its subsidiaries also include TV Investment Holdings LLC, which owns and operates a marina facility located in Florida; Unthink Technologies Private Limited. During the year ended December 31, 2011, it organized TV Investment Holdings LLC, HCI Holdings LLC and HCI Technical Resources, Inc.

NK Lukoil OAO (Neftyanaya Kompaniya LUKOIL OAO or NK LUKOIL OJSC) is a Russia-based integrated oil and gas company. The Company is engaged in the business of oil exploration, production, refining, marketing and distribution. It is an owner of refineries, gas processing, petrochemical plants and gas stations network located in Russia, Eastern and Western Europe, as well as Africa. The Company's petroleum products are sold in the Russian Federation, the Commonwealth of Independent States (CIS) countries, Eastern and Western Europe, Asia and the United States. NK Lukoil OAO operates through numerous subsidiaries and affiliated companies. In April 2013, the Company acquired a 100% of Samara-Nafta ZAO and completed acquisition of CJSC Kama-Oil. In June 2013, it sold a 99.57% stake in Lukoil Odes'kyi NPZ PAT. The Company's major shareholder is NKO ZAO NRD with a stake of 91.60%.

Lear Corporation is a tier 1 supplier to the global automotive industry. The Company supplies its products to automotive manufacturers with automotive seat systems and related components, as well as electrical distribution systems and related components. The Company has two segments: seating and electrical power management systems (EPMS). The seating segment includes seat systems and related components, such as seat frames, recliner mechanisms, seat tracks, seat trim covers, headrests and seat foam. The EPMS segment includes electrical distribution systems for traditional powertrain vehicles, as well as for hybrid and electric vehicles. As of December 31, 2011, it had 20 joint ventures located throughout Asia, as well as five in North America, two in Europe and Africa and one with operations in all three regions.

HollyFrontier Corporation (HollyFrontier), formerly Holly Corporation, is a petroleum refiner, which produces light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. HollyFrontier operates in two segments: Refining and Holly Energy Partners, L.P. (HEP). The Refining segment includes the operations of its El Dorado, Tulsa, Navajo, Cheyenne and Woods Cross Refineries and NK Asphalt. The HEP segment involves all of the operations of HEP. As of December 31, 2011, it operated five refineries having a combined crude oil processing capacity of 443,000 barrels per day that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. The Company merged with Frontier Oil Corporation (Frontier), on July 1, 2011. On November 9, 2011, HEP acquired from the Company certain tankage, loading rack and crude receiving assets located at its El Dorado and Cheyenne Refineries.

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 activities, power generation and energy services. Upstream operations consist primarily of exploring for, developing and producing crude oil and natural gas; processing, transportation and regasification associated with liquefied natural gas; transporting crude oil by international oil export pipelines; transporting, storage and marketing of natural gas, and a gas-to-liquids project. Downstream operations consist primarily of refining crude oil into petroleum products; transporting crude oil and refined products by pipeline, marine vessel, motor equipment and rail car, and manufacturing and marketing of commodity petrochemicals, plastics for industrial uses and fuel and lubricant additives.

Alliance Fiber Optic Products Inc. (AFOP) designs, manufactures and markets a range of fiber optic components, and integrated modules incorporating these components, for communications equipment manufacturers and service providers. The Company offers a range of products, including interconnect devices that are used to connect optical fibers and components, couplers and splitters that are used to divide and combine optical power, and dense wavelength division multiplexing (DWDM) devices that separate and combine multiple specific wavelengths. The Company's optical passive products include wavelength division multiplexing (WDM), coarse wavelength division multiplexers (CWDM) and DWDM components and modules that utilize thin film filter technologies to separate optical signals, variable attenuators, optical switches and other optical devices utilizing micro optic lensing technology including integrated electro-optical modules incorporating these products.

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.

The TJX Companies, Inc. (TJX) is the off-price apparel and home fashions retailer in the United States and worldwide. As of January 28, 2012, the Company operated in four business segments. It has two segments in the United States, Marmaxx (T.J. Maxx and Marshalls) and HomeGoods; one in Canada, TJX Canada (Winners, Marshalls and HomeSense) and one in Europe, TJX Europe (T.K. Maxx and HomeSense). As a result of the consolidation of the A.J. Wright chain, all A.J. Wright stores ceased operations by the end of February 2011. It completed the consolidation of A.J. Wright, converting 90 of the A.J. Wright stores to T.J. Maxx, Marshalls or HomeGoods banners and closed the remaining 72 stores, two distribution centers and home office. In December 2012, the Company acquired Sierra Trading Post, an off-price Internet retailer.

CNOOC Limited is an investment holding company. The Company, along with its subsidiaries, is a producer of offshore crude oil and natural gas and an independent oil and gas exploration and production company. Its subsidiaries are engaged in exploration, development, production and sales of oil and natural gas. It has three segments: independent operations, operations under joint arrangement and trading business. The Company has four producing areas in offshore China, which include the Bohai Bay, Western South China Sea, Eastern South China Sea and East China Sea. It also has oil and gas assets in Indonesia, Iraq, Australia, Africa, North America and South America. As of December 31, 2012, its subsidiaries included CNOOC China Limited, CNOOC International Limited, China Offshore Oil (Singapore) International Pte Ltd and others.

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.

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