Economy & Markets

As the markets awaited the quarterly GDP number, due out on Friday, the much-discussed big technology stocks that make up the FANG group lost their momentum in the last week, first Netflix and then Facebook. Since they have had such an outsized influence on the broad market's gains this year, their deterioration has also proven a challenge for the indexes. But small cap and non-tech stocks have risen to the occasion. With Facebook off nearly 20% on Thursday alone, weighing on the tech-heavy Nasdaq, the broader S&P 500 was holding steady. Trade war fears have eased, and expectations are high for a solid number on economic growth even as the Federal Reserve raises rates. The S&P 500 is trading at a multiple of 24.4, while the Dow Jones Industrial Average trades at 23.4.

Some positive numbers:

1. The Commerce Department said orders for non-defense capital goods rose 0.6% in June. The closely watched proxy for business spending was running higher than expected.

2. Speaking of expectations, a Bloomberg survey has people looking for U.S. gross domestic product expanding at a 4.3% annualized rate in the second quarter, with a forecast as high as 5.4%.

3. The Richmond Fed's manufacturing index fell 1%, to 20, in July, beating the consensus of 19. A reading above zero means conditions are improving.

Some not-so-positive numbers:

1. New home sales fell 5.3% in June, the weakest reading of the year and an 8-month low.

2. China's currency, the yuan, is down 15% against the U.S. dollar this year, as President Trump threatens a trade war against the world's second-largest economy.

3. Initial jobless claims, viewed as a proxy on layoffs, rose by 9,000 last week from the lowest level in nearly 50 years.

Recommended Reading

A Morgan Stanley index that examines the correlations among regions and asset classes has reached its peak and may signal a flight to safety by investors. It's at its highest level since late 2016, according to this article in Bloomberg. What's more, while there have been other such flights to safety in the recent past, the signal may be calling for a prolonged period of risk aversion. It could be the canary in the coal mine the bears have been looking for. Here are some other articles and blog posts, in case you missed them:

FANG Influence For 2018, 99% of the market return can be attributed to just a handful of tech stocks, the ones known as FANG. The average return of the five was about 37%. How could an investor have identified these momentum stocks in advance? Read more

Business Signals Peaks in small business owner sentiment often precede short-term stock declines, according to Bloomberg. A recent National Federation of Independent Business survey found a record 34% of small business owners said now is a good time to expand. But that's not what the data say. Read more

Bond Call Rising rates are making some bonds look more attractive than real estate investment trusts, which had been a hot destination for dividend-seeking investors. REIT performance often moves in the opposite direction of rates, according to Wells Fargo's John LaForge. Read more

Berkshire Succession Warren Buffett doesn't seem ready to leave his Berkshire Hathaway completely in the hands of a successor, and some are asking for more information about his plans. Barron's recently invited readers to send in letters they might write to Buffett. One such letter explained by Buffett should be more transparent about succession plans. Read more

Earnings Expectations Earnings growth has remained strong, boosting the bull market, but it is expected to slow down by next year. Some argue the most recent gains are the result of tax cuts boosting profit. The question is whether a slow-down in growth next year will put a stop to the boom times. Read more

Total Return There are 8 elements that determine a portfolio's total return, writes Barry Ritholtz in Bloomberg. Obviously security selection is the first. Then there are costs and expenses, the allocation of the portfolio, the timing of the investment and the length it is held, and then some other factors that could offset some of the earlier elements. Read more

Bond Factors Larry Swedroe recently wrote an article for ETF.com describing how factor investing can apply to fixed income. He cites a study by AQR of value, momentum, carry and defensive factors. The study concluded that fixed income style investing can provide diversification benefits and boost returns. Read more

Fund Timing Morningstar recently looked at whether investors were timing their investments well, looking at the degree to which the typical investor captured or didn't capture a fund's total return. The average investor return for 10 years was 5.53%, versus 5.79% for the average fund. Read more

Economic Disruptors The U.S. economy is strong but there are a few elements that are vulnerable to disruption, according to Allianz chief Mohamed El-Erian. Global synchronized growth is breaking down and central banks are not trying to actively tamp down volatility. Emerging markets are also vulnerable to the strong U.S. dollar. Read more

Contrarian Rules It's tough to be a contrarian investor without following a couple of rules to avoid some of the most obvious errors. The best condition for contrarian investing is when investors are behaving irrationally. Look for herding behavior, a recent Morningstar article recommends. That indicates the market is getting more fragile. Read more

Factor Overload The hunt for factors has gone too far, according to new research by professors at University of Chicago and Yale. Many of the newer discovered factors may actually be subsets of existing factors, and are thus redundant. They could even suggest overuse of data mining. Read more

Opportunity Missed There's no rush to push the sell button, according to J.P. Morgan's Samantha Azzarello. The late-stage bull market could be prolonged, the bank's global market strategist said in a recent Bloomberg article. Investors bailing during past market run-ups have given up about 46% upside. Read more

Hot List Performance Update

Since our last newsletter, the S&P 500 returned 1.4%, while the Hot List returned -1.0%. So far in 2015, the portfolio has returned -6.5% vs. 6.1% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 240.0% vs. the S&P's 183.6% gain.


The Fallen

As we rebalance the Validea Hot List, 3 stocks leave our portfolio. These include: Universal Forest Products, Inc. (UFPI), Thor Industries, Inc. (THO) and Acuity Brands, Inc. (AYI).

The Keepers

7 stocks remain in the portfolio. They are: Magna International Inc. (Usa) (MGA), Credit Acceptance Corp. (CACC), Sanderson Farms, Inc. (SAFM), Schnitzer Steel Industries, Inc. (SCHN), Seacoast Banking Corporation Of Florida (SBCF), Trinet Group Inc (TNET) and New Residential Investment Corp (NRZ).

The New Additions

We are adding 3 stocks to the portfolio. These include: Alliance Data Systems Corporation (ADS), Argan, Inc. (AGX) and Arista Networks Inc (ANET).

Latest Changes

Additions  
ALLIANCE DATA SYSTEMS CORPORATION ADS
ARGAN, INC. AGX
ARISTA NETWORKS INC ANET
Deletions  
UNIVERSAL FOREST PRODUCTS, INC. UFPI
THOR INDUSTRIES, INC. THO
ACUITY BRANDS, INC. AYI

Process, Not Politics

President Donald Trump's election in late 2016 ushered in a huge rally in U.S. stocks, as investors looked forward to deregulation and a more business-friendly administration aimed at creating jobs and economic growth. Of course, the economy was already well into a nearly decade long recovery from the financial crisis of 2008, when another president of the opposite party was elected.

Often, investors fear a change of control in Washington, Democrat or Republican, because it means at least a temporary period of instability. What is remarkable about the last year and a half is the unrelenting optimism in the market - with a couple of notably hiccups - and an uptick in economic growth spurred in part by a massive corporate tax cut pushed through by the GOP administration and a GOP-dominated Congress. People are looking to the fall to see if Republicans can hold on to that majority.

Despite conventional wisdom, Democrats are better for stocks than Republicans. A working paper by two University of Chicago researchers last year, which expanded on earlier research, found that from 1927 through 2015, the stock market had excess returns of 10.7 percent under Democrat presidents and negative 0.2 percent under Republicans.

The researchers, Lubos Pastor and Pietro Veronesi, called this the "presidential puzzle." They surmised that when investors are risk adverse, they gravitate to Democrats. And when risk aversion is low, such as during boom times, they go for Republicans. It's not a coincidence Democrats were elected to succeed Republican presidents immediately following the two big market crashes, 1929 and 2008,that happened during that span of time. But it's not that Democrats were seen as better for the economy, it's the timing. Voters choose Democrats when the economy had taken a dive and was more likely to rebound.

A president's economic plan is just one of many factors that drive the economy and stock market. President Trump inherited a stock market that had recovered from the 2008 freefall, and an economy that was already well on its way to recovery.

Persistently low interest rates were heading up as the Fed promised to return things to more normal conditions after a decade of easy money. Trump's promise to cut regulation and taxes added momentum to the economic growth story. But he has more recently talked about tariffs and trade wars, which could complicate this growth narrative.

Economic and market crises aren't a new phenomenon. Ten years ago, the world endured a financial crisis that shook investors' resolve and fear and negativity made people question whether stocks would ever come back. The investors who held firm benefited from a massive rebound within two years' time. In fact, each time, the market has done more than bounce back, it has gone on to new highs.

Stocks have these bounce-backs when they are least expected, and the turnarounds come swiftly. In the first 40 days of a bull market, stocks regain about one-third what they lost during the most recent downturn, according to Money magazine.

The coming period will thus be dangerous for many investors, who have been lulled into complacency during an unprecedented decade-long bull run that seems to have no end in sight. It's not that the market or economy are on the precipice of another Great Depression or even a massive bubble-bursting as we had seen in 2000.

The danger, rather, is that every day the bull market continues, those investors will be more and more tempted to pile in in a "fear of missing out" frenzy. And if they do bail and markets do fall, they will be tempted to stay on the sidelines far longer than they should, missing out on a major portion of the rebound. That's why at Validea we use processes and models that take the guesswork and emotion out of the equation as much as possible. We'll keep sticking our guru-based strategies and our disciplined approach, which we believe will help us ride through the volatility and help us reap the rewards for our patience.

Newcomers to the Hot List

Alliance Data Systems Corp. (ADS) - The customer loyalty program software provider sores highly on the models tracking John Neff, Warren Buffett, Martin Zweig and Peter Lynch.

Argan, Inc. (AGX) - The construction engineering company scores highly on the models tracking Peter Lynch, Kenneth Fisher and Benjamin Graham.

Arista Networks, Inc. (ANET) - The cloud network solutions provider scores highly on Validea's small cap and momentum stock model portfolios.

News on Hot List Stocks

Alliance Data Systems said its CFO, Charles Horn, announced plans to retire in 2019, setting off the company's succession planning that will include both internal and external candidates.

Seacoast Banking Corp. reported second quarter profit of $17 million or 35 cents a share, more than double last year.

Sanderson Farms declared a regular quarterly dividend of 32 cents a share payable Aug. 14 to stockholders of record as of July 31.

New Residential Investment announced second quarter profit of $174.8 million, or 51 cents a share.


Portfolio Holdings
Ticker Date Added Return
CACC 3/9/2018 12.1%
AGX 7/27/2018 TBD
SCHN 6/29/2018 1.6%
ADS 7/27/2018 TBD
ANET 7/27/2018 TBD
TNET 6/29/2018 3.8%
SBCF 5/4/2018 19.7%
NRZ 5/4/2018 0.1%
MGA 6/29/2018 1.3%
SAFM 4/6/2018 -12.1%


Guru 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

CACC   |   AGX   |   SCHN   |   ADS   |   ANET   |   TNET   |   SBCF   |   NRZ   |   MGA   |   SAFM   |  

CREDIT ACCEPTANCE CORP.

Strategy: Patient Investor
Based on: Warren Buffett

Credit Acceptance Corporation offers financing programs that enable automobile dealers to sell vehicles to consumers. The Company's financing programs are offered through a network of automobile dealers. The Company has two Dealers financing programs: the Portfolio Program and the Purchase Program. Under the Portfolio Program, the Company advances money to dealers (Dealer Loan) in exchange for the right to service the underlying consumer loans. Under the Purchase Program, the Company buys the consumer loans from the dealers (Purchased Loan) and keeps the amounts collected from the consumer. Dealer Loans and Purchased Loans are collectively referred to as Loans. As of December 31, 2016, the Company's target market included approximately 60,000 independent and franchised automobile dealers in the United States. The Company has market area managers located throughout the United States that market its programs to dealers, enroll new dealers and support active dealers.

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 2.16, 4.61, 5.67, 7.07, 8.58, 10.54, 11.92, 14.28, 16.31, 29.14. Buffett would consider CACC's earnings predictable. In fact EPS have increased every year. CACC's long term historical EPS growth rate is 30.3%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 16.0% 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 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 CACC, over the last ten years, is 31.1%, 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 19.6%, 28.7%, 32.7%, 33.6%, 33.3%, 32.2%, 35.0%, 31.3%, 27.6%, 36.6%, and the average ROE over the last 3 years is 31.8%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON ASSETS: PASS

Buffett also requires, for financial companies, that the average Return On Assets (ROA) be at least 1% and consistent. Return On Assets is defined as the net earnings of the business divided by the total assets of the business. The average ROA for CACC, over the last ten years, is 9.6%, which is high enough to pass. It is not enough that the average be at least 1%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROA must be at least 1% for Buffett to feel comfortable that the ROA is consistent. The ROA for the last 10 years, from earliest to latest, is 5.8%, 12.2%, 11.5%, 10.3%, 9.7%, 9.9%, 8.8%, 8.6%, 7.7%, 11.3%, 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. CACC's free cash flow per share of $28.51 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 $110.28 and compares it to the gain in EPS over the same period of $26.98. CACC's management has proven it can earn shareholders a 24.5% 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. CACC's shares outstanding have fallen over the past five years from 22,940,001 to 19,000,000, 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 CACC 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 $30.58 and divide it by the current market price of $380.70. An investor, purchasing CACC, could expect to receive a 8.03% initial rate of return. Furthermore, he or she could expect the rate to increase 16.0% 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 CACC's initial yield of 8.03%, which will expand at an annual rate of 16.0%, 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]

CACC currently has a book value of $85.74. It is safe to say that if CACC can preserve its average rate of return on equity of 31.1% and continues to retain 100.00% of its earnings, it will be able to sustain an earnings growth rate of 31.1% and it will have a book value of $1,281.45 in ten years. If it can still earn 31.1% on equity in ten years, then expected EPS will be $397.94.


CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now take the expected future EPS of $397.94 and multiply them by the lower of the 5 year average P/E ratio or current P/E ratio (12.4) (5 year average P/E in this case), which is 12.4 and you get CACC's projected future stock price of $4,946.42.


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 $4,946.42. These numbers indicate that one could expect to make a 29.2% average annual return on CACC'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 16.0%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $134.90. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio or current P/E ratio (12.4) (5 year average P/E in this case), which is 12.4. This equals the future stock price of $1,676.83. Add in the total expected dividend pool of $0.00 to get a total dollar amount of $1,676.83.


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 $380.70 and the future expected stock price, including the dividend pool, of $1,676.83. If you were to invest in CACC at this time, you could expect a 15.98% average annual return on your money. Buffett would consider this a great return.


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 16.0% and 29.2%. 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 22.6% on CACC stock for the next ten years, based on the current fundamentals. Buffett would consider this an exceptional return, thus passing the criterion.

ARGAN, INC.

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Argan, Inc. is a holding company. The Company conducts operations through its subsidiaries, Gemma Power Systems, LLC and affiliates (GPS), Atlantic Projects Company Limited (APC), Southern Maryland Cable, Inc. (SMC) and The Roberts Company (Roberts). Through GPS and APC, the Company's power industry services segment provides engineering, procurement, construction, commissioning, operations management, maintenance, development, technical and consulting services to the power generation and renewable energy markets. Through SMC, the telecommunications infrastructure services segment of the Company provides project management, construction, installation and maintenance services to commercial, local government and federal government customers. Through Roberts, the Company's industrial fabrication and field services segment produces, delivers and installs fabricated steel components specializing in pressure vessels and heat exchangers for industrial plants.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratios below 0.75 are tremendous values and should be sought. AGX's P/S of 0.73 based on trailing 12 month sales, is below 0.75 which is considered quite attractive. It passes this methodology's P/S ratio test with flying colors.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. AGX's Debt/Equity of 0.00% is exceptional, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. AGX is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in AGX At this Point

Is AGX a "Super Stock"? NO


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical(non-Smokestack) companies with Price/Sales ratios below .75 are tremendous values and should be sought.AGX's P/S ratio of 0.73 is below .75 which is considered extremely attractive. It passes this methodology's P/S ratio test with flying colors.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. AGX's inflation adjusted EPS growth rate of 19.30% passes the test.


FREE CASH PER SHARE: FAIL

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. AGX's free cash per share of -5.90 fails this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: PASS

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. AGX, whose three year net profit margin averages 9.09%, passes this evaluation.

SCHNITZER STEEL INDUSTRIES, INC.

Strategy: Contrarian Investor
Based on: David Dreman

Schnitzer Steel Industries, Inc. is a recycler of ferrous and nonferrous scrap metal, including end-of-life vehicles, and a manufacturer of finished steel products. The Company operates through two segments: the Auto and Metals Recycling (AMR) business and the Steel Manufacturing Business (SMB). The AMR segment collects and recycles auto bodies, rail cars, home appliances, industrial machinery, manufacturing scrap and construction and demolition scrap from bridges, buildings and other infrastructure. AMR's primary products include recycled ferrous and nonferrous scrap metal. The SMB segment produces finished steel products such as rebar, wire rod, coiled rebar, merchant bar and other specialty products using 100% recycled metal sourced from AMR. SMB's products are primarily used in nonresidential and infrastructure construction in North America. SMB operates a steel mini-mill in McMinnville, Oregon that produces finished steel products using recycled metal and other raw materials.

MARKET CAP: FAIL

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. SCHN has a market cap of $924 million, therefore failing the test.


EARNINGS TREND: PASS

A company should show a rising trend in the reported earnings for the most recent quarters. SCHN's EPS for the past 2 quarters, (from earliest to most recent quarter) 0.62, 1.31 have been increasing, and therefore the company passes this test.


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: PASS

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. SCHN passes this test as its EPS growth rate over the past 6 months (118.33%) has beaten that of the S&P (9.93%). SCHN's estimated EPS growth for the current year is (143.75%), which indicates the company is expected to experience positive earnings growth. As a result, SCHN passes this test.


This methodology would utilize four separate criteria to determine if SCHN is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. SCHN's P/E of 9.14, based on trailing 12 month earnings, meets the bottom 20% criterion (below 12.23), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: PASS

The P/CF of a company should be in the bottom 20% of the overall market. SCHN's P/CF of 5.75 meets the bottom 20% criterion (below 7.14) and therefore passes this test.


PRICE/BOOK (P/B) VALUE: FAIL

The P/B value of a company should be in the bottom 20% of the overall market. SCHN's P/B is currently 1.50, which does not meet the bottom 20% criterion (below 1.13), and it therefore fails this test.


PRICE/DIVIDEND (P/D) RATIO: FAIL

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). SCHN's P/D of 45.66 does not meet the bottom 20% criterion (below 20.00), and it therefore fails this test.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


CURRENT RATIO: PASS

A prospective company must have a strong Current Ratio (greater than or equal to the average of it's industry [2.30] or greater than 2). This is one identifier of financially strong companies, according to this methodology. SCHN's current ratio of 2.20 passes the test.


PAYOUT RATIO: PASS

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for SCHN is 19.42%, while its historical payout ratio has been 77.16%. Therefore, it passes the payout criterion.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 17.96%, and would consider anything over 27% to be staggering. The ROE for SCHN of 19.16% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: FAIL

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. SCHN's pre-tax profit margin is 5.71%, thus failing this criterion.


YIELD: FAIL

The company in question should have a yield that is high and that can be maintained or increased. SCHN's current yield is 2.19%, while the market yield is 2.47%. SCHN fails this test.


LOOK AT THE TOTAL DEBT/EQUITY: PASS

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry of 61.02%. SCHN's Total Debt/Equity of 28.08% is considered acceptable.

ALLIANCE DATA SYSTEMS CORPORATION

Strategy: Patient Investor
Based on: Warren Buffett

Alliance Data Systems Corporation is a provider of data-driven marketing and loyalty solutions serving consumer-based businesses in a range of industries. The Company offers a portfolio of integrated outsourced marketing solutions, including customer loyalty programs, database marketing services, end-to-end marketing services, analytics and creative services, direct marketing services, and private label and co-brand retail credit card programs. The Company operates through three segments: LoyaltyOne, which provides coalition and short-term loyalty programs through the Company's Canadian AIR MILES Reward Program and BrandLoyalty Group B.V. (BrandLoyalty); Epsilon, which provides end-to-end, integrated direct marketing solutions, and Card Services, which provides risk management solutions, account origination, funding, transaction processing, customer care, collections and marketing services for the Company's private label and co-brand retail credit card programs.

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 3.16, 3.06, 3.51, 5.45, 6.58, 7.42, 7.87, 8.85, 7.34, 12.95. Buffett would consider ADS's earnings predictable, although earnings have declined 2 time(s) in the past seven years, with the most recent decline 2 years ago. The dips have totaled 20.2%. ADS's long term historical EPS growth rate is 15.8%, based on the average of the 3, 4 and 5 year historical eps growth rates, and it is expected to grow earnings 11.9% 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 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 ADS, over the last ten years, is 32.1%, 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 36.2%, 58.6%, 781.2%, 154.5%, 61.8%, 44.7%, 21.0%, 26.8%, 25.4%, 38.7%, and the average ROE over the last 3 years is 30.3%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON ASSETS: PASS

Buffett also requires, for financial companies, that the average Return On Assets (ROA) be at least 1% and consistent. Return On Assets is defined as the net earnings of the business divided by the total assets of the business. The average ROA for ADS, over the last ten years, is 2.7%, which is high enough to pass. It is not enough that the average be at least 1%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROA must be at least 1% for Buffett to feel comfortable that the ROA is consistent. The ROA for the last 10 years, from earliest to latest, is 4.6%, 3.1%, 2.2%, 3.0%, 2.7%, 2.9%, 2.5%, 2.4%, 1.7%, 2.3%, 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. ADS's free cash flow per share of $40.58 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 $63.77 and compares it to the gain in EPS over the same period of $9.79. ADS's management has proven it can earn shareholders a 15.4% 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. ADS's shares outstanding have fallen over the past three years from 60,799,999 to 55,000,000, 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 ADS 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 $14.78 and divide it by the current market price of $234.15. An investor, purchasing ADS, could expect to receive a 6.31% initial rate of return. Furthermore, he or she could expect the rate to increase 11.9% 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 ADS's initial yield of 6.31%, which will expand at an annual rate of 11.9%, 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]

ADS currently has a book value of $38.26. It is safe to say that if ADS can preserve its average rate of return on equity of 30.3% and continues to retain 91.57% of its earnings, it will be able to sustain an earnings growth rate of 27.7% and it will have a book value of $442.25 in ten years. If it can still earn 30.3% on equity in ten years, then expected EPS will be $133.93.


CALCULATE THE FUTURE STOCK PRICE BASED ON THE AVERAGE ROE METHOD: [No Pass/Fail]

Now take the expected future EPS of $133.93 and multiply them by the lower of the 5 year average P/E ratio (29.4) or current P/E ratio (current P/E in this case), which is 15.8 and you get ADS's projected future stock price of $2,121.41.


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 $24.30. This gives you a total dollar amount of $2,145.71. These numbers indicate that one could expect to make a 24.8% average annual return on ADS'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 11.9%, based on the analysts' consensus estimated long term growth rate, you can project EPS in ten years to be $45.33. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (29.4) or current P/E ratio (current P/E in this case), which is 15.8. This equals the future stock price of $718.09. Add in the total expected dividend pool of $24.30 to get a total dollar amount of $742.39.


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 $234.15 and the future expected stock price, including the dividend pool, of $742.39. If you were to invest in ADS at this time, you could expect a 12.23% average annual return on your money. Buffett likes to see a 15% return, but nonetheless would accept this return.


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 12.2% and 24.8%. 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 18.5% on ADS stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.

ARISTA NETWORKS INC

Strategy: Growth Investor
Based on: Martin Zweig

Arista Networks, Inc. is a supplier of cloud networking solutions that use software innovations to address the needs of Internet companies, cloud service providers and data centers for enterprise support. It develops, markets and sells cloud networking solutions, which consist of its Gigabit Ethernet switches and related software. The Company's cloud networking solutions consist of its Extensible Operating System (EOS), a set of network applications and its Ethernet switching and routing platforms. The programmability of EOS has allowed it to create a set of software applications that address the requirements of cloud networking, including workflow automation, network visibility and analytics, and has also allowed it to integrate with a range of third-party applications for virtualization, management, automation, orchestration and network services. EOS supports cloud and virtualization solutions, including VMware NSX, Microsoft System Center and other cloud management frameworks.


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. ANET's P/E is 41.22, based on trailing 12 month earnings, while the current market PE is 38.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: PASS

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. ANET's revenue growth is 46.78%, while it's earnings growth rate is 69.57%, based on the average of the 3, 4 and 5 year historical eps growth rates. Sales growth is not at least 85% of EPS growth so the initial part of this criteria is not met, however, since both sales growth and eps growth are greater than 30%, that requirement is waived and the company passes this test.


SALES GROWTH RATE: FAIL

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 (40.8%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (42.7%) of the current year. Sales growth for the prior must be greater than the latter. For ANET this criterion has not been met and fails this test.


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. ANET's EPS ($1.79) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. ANET's EPS for this quarter last year ($1.05) 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. ANET's growth rate of 70.48% 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 ANET is 34.79%. This should be less than the growth rates for the 3 previous quarters which are 30.00%, 143.48% and 145.57%. ANET 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, 98.39%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 70.48%, (versus the same quarter one year ago) then the stock fails, with one exception: if the growth rate in earnings between the current quarter and the same quarter one year ago is greater than 30%, then the stock would pass. The growth rate over this period for ANET is 70.5%, and it would therefore pass this test.


EPS GROWTH FOR CURRENT QUARTER MUST BE GREATER THAN THE HISTORICAL GROWTH RATE: PASS

The EPS growth rate for the current quarter, 70.48% must be greater than or equal to the historical growth which is 69.57%. ANET 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. ANET, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.72, 1.29, 1.67, 2.50 and 6.00, 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. ANET's long-term growth rate of 69.57%, 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. ANET's Debt/Equity (2.01%) is not considered high relative to its industry (46.38%) 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 ANET, this criterion has not been met (insider sell transactions are 233, while insiders buying number 82). Despite the fact that insider sells out number insider buys for this company, Zweig considers even one insider buy transaction enough to prevent an insider sell signal, therefore there is not an insider sell signal and the stock passes this criterion.

TRINET GROUP INC

Strategy: Small-Cap Growth Investor
Based on: Motley Fool

TriNet Group, Inc. is a provider of human resources (HR) solutions for small to medium-sized businesses (SMBs). The Company's HR solutions include services, such as multi-state payroll processing and tax administration, employee benefits programs, including health insurance and retirement plans, workers' compensation insurance and claims management, employment and benefit law compliance, and other services. The Company provides an HR technology platform with online and mobile tools that allow its clients and their worksite employees (WSEs) to store, view and manage their HR-related information and conduct a range of HR-related transactions anytime and anywhere. The Company's HR products and solutions include capabilities, such as technology platform, HR expertise, benefits and compliance. The Company's clients are distributed across a range of industries, including technology, life sciences, financial services, property management, retail, manufacturing and hospitality.


PROFIT MARGIN: FAIL

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. TNET's profit margin of 6.11% fails 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. TNET, with a relative strength of 90, satisfies this test.


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 TNET (87.50% for EPS, and 6.61% for Sales) are not good enough to pass.


INSIDER HOLDINGS: PASS

TNET's insiders should own at least 10% (they own 38.51% ) of the company's outstanding shares which is extremely attractive since the minimum requirement is 10%. A high percentage indicates that the insiders are confident that the company will do well.


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. TNET's free cash flow of $3.01 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

TNET's profit margin has been consistent or even increasing over the past three years (Current year: 5.44%, Last year: 2.01%, Two years ago: 1.19%), 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 TNET's case.


CASH AND CASH EQUIVALENTS: FAIL

TNET does not have a sufficiently large amount of cash, $336.00 million, on hand relative to its size. Although this criteria does not apply to companies of this size, we defined anything greater than $500 million in cash as having 'a lot of cash' to allow analysis of these companies. TNET will have more of a difficult time paying off debt (if it has any) or acquiring other companies than a company that passes this criterion.


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 TNET was 9.74% last year, while for this year it is 9.68%. Since the AR to sales has been flat, TNET passes this test.


LONG TERM DEBT/EQUITY RATIO: FAIL

TNET's trailing twelve-month Debt/Equity ratio (141.22%) is too high, according to this methodology. You can find other more superior companies that do not have 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 (TNET's is 0.17), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. TNET passes this test.

The following criteria for TNET are less important which means you would place less emphasis on them when making your investment decision using this strategy:

AVERAGE SHARES OUTSTANDING: PASS

TNET has not been significantly increasing the number of shares outstanding within recent years which is a good sign. TNET currently has 72.0 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: FAIL

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. TNET's sales of $3,328.4 million based on trailing 12 month sales, are too high and would therefore fail the test. It is companies with $500 million or less in sales that are most likely to double or triple in size in the next few years.


DAILY DOLLAR VOLUME: PASS

TNET passes the Daily Dollar Volume (DDV of $19.5 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. TNET with a price of $58.05 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: FAIL

TNET's income tax paid expressed as a percentage of pretax income either this year (11.00%) or last year (41.22%) is below 20% which is cause for concern. Because the tax rate is below 20% this could mean that the earnings that were reported are unrealistically inflated due to the lower level of income tax paid. However, we have utilized a sophisticated formula so that the appropriate figures reflect a 'normal' tax rate (35%).

SEACOAST BANKING CORPORATION OF FLORIDA

Strategy: P/E/Growth Investor
Based on: Peter Lynch

Seacoast Banking Corporation of Florida is a bank holding company. The Company's principal subsidiary is Seacoast National Bank, a national banking association (the Bank). The Company and its subsidiaries offer an array of deposit accounts and retail banking services, engage in consumer and commercial lending and provide a range of trust and asset management services, as well as securities and annuity products to its customers. The Company, through its bank subsidiary, provides a range of community banking services to commercial, small business and retail customers, offering a range of transaction and savings deposit products, treasury management services, brokerage, and secured and unsecured loan products, including revolving credit facilities, letters of credit and similar financial guarantees, and asset based financing. The Bank also provides trust and investment management services to retirement plans, corporations and individuals.


DETERMINE THE CLASSIFICATION:

This methodology would consider SBCF a "fast-grower".


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (24.43) relative to the growth rate (33.18%), based on the average of the 3 and 4 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 SBCF (0.74) makes it 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. SBCF, whose sales are $206.3 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.


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 SBCF is 33.2%, based on the average of the 3 and 4 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

SBCF is a financial company so debt to equity rules are not applied to determine the company's financial soundness.


EQUITY/ASSETS RATIO: PASS

This methodology uses the Equity/Assets Ratio as a way to determine a financial intermediary's health, as it is a better measure than the Debt/Equity Ratio. SBCF's Equity/Assets ratio (12.00%) is healthy and above the minimum 5% this methodology looks for, thus passing the criterion.


RETURN ON ASSETS: PASS

This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. SBCF's ROA (1.16%) is above the minimum 1% that this methodology looks for, thus passing the criterion.


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 SBCF (3.03%) 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 SBCF (2.11%) 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.

NEW RESIDENTIAL INVESTMENT CORP

Strategy: Contrarian Investor
Based on: David Dreman

New Residential Investment Corp. is a real estate investment trust (REIT). The Company focuses on investing in, and managing, investments related to residential real estate. The Company's segments include investments in excess mortgage servicing rights (Excess MSRs); investments in mortgage servicing rights (MSRs); investments in servicer advances; investments in real estate securities; investments in residential mortgage loans; investments in consumer loans, and corporate. Its portfolio includes mortgage servicing related assets, residential mortgage backed securities (RMBS), residential mortgage loans and other investments. The Company's servicing related assets include its investments in Excess MSRs, MSRs and servicer advances. The Company invests in agency RMBS and non-agency RMBS. The Company's other investments consist of consumer loans.

MARKET CAP: PASS

Medium to large-sized companies (the largest 1500 companies) should be chosen, because they are more in the public eye. Furthermore, the investor is exposed to less risk of "accounting gimmickry", and companies of this size have more staying power. NRZ has a market cap of $6,249 million, therefore passing the test.


EARNINGS TREND: FAIL

A company should show a rising trend in the reported earnings for the most recent quarters. NRZ's EPS for the latest quarter is not greater than the prior quarter, (from earliest to most recent quarter) 1.81, 0.52. Hence the stock fails this test, but the investor should evaluate this company qualitatively to see if it qualifies under this methodology's "exception rule".


EPS GROWTH RATE IN THE IMMEDIATE PAST AND FUTURE: FAIL

This methodology likes to see companies with an EPS growth rate higher than the S&P in the immediate past and a likelihood that this trend will continue in the near future. NRZ fails this test as its EPS growth rate for the past 6 months (-42.22%) does not beat that of the S&P (9.93%).


This methodology would utilize four separate criteria to determine if NRZ is a contrarian stock. In order to eliminate weak companies we have stipulated that the stock should pass at least two of the following four major criteria in order to receive "Some Interest".


P/E RATIO: PASS

The P/E of a company should be in the bottom 20% of the overall market. NRZ's P/E of 4.54, based on trailing 12 month earnings, meets the bottom 20% criterion (below 12.23), and therefore passes this test.


PRICE/CASH FLOW (P/CF) RATIO: PASS

The P/CF of a company should be in the bottom 20% of the overall market. NRZ's P/CF of 5.44 meets the bottom 20% criterion (below 7.14) and therefore passes this test.


PRICE/BOOK (P/B) VALUE: PASS

The P/B value of a company should be in the bottom 20% of the overall market. NRZ's P/B is currently 1.07, which meets the bottom 20% criterion (below 1.13), and it therefore passes this test.


PRICE/DIVIDEND (P/D) RATIO: PASS

The P/D ratio for a company should be in the bottom 20% of the overall market (that is the yield should be in the top 20%). NRZ's P/D of 8.98 meets the bottom 20% criterion (below 20.00), and it therefore passes this test.


This methodology maintains that investors should look for as many healthy financial ratios as possible to ascertain the financial strength of the company. These criteria are detailed below.


PAYOUT RATIO: PASS

A good indicator that a company has the ability to raise its dividend is a low payout ratio. The payout ratio for NRZ is 37.05%, while its historical payout ratio has been 70.07%. Therefore, it passes the payout criterion.


RETURN ON EQUITY: PASS

The company should have a high ROE, as this helps to ensure that there are no structural flaws in the company. This methodology feels that the ROE should be greater than the top one third of ROE from among the top 1500 large cap stocks, which is 17.96%, and would consider anything over 27% to be staggering. The ROE for NRZ of 25.33% is high enough to pass this criterion.


PRE-TAX PROFIT MARGINS: PASS

This methodology looks for pre-tax profit margins of at least 8%, and considers anything over 22% to be phenomenal. NRZ's pre-tax profit margin is 57.78%, thus passing this criterion.


YIELD: PASS

The company in question should have a yield that is high and that can be maintained or increased. NRZ's current yield is 11.14%, while the market yield is 2.47%. NRZ passes this test.

MAGNA INTERNATIONAL INC. (USA)

Strategy: Growth/Value Investor
Based on: James P. O'Shaughnessy

Magna International Inc. (Magna) is a global automotive supplier. The Company's segments are North America, Europe, Asia, Rest of World, and Corporate and Other. The Company's product capabilities include producing body, chassis, exterior, seating, powertrain, electronic, active driver assistance, vision, closure, and roof systems and modules, as well as vehicle engineering and contract manufacturing. The Company has over 320 manufacturing operations and approximately 100 product development, engineering and sales centers in over 30 countries. It provides a range of body, chassis and engineering solutions to its original equipment manufacturer (OEM) customers. It has capabilities in powertrain design, development, testing and manufacturing. It offers bumper fascia systems, exterior trim and modular systems. It offers exterior and interior mirror systems. It offers sealing, trim, engineered glass and module systems. It offers softtops, retractable hardtops, modular tops and hardtops.


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. MGA, with a market cap of $20,602 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. MGA, whose annual EPS before extraordinary items for the last 5 years (from earliest to the most recent fiscal year) were 3.38, 4.44, 4.72, 5.16 and 5.84, 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. MGA's Price/Sales ratio of 0.51, 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. MGA, whose relative strength is 70, is in the top 50 and would pass this last criterion.

SANDERSON FARMS, INC.

Strategy: Price/Sales Investor
Based on: Kenneth Fisher

Sanderson Farms, Inc. is a poultry processing company. The Company is engaged in the production, processing, marketing and distribution of fresh and frozen chicken, and also preparation, processing, marketing and distribution of processed and minimally prepared chicken. It sells ice pack, chill pack, bulk pack and frozen chicken, in whole, cut-up and boneless form, under the Sanderson Farms brand name to retailers, distributors, casual dining operators, customers reselling frozen chicken into export markets. The Company, through its subsidiaries, Sanderson Farms, Inc. (Production Division) and Sanderson Farms, Inc. (Processing Division), conducts its chicken operations. Sanderson Farms, Inc. (Production Division) is engaged in the production of chickens to the broiler-stage. Sanderson Farms, Inc. (Foods Division) is engaged in the processing, sale and distribution of chickens. The Company, through Sanderson Farms, Inc. (Foods Division), conducts its prepared chicken business.


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical (non-Smokestack) companies with Price/Sales ratios below 0.75 are tremendous values and should be sought. SAFM's P/S of 0.65 based on trailing 12 month sales, is below 0.75 which is considered quite attractive. It passes this methodology's P/S ratio test with flying colors.


TOTAL DEBT/EQUITY RATIO: PASS

Less debt equals less risk according to this methodology. SAFM's Debt/Equity of 0.00% is exceptional, thus passing the test.


PRICE/RESEARCH RATIO: PASS

This methodology considers companies in the Technology and Medical sectors to be attractive if they have low Price/Research ratios. SAFM is neither a Technology nor Medical company. Therefore the Price/Research ratio is not available and, hence, not much emphasis should be placed on this particular variable.


PRELIMINARY GRADE: Some Interest in SAFM At this Point

Is SAFM a "Super Stock"? YES


PRICE/SALES RATIO: PASS

The prospective company should have a low Price/Sales ratio. Non-cyclical(non-Smokestack) companies with Price/Sales ratios below .75 are tremendous values and should be sought.SAFM's P/S ratio of 0.65 is below .75 which is considered extremely attractive. It passes this methodology's P/S ratio test with flying colors.


LONG-TERM EPS GROWTH RATE: PASS

This methodology looks for companies that have an inflation adjusted EPS growth rate greater than 15%. SAFM's inflation adjusted EPS growth rate of 19.32% passes the test.


FREE CASH PER SHARE: PASS

This methodology looks for companies that have a positive free cash per share. Companies should have enough free cash available to sustain three years of losses. This is based on the premise that companies without cash will soon be out of business. SAFM's free cash per share of 8.74 passes this criterion.


THREE YEAR AVERAGE NET PROFIT MARGIN: PASS

This methodology looks for companies that have an average net profit margin of 5% or greater over a three year period. SAFM, whose three year net profit margin averages 7.59%, passes this evaluation.


Watch List

The top scoring stocks not currently in the Hot List portfolio.

Ticker Company Name Current
Score
UVE UNIVERSAL INSURANCE HOLDINGS, INC. 68%
LMAT LEMAITRE VASCULAR INC 62%
BMA BANCO MACRO SA (ADR) 53%
THO THOR INDUSTRIES, INC. 51%
LGIH LGI HOMES INC 47%
DHI D. R. HORTON INC 46%
ESNT ESSENT GROUP LTD 46%
WDFC WD-40 COMPANY 43%
PLCE CHILDRENS PLACE INC 43%
BOFI BOFI HOLDING, INC. 42%



Disclaimer

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.