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Executive Summary April 25, 2014

The Economy

While the housing market recovery seems to have stalled, economic data overall has been pretty good over the past fortnight, helping stocks rebound from the pullback we saw in late March and early April.

Retail and food service sales made a big jump in March, for example, rising 1.1%, according to the Commerce Department. They are now about 2.6% above where they stood a year ago -- not a particularly big year-over-year increase, however, despite March's impressive numbers.

The job market also continues to look better than it's looked in a long time. While new claims for unemployment have risen a bit since our last newsletter, the four-week moving average remained almost unchanged. And new claims are about 9% below their year-ago level. Continuing claims, meanwhile, are down about 2.5% since our last newsletter. They are close to 11% below year-ago levels.

As for housing, new data shows that the market continues to level off. Housing starts increased 2.8% in March, according to the Census Bureau, but were 5% below where they were a year ago. Permit issuance for new construction fell 2.4%, but was 9.5% above year-ago levels.

Homebuying activity has also slowed, with lack of inventory pushing prices higher, mortgage rates continuing to rise, and the cold winter possibly delaying some buying activity. New home sales, for example, tumbled 14.5% in March, according to the Census Bureau. That put them 12.2% below their year-ago level. Prices keep rising, however, with March's median new home sales price coming in more than 11% higher than February's. Existing-home sales were essentially flat for the month, according to the National Association of Realtors. Sales were 8.5% below where they were last March, while sales prices were about 8% higher than they were a year ago.

Overseas, China's first quarter GDP growth came in at 7.4%. That was down a bit from 7.7% in the last quarter of 2013, but beat analyst expectations of 7.3%. The figure led to optimism that China may indeed be able to engineer the soft landing it has sought.

Since our last newsletter, the S&P 500 returned 2.5%, while the Hot List returned 2.2%. So far in 2014, the portfolio has returned -10.4% vs. 1.6% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 226.2% vs. the S&P's 87.8% gain.

Portfolio Update

Stocks have been rebounding from the technology- and momentum-stock-driven downturn that rattled markets, and the Hot List portfolio, in March and early April. Whether sentiment has truly shifted or this is simply a pause in a more lengthy correction remains to be seen, of course. But over the past two weeks, the Hot List has fared quite well as the market has turned upward.

As of midmorning trading on April 24, eight of the portfolio's holdings were in the black since our last newsletter, and three had fared particularly well. BofI Holding was leading the way with a 12.5% gain, while Valero Energy and HollyFrontier Corp. were both up 8.6%.

The catalyst for BofI's big upward move was the fact that it reached an agreement to buy the banking arm of the H&R Block. While financial terms of the deal were not disclosed, BofI said that it expects ongoing annual revenue from H&R Block Bank to be $26 million to $28 million starting in fiscal year 2015. BofI had been hit hard in recent weeks amid the momentum-stock-driven downturn, but news about the H&R Block acquisition seemed to hearten investors a good deal.

For Valero and HollyFrontier, there didn't appear to be any company-specific catalysts driving the stocks' gains. But recent increases in gas prices and a widening WTI-Brent spread amid the Ukraine turmoil seem to be helping refiners' shares. In addition, stocks like these also may tend to be subject to more dramatic shifts when the broader market swings, contributing to their recent outperformance.

After a rough start to 2014, the recent gains for the Hot List's holdings are certainly encouraging. We'll see if the rebound continues when we check back in again two weeks from now.

 
Editor-in-Chief: John Reese










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Guru Spotlight: Kenneth Fisher

For decades, the price-to-earnings ratio has been the most widely used valuation measure for stock investors, and a key tool in the arsenals of many of the gurus I follow. While legendary investors like Benjamin Graham, Peter Lynch, and John Neff all used the ratio differently, they and many others agreed that the ratio itself was a key to finding bargain-priced stocks. The investing public and media seem to share their view, with the P/E ratio having long been the only valuation metric that most newspapers include in their daily stock listings.

But in 1984, Kenneth Fisher sent a shockwave through the P/E-conscious investment world. Fisher -- the son of Phillip Fisher, who is known as the "Father of Growth Stock Investing" -- thought there was a major hole in the P/E ratio's usefulness. Part of the problem, he explained in his book Super Stocks, is that earnings -- even earnings of good companies -- can fluctuate greatly from year to year. The decision to replace equipment or facilities in one year rather than in another, the use of money for new research that will help the company reap profits later on, and changes in accounting methods can all turn one quarter's profits into the next quarter's losses, without regard for what Fisher thought was truly important in the long term -- how well or poorly the company's underlying business was performing.

While earnings can fluctuate, Fisher found that sales were far more stable. In fact, he found that the sales of what he termed "Super Companies" -- those that were capable of growing their stock price 3 to 10 times in value in a period of 3 to 5 years -- rarely decline significantly. Because of that, he pioneered the use of a new way to value stocks: the price-to-sales ratio (PSR), which compared the total price of a company's stock to the sales the company generated.

Fisher's findings -- and his results -- helped make the PSR a common part of investment parlance, and helped make him one of the most well-known investors in the world. (He is a perennial member of Forbes' list of "The 400 Richest Americans", his money management firm oversees tens of billions of dollars, and he is one of Forbes' longest running magazine columnists.) The common sense, mostly quantitative approach he laid out in Super Stocks also caught my attention, and led me to create my Fisher-based Guru Strategy.

It's important to note that today, Fisher says his approach to investing has evolved quite a bit since Super Stocks. The key to winning big on Wall Street is knowing something that other people don't, he believes, and when too many people became familiar with PSR investing, he says he needed to find other ways to exploit the market.

So why have I continued to use my Super Stocks-based model? Two reasons: First, Fisher's publisher reissued the book in 2007, with the same PSR focus. Second, the strategy flat out works. Since its July 2003 inception, my 10-stock Fisher-based portfolio has gained 308.0%, or 13.9% annualized, while the S&P 500 gained just 87.5%, or 6.0% annualized (figures through April 23). That makes it one of my most successful long-term strategies.

Price-to-Sales and "The Glitch"

Fisher is a student of investor psychology, and his observations about investor behavior are what led to his PSR discovery. Often, he found, companies will have a period of strong early growth and become the darlings of Wall Street, raising expectations to unrealistic levels. Then, they then have a setback. Their earnings drop, or continue to grow but simply don't keep pace with Wall Street's lofty expectations. Their stocks can then plummet as investors overreact and sell, thinking they've been led astray.

But while investors overreact, Fisher believed that these "glitches" are often simply a part of a firm's maturation. Good companies with good management identify the problems, solve them, and move forward, and as they do the stock's price begins to rise again. If you can buy a stock when it hits a glitch and its price is down, you can make a bundle by sticking with it until it rights the ship and other investors jump on board.

The key in all of this was finding a way to evaluate a firm when its earnings were down, or when it was losing money (remember, you can't use a P/E ratio to evaluate a company that is losing money, because it has no earnings). The answer: by looking at sales, and the PSR.

According to the model I base on Fisher's writings, stocks with PSRs below 1.5 are good values. And the real winners are those with PSR values under 0.75 -- that's the sign of a Super Stock. To find the PSR, Fisher says to take the total value of a company's stock, i.e. its market cap (the per-share price multiplied by the number of shares outstanding). We then divide that number by the firm's trailing 12-month sales.

One note: Because companies in what Fisher called "smokestack" industries -- that is, industrial or manufacturing type firms that make the everyday products we use -- grow slowly and don't earn exceptionally high margins, they don't generate a lot of excitement or command high prices on Wall Street. Their PSRs thus tend to be lower than those of companies that produce more exciting products, Fisher said. He adjusted his PSR target for these firms, and the model I base on his writings looks for smokestack firms with PSRs between 0.4 and 0.8; it is particularly high on those with PSR values under 0.4.

Beyond the PSR

While the PSR was key to Fisher's strategy, he warned not to rely exclusively on it. Terrible companies can have low PSRs simply because the investment world knows they are headed for financial ruin.

Other quantitative measures Fisher used include profit margins (he wanted three-year average net margins to be at least 5%; the debt/equity ratio (this should be no greater than 40%, and is not applied to financial firms); and earnings growth (the inflation-adjusted long-term EPS growth rate should be at least 15% per year).

Fisher also made an interesting observation about companies in the technology and medical industries. He saw research as a commodity, and to measure how much Wall Street valued the research that a company did, he compared the value of the company's stock (its market cap) to the money it spends on research. Price/research ratios less than 5% were the best case, and those between 5 and 10% were still indicative of bargains. Those between 10 and 15% were borderline, while those over 15% should be avoided.

One of the Best

The variety of variables in my Fisher-based model are a big part of why I think it continues to work, long after the PSR has become a well-known stock analysis tool. While it uses the PSR as its focal point, it also makes sure firms have strong profit margins, earnings growth, and cash flows, and low debt/equity ratios. That well-rounded approach helped it get through one of the worst periods for the broader market in history and stay far, far ahead of the market over the long haul -- all while the PSR has been a well-known investing tool. I expect this solid approach will continue to pay dividends over the long haul.

Now, here's a look at the stocks that currently make up my 10-stock Fisher-based portfolio.

AGCO Corporation (AGCO)
Telecom Argentina (TEO)
Navigant Consulting, Inc. (NCI)
Ross Stores Inc (ROST)
Liquidity Services Inc (LQDT)
TrueBlue Inc (TBI)
Hyster-Yale Materials Handling (HY)
Valero Energy Corporation (VLO)
Bed Bath & Beyond Inc. (BBBY)
Foot Locker (FL)




News about Validea Hot List Stocks

BofI Holding Inc (BOFI): BofI shares jumped after it announced it had reached an agreement to purchase H&R Block's banking unit. Financial terms of the deal weren't disclosed, but BofI said that it expects ongoing annual revenue from H&R Block Bank to be $26 million to $28 million starting in fiscal 2015, the Motley Fool reported. The agreement is subject to regulatory approvals and other closing conditions.



The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will rebalance the portfolio. If you have any questions, please feel free to contact us at hotlist@validea.com.


Current Portfolio






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

AGCO   |   VLO   |   DORM   |   HY   |   TBI   |   BOFI   |   SWHC   |   FL   |   HFC   |   CEO   |  



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.





Valero Energy Corporation (Valero) is an independent petroleum refining and marketing company. Valero's refineries can produce conventional gasoline's, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products, as well as a slate of premium products, including conventional blendstock for oxygenate blending and reformulated gasoline blendstock for oxygenate blending, gasoline meeting the specifications of the California Air Resources Board, a diesel fuel, and low-sulfur and ultra-low-sulfur diesel fuel. It also owns 10 ethanol plants in the central plains region of the United States with a combined ethanol nameplate production capacity of about 1.1 billion gallons per year. It operates in three business segments: refining, ethanol, and retail. In May 2013, CST Brands Inc announced that the Company which includes Corner Store and Depanneur du Coin, spun off from Valero Energy Corporation.





Dorman Products, Inc. (Dorman) is a supplier of automotive and heavy duty truck replacement parts and service line products primarily for the automotive aftermarket. The Company market approximately 133,000 different stock keeping units (SKU's) of automotive replacement parts (including brake parts), fasteners and service line products. Original equipment dealer parts are those parts, which were available to consumers only from original equipment manufacturers or salvage yards. These parts include, among other parts, intake manifolds, exhaust manifolds, oil cooler lines, window regulators, radiator fan assemblies, power steering pulleys, harmonic balancers, tire pressure monitor sensors and keyless entry devices. Fasteners include such items as oil drain plugs, wheel bolts, and wheel lug nuts.





Hyster-Yale Materials Handling, Inc. (Hyster-Yale), formerly NMHG Holding Co., , designs, engineers, manufactures, sells and services a line of lift trucks and aftermarket parts. The Company's products are marketed globally under the Hyster and Yale brand names. The Company segments include three management units: Americas, Europe and Asia-Pacific. Americas includes its operations in the United States, Canada, Mexico, Brazil and Latin America. Europe includes its operations in Europe, the Middle East and Africa. Asia-Pacific includes its operations in the Asia-Pacific region and China. Lift trucks and component parts are manufactured in the United States, Northern Ireland, Mexico, The Netherlands, the Philippines, Italy, Japan, Vietnam, Brazil and China. Hyster-Yale has a 20% ownership interest in Hyster-Yale Financial Services, Inc. (NFS). Hyster-Yale is a wholly owned subsidiary of NACCO Industries, Inc. (NACCO).





TrueBlue, Inc. (TrueBlue) is a provider of temporary blue-collar staffing services. The Company has a network of 691 branches in all 50 states, Puerto Rico and Canada, which supply its customers with temporary workers. It operates as Labor Ready for general labor, Spartan Staffing for light industrial services, CLP Resources for skilled trades, PlaneTechs for aviation and diesel mechanics and technicians, and Centerline Drivers for dedicated and temporary drivers to the transportation and distribution industries. In June 2013, Trueblue Inc acquired the assets of Crowley Transportation Services. On September 30, 2013, the Company acquired The Work Connection (TWC).





BofI Holding, Inc. is a holding company for BofI Federal Bank, a diversified financial services company. The Bank operate its bank from a single location in San Diego, California, serving approximately 40,000 retail deposit and loan customers across all 50 states. As of June 30, 2012, it had total assets of $2,386.8 million, loans of $1,799.7 million, mortgage-backed and other investment securities of $483.0 million, total deposits of $1,615.1 million and borrowings of $547.2 million. It distributes its deposit products through a range of retail distributions channels, and its deposits consist of demand, savings and time deposits accounts. It distributes its loan products through its retail, correspondent and wholesale channels, and the loans it retains are primarily first mortgages secured by single family real property and by multifamily real property.





Smith & Wesson Holding Corporation (Smith & Wesson) is a manufacturer of firearms. The Company manufactures a range of handguns, modern sporting rifles, hunting rifles, black powder firearms, handcuffs, and firearm-related products and accessories for sale to a range of customers, including gun enthusiasts, collectors, hunters, sportsmen, competitive shooters, individuals desiring home and personal protection, law enforcement and security agencies and officers, and military agencies in the United States and globally. It sells its products under the Smith & Wesson brand, the M&P brand, the Thompson/Center Arms brand, and the Performance Center brand. The Company manufactures its firearm products at its facilities in Springfield, Massachusetts and Houlton, Maine.





Foot Locker, Inc. is a global retailer of shoes and apparel, operating 3,335 primarily mall-based stores in the United States, Canada, Europe, Australia, and New Zealand as of February 2, 2013. The Company operates in two segments: Athletic Stores and Direct-to-Customers. The Athletic Stores segment is an athletic footwear and apparel retailer whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports, Footaction, and CCS. The Direct-to-Customers segment includes Footlocker.com, Inc. and other affiliates, including Eastbay, Inc. and CCS, which sell to customers through Internet websites, mobile devices, and catalogs. In September 2013, the Company acquired Runners Point Warenhandels GmbH (Runners) from Hannover Finanz GmbH.





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.





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.





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.

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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.