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Executive Summary August 14, 2015

The Economy

While investors have been worrying about China's currency devaluation, things at home continue to look good, with a solid jobs report and stellar service sector growth highlighting a nice fortnight of data for the US.

The economy added 215,000 jobs during July, the Labor Department said, with the unemployment rate holding at 5.3%, equaling the lowest it has been since April 2008. The jobs-added figures for June and May were also revised higher by a total of 14,000. The broader "U-6" unemployment rate (which unlike the headline number takes into account those working part-time who want full-time work, and discouraged workers who have given up looking for a job) fell to 10.4%, the lowest it has been since June 2008.

Average hourly wages rose at a 2.4% annualized rate vs. June, and average weekly wages jumped at a 6% annualized pace, as hours worked per week also edged higher.

Good news came from the service sector, which expanded in July for the 66th straight month, according to the Institute for Supply Management, doing so at the fastest pace since ISM started tracking an overall service sector index in 2008. New orders also jumped, hitting a 10-year high. Employment conditions improved markedly in the sector, with the employment sub-index also making a 10-year high.

The manufacturing sector, meanwhile, expanded for the 31st straight month, according to ISM, doing so at a slightly slower pace vs. June. New orders growth ticked higher and is at a very healthy level, while employment conditions improved but not as much as they did in June.

Personal income jumped 0.4% in June, according to the Commerce Department.. Real disposable personal income rose 0.2%, while real personal consumption expenditures were flat. That meant the personal savings rate moved slightly higher to 4.8%, from 4.6%.

Elsewhere, retail and food service sales jumped 0.6% in July, according to a new report from the Census Bureau. Compared to the year-ago period, they were up 2.9%, one of the better year-over-year gains we've seen in recent months.

Gas prices are falling again. A gallon of regular unleaded on average cost $2.59 as of August 12, down from $2.77 a month earlier, according to AAA. That's about 25% below where it was a year ago.

Since our last newsletter, the S&P 500 returned -1.2%, while the Hot List returned -7.8%. So far in 2015, the portfolio has returned -1.2% vs. 1.2% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 219.7% vs. the S&P's 108.3% gain.

Portfolio Update

There's no getting around it: It has been a horrible fortnight for the Hot List. Through August 12, the portfolio had lost more than 7 percent since our last newsletter, the wide lead that it has enjoyed over the broader market just about all year evaporating.

Two big losers drove the declines. The first was Lumber Liquidators (LL), the much-maligned flooring company whose shares tumbled earlier this year amid allegations that the firm used wood products that had excessive levels of potentially dangerous chemicals in them. My models indicated that Lumber Liquidators shares had been hit too hard amid the scandal and snatched the stock up as a beaten-down value play in June. But last week, the firm reported that it lost $20.3 million, or 75 cents per share, in the second quarter, falling well short of the per-share profit of 7 cents that analysts expected, according to a poll by Zacks Investment Research. Revenue was down 5.8% from a year earlier and also short of the $256.9 million that Wall Street was looking for, according to the Associated Press, which added that the firm said it was unable to give a full-year outlook. Shares plunged 34% in the two days following the announcement.

The other big loser was Heritage Insurance Holdings Inc. (HRTG), which fell 25% in the three days following its latest quarterly report. Heritage reported second-quarter profit of $25.4 million, a 166% increase over the year-ago quarter, beating analysts' estimates. Total revenue more than doubled. But a couple factors may have spooked investors. One is that Heritage filed documents with the Securities and Exchange Commission stating that it plans to sell "from time to time" up to $400 million of various types of debt and equity securities, including common stock, preferred stock, debt, warrants and units. Investors don't like it when a company needs to raise external cash, so the possibility of Heritage issuing new shares may be worrying them, even though Heritage's CEO said the company has "no immediate plans of issuing any equity securities pursuant to the shelf registration in the near future. Shelf registration filings are common for public companies following the first anniversary of their IPO." The Insurance Insider also said investors seem to be reacting to Heritage's more cautious growth outlook.

When you're running a concentrated, quantitative portfolio, you are unfortunately going to get occasional big losers like these. Over the long term, as the gurus have shown, snatching up shares of beaten-down value picks with solid fundamentals like Lumber Liquidators is a winning strategy. In this case, the firm's disappointing quarter and the extreme negative sentiment around the stock have combined to cause trouble.

Investing is about the long-term however, so we'll continue to stick to our knitting, and I expect the Hot List to bounce back strong over the long haul. Lumber Liquidators and Heritage have both started to rebound from their respective declines -- we'll check back in our next newsletter and see whether they are continuing to make up ground.

 
Editor-in-Chief: John Reese












Guru Spotlight: John Neff

In the middle of 1999, most investors were snatching up shares of high-priced, flashy tech companies as the decade-old bull market soared higher and higher. Not John Neff. In June of that year, Neff, who in his three-plus decades overseeing the Windsor fund compiled one of the greatest track records ever, was writing this in his book John Neff On Investing:

Taken from John Neff on Investing (John Wiley & Sons, 1999)

Screen shot 2014-11-04 at 5.44.27 PM



Nine months later, the tech bubble had burst and the bull was over. Neff was right, and all those investors who had piled into pricey technology stocks saw their portfolios get hammered.

In his sage prediction, Neff demonstrated two qualities shared by just about every great investor that I have studied: a willingness to go against the crowd, and the belief that fundamentals are the key to good investing. Such beliefs can be very difficult to put into practice during times like the Internet bubble. It will seem like the whole world is against you, and that you are missing out and going to be forever left behind other investors. But over the long term, buying flashy, high-priced stocks of poor companies just doesn't work, no matter how much short-term success such stocks may have.

Those who have the courage and discipline to go against the crowd end up being far better off. While Neff stopped managing money in the mid-1990s, it's a good bet that his value strategy -- which looks for firms with moderate earnings and revenue growth that trade at between 40% and 60% of the broader market P/E ratio -- would've fared quite well amid the tech crash. Using such a strategy, it is unlikely that he would have held many, if any, tech stocks leading up to the crash. At the time, many hot tech plays were all hype and no substance -- the type of picks that a fundamental-focused investor like Neff wouldn't touch. Other value-focused managers who avoided overpriced tech plays, like David Dreman, Warren Buffett, and Joel Greenblatt, did, in fact, produce exceptional returns while most investors were watching their flashy tech stocks get pummeled.

Whatever the specifics of the strategy that you use to invest in stocks, you should be a lot better off if you exercise the type of independent thinking and fundamental-focused mentality that Neff demonstrated while the tech bubble was inflating and popping.



News about Validea Hot List Stocks

AmTrust Financial Services (AFSI): AmTrust reported second-quarter earnings of $79.4 million, or 84 cents per share. Adjusted for non-recurring costs and amortization costs, earnings were $1.55 per share, up 16% from the year-ago period and beating the average estimate of four analysts surveyed by Zacks Investment Research of $1.34 per share. The insurer posted revenue of $1.1 billion, up 10% from a year ago.

AmTrust also approved a 20% increase to its quarterly dividend, and announced that it has entered into an agreement to acquire Amsterdam based, N.V, Nationale Borg-Maatschappij and its affiliates from Egeria and HAL Investments for 154 million euro, an amount which is subject to adjustment based upon Nationale Borg's tangible book value at time of closing. Nationale Borg is a 120 year old international direct writer and reinsurer of surety and trade credit insurance in over 70 countries. Pending regulatory approval, the parties anticipate closing will occur by year-end 2015.



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

GTLS   |   JLL   |   SAFM   |   FL   |   AAPL   |   AFSI   |   SC   |   EGBN   |   HRTG   |   LL   |  



Chart Industries, Inc. (Chart) is a diversified manufacturer of engineered equipment engineered equipment for the industrial gas, energy, and biomedical industries. The Company's equipment and engineered systems are used for low-temperature and cryogenic applications. It operates through three segments: Energy & Chemicals (E&C), Distribution & Storage (D&S) and BioMedical. Its products include vacuum insulated containment vessels, heat exchangers, cold boxes and other cryogenic components. Its E&C and D&S segments manufacture products used in energy-related and industrial applications, such as the separation, liquefaction, distribution and storage of hydrocarbon and industrial gases. Through its BioMedical segment, it supplies cryogenic and other equipment used in the medical, biological research and animal breeding industries. The Company, through Thermax, Inc., provides cryogenic fluid vaporizers utilized in industrial gas, petro-chemical and liquefied natural gas applications.





Jones Lang LaSalle Incorporated (JLL) is a financial and professional services firm specializing in real estate. The Company operates through four business segments. JLL provides real estate services through three business segments: the Americas, Europe, the Middle East and Africa (EMEA), and Asia Pacific. JLL's fourth business segment is LaSalle Investment Management (LaSalle). The Company provides a range of integrated property, project management and transaction services locally, regionally and globally through its Americas, EMEA and Asia Pacific operating segments. The Company manages its investment management business globally as LaSalle. The Company provides a range of real estate services to real estate owners, occupiers, investors and developers for a range of property types. The Company offers its products and services under the JLL, LaSalle Investment Management and Tetris brands.





Sanderson Farms, Inc. is a poultry processing company which is engaged in the production, processing, marketing and distribution of fresh and frozen chicken and other prepared chicken items. In addition, the Company is engaged in the processing, marketing and distribution of prepared chicken through its wholly owned subsidiary, Sanderson Farms, Inc. (Foods Division). It produces a range of processed chicken products and prepared chicken items. 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, and casual dining operators in the south-eastern, south-western, north-eastern and western United States and to customers who resell frozen chicken into export markets. During the fiscal year ended October 31, 2013 (fiscal 2013), it processed 452 million chickens, or over 3.0 billion dressed pounds.





Foot Locker, Inc. is a retailer of shoes and apparel. 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 SIX:02, as well as the retail stores of Runners Point Group, including Runners Point and Sidestep. The Direct-to-Customers segment includes Footlocker.com, Inc. and other affiliates, including Eastbay, Inc., and the direct-to-customer subsidiary of Runners Point Group, which sell to customers through their Internet and mobile sites and catalogs. As of January 31, 2015, the Company operated 3,423 primarily mall-based stores in the United States, Canada, Europe, Australia and New Zealand. As of January 31, 2015, the Company operated a total of 78 franchised stores, of which 31 are in the Middle East, 27 in Germany and Switzerland, and 20 in the Republic of Korea.





Apple Inc. designs, manufactures and markets mobile communication and media devices, personal computers and portable digital music players and sells a variety of related software, services, peripherals, networking solutions and third-party digital content and applications. The Company's products and services include iPhone, iPad, Mac, iPod, Apple TV, a portfolio of consumer and professional software applications, the iOS and OS X operating systems, iCloud and a variety of accessory, service and support offerings. The Company offers a range of mobile communication and media devices, personal computing products and portable digital music players, as well as a variety of related software, services, peripherals, networking solutions and third-party hardware and software products. The Company's primary products include iPhone, iPad, Mac, iPod, iTunes, Mac App Store, iCloud, Operating System Software, Application Software and Other Application Software.





Amtrust Financial Services, Inc. is an insurance holding company. Through its wholly owned subsidiaries, the Company provides specialty property and casualty insurance focusing on workers' compensation and commercial package coverage for small business, specialty risk and extended warranty coverage, and property and casualty coverage for middle market business. The Company operates through three segments. The Small Commercial Business segment provides workers' compensation and commercial package and other property and casualty insurance products. The Specialty Risk and Extended Warranty segment provides coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans. The Specialty Program segment provides workers' compensation, package products, general liability, commercial auto liability, excess and surplus lines programs and other specialty commercial property and casualty insurance.





Santander Consumer USA Holdings Inc. is a holding company. The Company is a specialized consumer finance company focused on vehicle finance and unsecured consumer lending products. The Company offers various auto financing products and services to Chrysler customers and dealers under the Chrysler Capital brand. These products and services include consumer retail installment contracts and leases, as well as dealer loans for inventory, construction, real estate, working capital and revolving lines of credit. The Company also originates vehicle loans through a Web-based direct lending program, purchases vehicle retail installment contracts and services automobile and recreational and marine vehicle portfolios for other lenders. Its products and services include vehicle finance, and origination and servicing.





Eagle Bancorp, Inc. is a bank holding company for EagleBank (the Bank). The Bank is the Company's principal operating subsidiary. The Bank is a chartered commercial bank. The Bank operates twenty two banking offices: seven in Montgomery County, Maryland; five located in the District of Columbia, and ten in Northern Virginia. The Bank offers a range of commercial banking services to its business and professional clients, as well as consumer banking services to individuals living or working in the service area. The Bank also provides commercial banking services to sole proprietorships, small, medium and large-sized businesses, partnerships, corporations, non-profit organizations and associations, and investors. The Bank offers a range of retail banking services to accommodate the individual needs of both corporate customers as well as the community the Bank serves. The Bank also offers online banking, mobile banking and a remote deposit service.





Heritage Insurance Holdings, Inc. (Heritage Insurance), formerly Heritage Insurance Holdings, LLC, is a property and casualty insurance holding company. The Company is engaged in providing personal and commercial residential insurance. Through Its subsidiary, Heritage Property & Casualty Insurance Company (Heritage P&C), it provides personal residential insurance for single-family homeowners and condominium owners, rental property insurance and commercial residential insurance in the state of Florida. The Company is vertically integrated and control or manage all aspects of insurance underwriting, actulato analysis, distribution and claims processing, and adjusting. It has approximately 207,000 personal residential policies in force and approximately 2,400 commercial residential policies in force.





Lumber Liquidators Holdings, Inc. (Lumber Liquidators) is a retailer of hardwood flooring, and hardwood flooring enhancements and accessories in North America. The Company's product categories include Solid and Engineered Hardwood; Laminate; Bamboo, Cork and Vinyl Plank, and Moldings and Accessories. The Company sells its products primarily to homeowners or to contractors on behalf of homeowners. The Company offers wood flooring under18 brand names, led by Bellawood, a collection of solid and engineered hardwood flooring, bamboo flooring, moldings and accessories. The Company also offers a range of flooring enhancements and installation accessories, including moldings, noise-reducing underlay and tools. It offers around 400 different flooring product stock-keeping units. As of February 23, 2015, Lumber Liquidators operated around 354 stores located in 46 states of the United States and nine store locations in Canada.





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.





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