The Economy

After a slow start to the year, the areas of the market that performed best immediately after President Trump's election victory have started to re-assert themselves. In just the last few days, small caps, financials and more economically sensitive areas of the market have started to pick up the pace. A sign of a healthy market is when the majority of sectors are performing well and there is not a bifurcation among stocks. We may be entering that type of period.

On the economic front, US home sales fell in December. Low inventory levels along with higher mortgage rates are impacting the sale of homes. But despite December's figure, 2016 was a good year for housing in the US. More jobs, higher wages and low interest rates were all contributing factors. The number of new housing starts in 2016, as reported by the Commerce Department, was the highest it has been since 2007.

U.S. Manufacturing continues to show signs of stability. On Wednesday, the Richmond Fed Manufacturing Index printed a 12 (vs. an estimate of 6). With the focus on Trump's trade policies and his "America first" economic and manufacturing views, it would appear, based on the data, that manufacturing in the US is doing fine and many businesses may see an even better environment going forward.

The domestic US job market continues to look healthy. U.S. jobless claims came in at 259,000 in the most recent report. Claims have now been below the 300,000 level for 99 consecutive weeks, which is the longest stretch since the 1970s.

It's still early in the fourth quarter earnings season, but so far through Jan. 20th, 61% of companies that have reported have beat the mean EPS estimate for the quarter. Using the reported data so far, earnings are up 3.4% according to FactSet. On a forward basis, the S&P 500 trades at multiple of 16.9 using the estimated 12-month forward earnings of $133.84/share.

One interesting development outside of the economic world, but related to asset management and endowments, was the announcement from Harvard University that it plans to outsource most money management responsibilities and lay off nearly half of the 230 financial professionals that work at Harvard Management Co. Harvard, which has an endowment of around $36 billion, has produced a 10 year return of 5.7% per year, which is well below the return of top ranked performers like Yale and Columbia, which are a little over 8% over that same time. Harvard, unlike many of the other schools, uses a combination of internal and external managers, whereas schools like Yale outsource the vast majority of their money management needs. This has been a difficult 10 years for actively managed strategies. Add to that asset bloat and a complex organization that needs to be simplified, and it's no wonder Harvard is making this move.

Dow 20,000

The Dow Jones Industrial Average hit the 20,000 mark for the first time on Jan. 25th. I view these market milestones as important, but only for a few days. Eventually the market will move on to more significant things, like corporate earnings, valuations, industry developments, fund flows and more. Dow 20,000 is really just a number, nothing more, but the media likes to make it an event, talking about what this means and where we are headed. While I try to stay away from short term market prognostications, I think hitting 20,000 on the Dow presents two important points for investors. The first is the power of long term investing and compounding returns. Over long periods of time, the stock market is one of the best ways to generate long term wealth.

The "rule of 72" as it is called is a simple way to figure out how long it takes an investment to double at an implied rate of return (the formula is 72 divided by the rate of return). For example, if an asset produces a 10% annualized return, it takes 7.2 years (72/10) for an investment in the asset to double in value. Since 1928, the Dow Jones 30 has produced an annualized return of about 10%, including dividends. While 5 year rolling periods can vary a lot in terms of returns, longer term returns, like 20 or 30 year periods, tend to be much closer to the long term averages. A number like Dow 20,000 reminds us of the power of compounding and the long term wealth creation that can be achieved when investing in the markets over time with discipline.

The second point that needs to be discussed in the same breath, and I provide much more on this below, is that returns don't come in a straight line. If you are just getting into the market now or you have funds to put to work, you shouldn't expect the same returns in the market over the next five years that the last five years have generated, and there will be plenty of bumps along the way. The reason that stocks produce the returns they do is because they are risky in the short term. So when you see figures like Dow 20,000 and get excited or think you are missing out, always remember that in the short term stocks are risky, and that you have to stomach that short term volatility to get the long term gains stocks have produced.

As an aside, if you are interested in seeing how the Dow Jones 30 components have changed over the last 120 years, see this neat interactive chart on the WSJ site.

Performance Update

Since our last newsletter, the S&P 500 returned 1.2%, while the Hot List returned 1.1%. So far in 2016, the portfolio has returned 2.3% vs. 2.6% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 216.6% vs. the S&P's 129.6% gain.

Mental Preparedness A Key When Investing in Markets

As the market hits milestones and all-time highs, it might not seem like the best time to talk about market downturns, but one of the most important things in being able to weather market volatility is understanding the risk of equities well in advance and making sure you don't let fear and your emotions overtake you when stocks fall by 20%, 30% or even more. Where there's a bull, there will eventually be a bear, and vice versa. What's impossible to know, however, is when one will end and the other begin. The most important thing is the market ups and downs are inevitable, and how you weather them will be the primary factor in determining your investment success.

The current bull market has been running since 2009, and some may argue, just based on its length, that we are closer to the end of the cycle than the beginning. A MarketWatch article from last March said what the then seven-year-old bull had in longevity, it lacked in "love," quoting Jim Paulsen, chief investment strategist at Wells Capital Management: "I think the most outstanding feature of this bull market compared to history is that it is truly the definition of climbing a 'wall of worry.'" Paulsen cited some macro issues agitating investors at the time, including bailouts of the financial and auto industries, fears of municipal bond market collapse and further trouble in the housing market.

The current bull market has seen some dips, but any corrections have been relatively small in the large-cap space. Revisiting the topic in this month's Barron's, Paulsen writes, "This recovery still appears young at heart" given low GDP growth and the fact that stronger employment numbers are relatively new. That said, Paulsen cites several factors that suggest, "Much of the foundation for an enduring solid bull market has dissipated," including the longevity of this recovery-- which points to a mature U.S. earnings cycle. "Most companies already have exploited the ability to expand profit margins," he argues, adding that "stocks are no longer cheap."

Based on most valuation measures, stocks look expensive at current levels. Based on our internal data going back to 2005, stocks, on average, are trading at a P/E of 23.4, which puts them in the 99% percentile in terms of valuation. This doesn't guarantee a market downturn or pullback, but what I think it indicates is that the market is discounting an improvement in company earnings and if higher profitability doesn't materialize it could be bad for the overall market. Valuations are often looked at as one of the key inputs in estimating future returns. The lower the valuation of a stock, or the overall market, the higher expected future potential return. When valuations have been higher than the historical average, future return often times are lower. This is the warning signal many, including GMO, Jack Bogle, Vanguard, Morningstar and others are making at current levels.

If you were to ask Warren Buffett, who has seen his share of market ups and downs, he might tell you to stick to business fundamentals, rather than stock market trends, when deciding what to buy. As he explained to Berkshire Hathaway investors back in 1992: "If we find a company we like, the level of the market will not really impact our decisions." This is characteristically Buffett-to resist being swayed by 'news', be it good or bad, and instead to stay focused on concrete metrics when making investment decisions. "The market," says Buffett, "is there only as a reference point to see if anybody is offering to do anything foolish. When we invest in stocks, we invest in businesses." His track record speaks for itself.

But who would want to dive into the stock market if, say, it had just fallen by as much as 80%? That's exactly what the great English economist and investor John Maynard Keynes did in the wake of the 1929 crash. He bought stocks throughout the Great Depression and, when they dropped again by nearly 40% in 1937, he bought more. From 1922 through 1946, a period that encompassed the worst market crash, economic depression and war in modern history, Keynes' U.S. stock portfolio outperformed the U.K. stock market by an average of nearly six percentage points annually.

Keynes, like his American contemporary Benjamin Graham, knew that participating in a bear market, rather than attempting the impossible task of side-stepping it, is the best strategy. A concept not foreign to Buffett, who famously said, "Be fearful when others are greedy and greedy when others are fearful."

Buffett also once said, "In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to [20,000]." The stocks market over most 10 or 20 year periods is one of the best ways to grow wealth, but you have to make sure you can stick with stocks in the worst of times to make sure you stay invested during the good times. And you also should understand that the period we've seen since the financial crisis, where the Dow bottomed around 7,000, has been incredibly good for equities and that it's unlikely that those returns will be replicated over the next 5-7 years. Being selective and focusing on stocks with the best fundamentals, like we do here at Validea, is going to be key for many investors as we continue to move throughout this cycle.

Latest Hot List Stock News

INDEPENDENT BANK GROUP INC (IBTX):
On January 25th, Independent Bank Group, Inc. (IBTX) reported net income of $0.79 per diluted share for the quarter ended December 31, 2016 compared to $0.78 per diluted share for the previous quarter. Full year earnings came in at $2.88 per diluted share compared to $2.21 per diluted share for the previous year. The stock was up slightly less than 1% on the news.

Portfolio Holdings
Ticker Date Added Return
SAFM 11/18/2016 12.7%
BMA 7/1/2016 4.2%
BWLD 1/13/2017 4.5%
THO 12/16/2016 1.8%
WDR 11/18/2016 -6.3%
UFPI 12/16/2016 2.5%
TREX 12/16/2016 2.3%
SLF 1/13/2017 -0.8%
LUKOY 12/16/2016 2.7%
IBTX 12/16/2016 3.3%


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

SAFM   |   BMA   |   BWLD   |   THO   |   WDR   |   UFPI   |   TREX   |   SLF   |   LUKOY   |   IBTX   |  

SANDERSON FARMS, INC.

Strategy: Growth Investor
Based on: Martin Zweig

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.


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. SAFM's P/E is 10.92, based on trailing 12 month earnings, while the current market PE is 18.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

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. SAFM's revenue growth is 2.92%, while it's earnings growth rate is 25.52%, based on the average of the 3 and 4 year historical eps growth rates. Therefore, SAFM fails this criterion.


SALES GROWTH RATE: PASS

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 (16.4%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (-1.6%) of the current year. Sales growth for the prior must be greater than the latter. For SAFM this criterion has been met.


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. SAFM's EPS ($3.36) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. SAFM's EPS for this quarter last year ($1.23) 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. SAFM's growth rate of 173.17% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: FAIL

Compare the earnings growth rate of the past four quarters with long-term EPS growth rate. Earnings growth in the past 4 quarters should be at least half of the long-term EPS growth rate. A stock should not be considered if it posted several quarters of skimpy earnings. SAFM had 2 quarters of skimpy growth in the last 2 years.


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, -55.48%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 173.17%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 173.17% must be greater than or equal to the historical growth which is 25.52%. SAFM would therefore pass this test.


EARNINGS PERSISTENCE: FAIL

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. SAFM, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 2.35, 5.68, 10.80, 9.52, and 8.37, fails 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. SAFM's long-term growth rate of 25.52%, based on the average of the 3 and 4 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. SAFM's Debt/Equity (0.00%) is not considered high relative to its industry (152.54%) 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 SAFM, this criterion has not been met (insider sell transactions are 1,043, while insiders buying number 293). 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.

BANCO MACRO SA (ADR)

Strategy: Growth Investor
Based on: Martin Zweig

Banco Macro SA is an Argnetina-based financial institution (the Bank) that offers traditional bank products and services to companies, including those operating in regional economies, as well as to individuals. In addition, the Bank performs certain transactions through its subsidiaries, including mainly Banco del Tucuman, Macro Bank Ltd, Macro Securities SA, Macro Fiducia SA and Macro Fondos SGFCI SA. It has approximately two categories of customers, such as retail customers, including individuals and entrepreneurs and corporate customers, which include small, medium and large companies and major corporations. In addition, it provides services to over four provincial governments. It provides its corporate customers with traditional banking products and services, such as deposits, lending (including overdraft facilities), check cashing advances and factoring, guaranteed loans and credit lines for financing foreign trade and cash management services.


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. BMA's P/E is 10.55, based on trailing 12 month earnings, while the current market PE is 18.00. 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. BMA's revenue growth is 42.07%, while it's earnings growth rate is 44.10%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, BMA passes this criterion.


SALES GROWTH RATE: PASS

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 (15.8%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (-46.2%) of the current year. Sales growth for the prior must be greater than the latter. For BMA this criterion has been met.


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. BMA's EPS ($1.75) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. BMA's EPS for this quarter last year ($0.21) 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. BMA's growth rate of 733.33% 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 BMA is 22.05%. This should be less than the growth rates for the 3 previous quarters which are 25.00%, 122.22% and -45.45%. BMA 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, -1.85%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 733.33%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 733.33% must be greater than or equal to the historical growth which is 44.10%. BMA 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. BMA, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.13, 0.17, 0.26, 0.38 and 0.54, 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. BMA's long-term growth rate of 44.10%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.

BUFFALO WILD WINGS

Strategy: Patient Investor
Based on: Warren Buffett

Buffalo Wild Wings, Inc. (Buffalo Wild Wings) is an owner, operator and franchisor of restaurants featuring various menu items. The Company's restaurants feature a bar, which offers a selection of 20 to 30 domestic, imported and craft beers on tap, as well as bottled beers, wine and liquor. The Buffalo Wild Wings restaurants feature various menu items, including its Buffalo, New York-style chicken wings spun in one of its signature sauces from sweet to screamin' hot, which includes Sweet barbeque (BBQ), Teriyaki, Bourbon Honey Mustard, Mild, Parmesan Garlic, Medium, Honey BBQ, Spicy Garlic, Asian Zing, Caribbean Jerk, Thai Curry, Hot BBQ, Hot, Mango Habanero, Wild and Blazin', or signature seasonings, Buffalo, Desert Heat, Chipotle BBQ, Lemon Pepper, and Salt & Vinegar. Its restaurants include a multi-media system, a bar and an open layout. It operates Buffalo Wild Wings, R Taco and PizzaRev restaurants, as well as sells Buffalo Wild Wings and R Taco restaurant franchises.

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 0.92, 1.10, 1.36, 1.69, 2.10, 2.73, 3.06, 3.79, 4.95, 4.97. Buffett would consider BWLD's earnings predictable. In fact EPS have increased every year. BWLD's long term historical EPS growth rate is 17.4%, based on the average of the 3, 4 and 5 year historical eps growth rates.


LOOK AT THE ABILITY TO PAY OFF DEBT PASS

Buffett likes companies that are conservatively financed. Nonetheless, he has invested in companies with large financing divisions and in firms with rather high levels of debt. BWLD has a debt of 93.4 million and earnings of 99.9 million, which could be used to pay off the debt in less than two years, which is considered exceptional.


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 BWLD, over the last ten years, is 14.8%. Although he prefers ROE to be 15% or higher, this level is acceptable to Buffett. 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 13.7%, 13.7%, 14.2%, 14.5%, 14.9%, 15.8%, 14.9%, 15.3%, 16.4%, 14.3%, and the average ROE over the last 3 years is 15.3%, thus passing this criterion.


LOOK FOR CONSISTENTLY HIGHER THAN AVERAGE RETURN ON TOTAL CAPITAL: PASS

Because some companies can be financed with debt that is many times their equity, they can show a consistently high ROE, yet still be in unattractive price competitive businesses. To screen this out, for non-financial companies Buffett also requires that the average Return On Total Capital (ROTC) be at least 12% and consistent. In addition, the average ROTC over the last 3 years must also exceed 12%. Return On Total Capital is defined as the net earnings of the business divided by the total capital in the business, both equity and debt. The average ROTC for BWLD, over the last ten years, is 13.9% and the average ROTC over the past 3 years is 14.9%, which is high enough to pass. It is not enough that the average be at least 12%. For each of the last 10 years, with the possible exception of the last fiscal year, the ROTC must be at least 9% for Buffett to feel comfortable that the ROTC is consistent. The ROTC for the last 10 years, from earliest to latest, is 12.7%, 12.6%, 13.1%, 13.5%, 13.9%, 14.7%, 13.9%, 15.3%, 16.4%, 12.9%, 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. BWLD's free cash flow per share of $3.38 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 $26.67 and compares it to the gain in EPS over the same period of $4.05. BWLD's management has proven it can earn shareholders a 15.2% 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. BWLD's shares outstanding have fallen over the past five years from 18,379,999 to 18,000,000, 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 BWLD 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 $5.55 and divide it by the current market price of $156.75. An investor, purchasing BWLD, could expect to receive a 3.54% initial rate of return. Furthermore, he or she could expect the rate to increase 17.4% per year, based on the average of the 3, 4 and 5 year historical eps growth rates, 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 2.25%. Compare this with BWLD's initial yield of 3.54%, which will expand at an annual rate of 17.4%, based on the average of the 3, 4 and 5 year historical eps growth rates. 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]

BWLD currently has a book value of $34.60. It is safe to say that if BWLD can preserve its average rate of return on equity of 14.8% and continues to retain 100.00% of its earnings, it will be able to sustain an earnings growth rate of 14.8% and it will have a book value of $137.18 in ten years. If it can still earn 14.8% on equity in ten years, then expected EPS will be $20.26.


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

Now take the expected future EPS of $20.26 and multiply them by the lower of the 5 year average P/E ratio (32.4) or current P/E ratio (current P/E in this case), which is 28.2 and you get BWLD's projected future stock price of $571.85.


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 $571.85. These numbers indicate that one could expect to make a 13.8% average annual return on BWLD's stock at the present time. Although, the return is slightly below the liking of Buffett, the return would still be somewhat acceptable.


CALCULATE THE EXPECTED FUTURE STOCK PRICE BASED ON AVERAGE EPS GROWTH: [No Pass/Fail]

If you take the EPS growth of 17.4%, based on the average of the 3, 4 and 5 year historical eps growth rates, you can project EPS in ten years to be $27.70. Now multiply EPS in 10 years by the lower of the 5 year average P/E ratio (32.4) or current P/E ratio (current P/E in this case), which is 28.2. This equals the future stock price of $781.92. Add in the total expected dividend pool of $0.00 to get a total dollar amount of $781.92.


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 $156.75 and the future expected stock price, including the dividend pool, of $781.92. If you were to invest in BWLD at this time, you could expect a 17.43% 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 13.8% and 17.4%. 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 15.6% on BWLD stock for the next ten years, based on the current fundamentals. Buffett would consider this a great return, thus passing the criterion.

THOR INDUSTRIES, INC.

Strategy: Growth Investor
Based on: Martin Zweig

Thor Industries, Inc. manufactures a range of recreational vehicles (RVs) in the United States and sells those vehicles primarily in the United States and Canada. The Company's segments include towable recreational vehicles, which consists of the operations of Airstream, Inc. (Airstream) (towable); Heartland Recreational Vehicles, LLC (Heartland) (including Bison Coach, LLC (Bison), Cruiser RV, LLC (CRV) and DRV, LLC (DRV)); Jayco, Corp. (Jayco) (including Jayco towable, Starcraft and Highland Ridge), Keystone RV Company (Keystone) (including CrossRoads and Dutchmen) and K.Z., Inc. (KZ) (including Livin' Lite RV, Inc. (Livin' Lite)); motorized recreational vehicles, which consists of the operations of Airstream (motorized), Jayco (including Jayco motorized and Entegra Coach) and Thor Motor Coach, Inc. (Thor Motor Coach), and Other, which includes the operations of its subsidiary, Postle Operating, LLC (Postle).


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. THO's P/E is 19.52, based on trailing 12 month earnings, while the current market PE is 18.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

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. THO's revenue growth is 13.75%, while it's earnings growth rate is 22.61%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, THO fails this criterion.


SALES GROWTH RATE: PASS

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 (65.8%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (22.2%) of the current year. Sales growth for the prior must be greater than the latter. For THO this criterion has been met.


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. THO's EPS ($1.49) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. THO's EPS for this quarter last year ($0.97) 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. THO's growth rate of 53.61% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: PASS

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 THO is 11.31%. This should be less than the growth rates for the 3 previous quarters, which are 50.88%, 26.89%, and 19.85%. THO passes this test, which means that it has 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, 28.34%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 53.61%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 53.61% must be greater than or equal to the historical growth which is 22.61%. THO 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. THO, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 2.07, 2.86, 3.29, 3.79 and 4.91, 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. THO's long-term growth rate of 22.61%, based on the average of the 3, 4 and 5 year historical eps growth rates, passes this test.


TOTAL DEBT/EQUITY RATIO: FAIL

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. THO's Debt/Equity (25.65%) is considered high relative to its industry (22.35%) and fails 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 THO, this criterion has not been met (insider sell transactions are 188, while insiders buying number 22). 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.

WADDELL & REED FINANCIAL, INC.

Strategy: Growth Investor
Based on: Martin Zweig

Waddell & Reed Financial, Inc. is a mutual fund and asset management company. The Company provides investment management, investment advisory, investment product underwriting and distribution and shareholder services administration to Waddell & Reed Advisors group of mutual funds, Ivy Funds, Ivy Funds Variable Insurance Portfolios, InvestEd Portfolios and 529 college savings plan (collectively, the Funds), and the Ivy Global Investors Fund SICAV and its Ivy Global Investors sub-funds (the IGI Funds), and institutional and separately managed accounts. Its retail products are distributed through third parties, such as other broker/dealers, registered investment advisors and various retirement platforms or through its sales force of independent financial advisors. The Company also markets its investment advisory services to institutional investors, either directly or through consultants. It operates its investment advisory business through Waddell & Reed Investment Management Company.


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. WDR's P/E is 7.91, based on trailing 12 month earnings, while the current market PE is 18.00. 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. WDR's revenue growth is 8.60%, while it's earnings growth rate is 9.88%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, WDR passes this criterion.


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 (-19.4%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (-19%) of the current year. Sales growth for the prior must be greater than the latter. For WDR 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. WDR's EPS ($0.65) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. WDR's EPS for this quarter last year ($0.58) 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. WDR's growth rate of 12.07% passes this test.


EARNINGS GROWTH RATE FOR THE PAST SEVERAL QUARTERS: FAIL

Compare the earnings growth rate of the past four quarters with long-term EPS growth rate. Earnings growth in the past 4 quarters should be at least half of the long-term EPS growth rate. A stock should not be considered if it posted several quarters of skimpy earnings. WDR had 3 quarters of skimpy growth in the last 2 years.


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, -36.96%, (versus the same three quarters a year earlier) is less than the growth rate of the current quarter earnings, 12.07%, (versus the same quarter one year ago) then the stock passes.


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

The EPS growth rate for the current quarter, 12.07% must be greater than or equal to the historical growth which is 9.88%. WDR would therefore pass this test.


EARNINGS PERSISTENCE: FAIL

Companies must show persistent yearly earnings growth. To fulfill this requirement a company's earnings must increase each year for a five year period. WDR, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 2.01, 2.25, 2.96, 3.71, and 2.94, fails this test.


LONG-TERM EPS GROWTH: FAIL

The final important criterion in this approach is that Earnings Growth be at least 15% per year. WDR's long-term growth rate of 9.88%, based on the average of the 3, 4 and 5 year historical eps growth rates, fails the minimum required.


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 WDR, this criterion has not been met (insider sell transactions are 89, while insiders buying number 7). 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.

UNIVERSAL FOREST PRODUCTS, INC.

Strategy: Growth Investor
Based on: Martin Zweig

Universal Forest Products, Inc. is a holding company. The Company, through its subsidiaries, supplies wood, wood composite and other products to three primary markets: retail, construction and industrial. Its industrial market serves as industrial manufacturers and other customers for packaging, material handling and other applications. The Company's segments include North, South, West, Alternative Materials, International and Corporate divisions. The Company designs, manufactures and markets wood and wood-alternative products for national home centers and other retailers, structural lumber and other products for the manufactured housing industry, engineered wood components for residential and commercial construction, and specialty wood packaging, components and packing materials for various industries. The Company's construction market consists of customers in three submarkets, including manufactured housing, residential construction and commercial construction.


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. UFPI's P/E is 21.45, based on trailing 12 month earnings, while the current market PE is 18.00. Therefore, it passes the first test.


REVENUE GROWTH IN RELATION TO EPS GROWTH: FAIL

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. UFPI's revenue growth is 10.96%, while it's earnings growth rate is 62.44%, based on the average of the 3, 4 and 5 year historical eps growth rates. Therefore, UFPI fails this criterion.


SALES GROWTH RATE: PASS

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 (8.4%) must be examined, and then compared to the previous quarter last year compared to the previous quarter (4%) of the current year. Sales growth for the prior must be greater than the latter. For UFPI this criterion has been met.


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. UFPI's EPS ($1.36) pass this test.


QUARTERLY EARNINGS ONE YEAR AGO: PASS

The EPS for the quarter one year ago must be positive. UFPI's EPS for this quarter last year ($1.26) 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. UFPI's growth rate of 7.94% 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 UFPI is 31.22%. This should be less than the growth rates for the 3 previous quarters which are 102.17%, 88.00% and 27.13%. UFPI 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: FAIL

If the growth rate of the prior three quarter's earnings, 56.00%, (versus the same three quarters a year earlier) is greater than the growth rate of the current quarter earnings, 7.94%, (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 UFPI is 7.9%, and it would therefore fail this test.


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

The EPS growth rate for the current quarter, 7.94% must be greater than or equal to the historical growth which is 62.44%. Since this is not the case UFPI would therefore fail 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. UFPI, whose annual EPS growth before extraordinary items for the previous 5 years (from the earliest to the most recent fiscal year) were 0.23, 1.21, 2.15, 2.86 and 3.99, 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. UFPI's long-term growth rate of 62.44%, 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. UFPI's Debt/Equity (15.04%) is not considered high relative to its industry (96.04%) 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 UFPI, this criterion has not been met (insider sell transactions are 336, while insiders buying number 843). Despite the lack of an insider buy signal, there also is not an insider sell signal, so the stock passes this criterion.

TREX COMPANY INC

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

Trex Company, Inc. is a manufacturer of wood-alternative decking and railing products. The Company markets its products under the brand name Trex. The Company offers a set of outdoor living products in the decking, railing, porch, fencing, trim, steel deck framing and outdoor lighting categories. Its decking products include Trex Transcend, Trex Enhance and Trex Select. The Company's railing products include Trex Transcend Railing, Trex Select Railing and Trex Reveal aluminum railing. It offers Trex Transcend Porch Flooring and Railing System, a porch product, and a fencing product called Trex Seclusions. The Company offers TrexTrim product, which is a cellular polyvinyl chloride residential exterior trim product. It offers a triple-coated steel deck framing system called Trex Elevations. The Company offers outdoor lighting systems, including Trex DeckLighting and Trex Landscape Lighting. It also offers Trex Hideaway, which a hidden fastening system for grooved boards.


PROFIT MARGIN: PASS

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. TREX's profit margin of 13.02% passes this test.


RELATIVE STRENGTH: FAIL

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. Although TREX's relative strength of 88 is below the acceptable level, yet it is very close. Keep an eye on the stock as it could move into the acceptable range.


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 TREX (91.67% for EPS, and 12.92% for Sales) are not good enough to pass.


INSIDER HOLDINGS: FAIL

TREX's insiders should own at least 10% (they own 0.32%) of the company's outstanding shares. This does not satisfy the minimum requirement, and companies that do not pass this criteria are less attractive.


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. TREX's free cash flow of $1.24 per share passes this test.


PROFIT MARGIN CONSISTENCY: PASS

TREX's profit margin has been consistent or even increasing over the past three years (Current year: 10.91%, Last year: 10.60%, Two years ago: 10.10%), 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 TREX's case.


CASH AND CASH EQUIVALENTS: FAIL

TREX does not have a sufficiently large amount of cash, $6.00 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. TREX 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.


INVENTORY TO SALES: PASS

This methodology strongly believes that companies, especially small ones, should have tight control over inventory. It's a warning sign if a company's inventory relative to sales increases significantly when compared to the previous year. Up to a 30% increase is allowed, but no more. Inventory to Sales for TREX was 6.06% last year, while for this year it is 5.24%. Since the inventory to sales is decreasing by -0.82% the stock 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 TREX was 9.29% last year, while for this year it is 11.91%. Although the AR to sales is rising, it is below the max 30% that is allowed. The investor can still consider the stock if all other criteria appear very attractive.


LONG TERM DEBT/EQUITY RATIO: PASS

TREX's trailing twelve-month Debt/Equity ratio (0.00%) is at a great level according to this methodology because the superior companies that you are looking for don't need 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 (TREX's is 0.39), the shares are looked upon favorably. These high quality companies can often wind up as the biggest winners. TREX passes this test.

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

AVERAGE SHARES OUTSTANDING: PASS

TREX has not been significantly increasing the number of shares outstanding within recent years which is a good sign. TREX currently has 29.0 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: PASS

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. TREX's sales of $473.5 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". TREX passes the sales test.


DAILY DOLLAR VOLUME: PASS

TREX passes the Daily Dollar Volume (DDV of $18.8 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. TREX with a price of $68.31 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: PASS

TREX's income tax paid expressed as a percentage of pretax income this year was (37.36%) and last year (37.98%) are greater than 20% which is an acceptable level. If the tax rate is below 20% this could mean that the earnings that were reported were unrealistically inflated due to the lower level of income tax paid. This is a concern.

SUN LIFE FINANCIAL INC

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

Sun Life Financial Inc. is the holding company of Sun Life Assurance Company of Canada. The Company is a financial services organization providing a range of protection and wealth products and services. It operates in five segments: Sun Life Financial Canada (SLF Canada), Sun Life Financial United States (SLF U.S.), Sun Life Financial Asset Management (SLF Asset Management), Sun Life Financial Asia (SLF Asia) and Corporate. SLF Canada has three main business units: Individual Insurance & Wealth, Group Benefits and Group Retirement Services. SLF U.S. has three business units: Group Benefits, International and In-force Management. SLF Asset Management is an asset management segment, including MFS Investment Management and Sun Life Investment Management. SLF Asia offers individual life insurance products in over seven markets, and group benefits and/or pension and retirement products in the Philippines, China, Hong Kong, India, Malaysia and Vietnam.


DETERMINE THE CLASSIFICATION:

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


P/E/GROWTH RATIO: PASS

The investor should examine the P/E (13.98) relative to the growth rate (32.80%), based on the average of the 3, 4 and 5 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 SLF (0.43) is very favorable.


SALES AND P/E RATIO: PASS

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 high enough to support a P/E above this threshold. SLF, whose sales are $24,277.2 million, needs to have a P/E below 40 to pass this criterion. SLF's P/E of (13.98) is considered acceptable.


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 SLF is 32.8%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is acceptable.


TOTAL DEBT/EQUITY RATIO: NEUTRAL

SLF 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. SLF's Equity/Assets ratio (8.00%) 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. SLF's ROA (1.02%) 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 SLF (5.71%) 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 SLF (-0.10%) 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.

NK LUKOIL PAO (ADR)

Strategy: Book/Market Investor
Based on: Joseph Piotroski

NK LUKOIL PAO is an energy company. The primary activities of LUKOIL and its subsidiaries are oil exploration, production, refining, marketing and distribution. The Company's segments include Exploration and Production; Refining, Marketing and Distribution, and Corporate and other. The Exploration and Production segment includes its exploration, development and production operations relating to crude oil and gas. These activities are located within Russia, with additional activities in Azerbaijan, Kazakhstan, Uzbekistan, the Middle East, Northern and Western Africa, Norway, Romania and Mexico. In addition to its production, the Company purchases crude oil in Russia and on international markets. The Refining, Marketing and Distribution segment includes refining, petrochemical and transport operations, marketing and trading of crude oil, natural gas and refined products, generation, transportation and sales of electricity, heat and related services.


BOOK/MARKET RATIO: PASS

The first criteria of this strategy requires that a company be in the top 20% of the market based on the Book/Market ratio (which is the inverse of the Price/Book ratio). LUKOY, which has a book to market ratio of 1.37, meets this criterion and thus this strategy will use the following rules to determine if it is a financially distressed firm or is unfairly trading at a discount to its book value.

The study conducted by Piotroski found that excess returns can be earned by holding a portfolio of high Book/Market stocks. He also found, however, that it is very important to separate companies that trade at a discount because they are financially distressed from companies that are unfairly trading at a discount. The following criteria are used to help provide this distinction.


RETURN ON ASSETS: PASS

As a first step to determining whether a firm is not financially distressed, this methodology requires that the return on assets for the most recent fiscal year be positive. LUKOY's return on assets was 5.75% in the most recent year, therefore it passes this test.


CHANGE IN RETURN ON ASSETS: FAIL

The next requirement is that the return on assets for the most recent fiscal year must be greater than the return on assets for the previous fiscal year. LUKOY's return on assets was 5.75% in the most recent year and 8.63% in the previous year, therefore it fails this test.


CASH FLOW FROM OPERATIONS: PASS

In addition to the return on assets, the cash flow from operations for the most recent fiscal year must also be positive. This eliminates companies that are burning cash and therefore are more likely to be financially distressed. LUKOY's cash flow from operations was $14,268.56 million in the most recent year, therefore it passes this test.


CASH COMPARED TO NET INCOME: PASS

This methodology requires that cash from operations for the most current fiscal year must be greater than net income for the most current fiscal year. LUKOY's cash from operations was $14,268.56 million in the most recent year, while its net income was $4,855.05 million, therefore it passes this test.


CHANGE IN LONG TERM DEBT/ASSETS: FAIL

The long term debt to assets ratio for the most recent fiscal year must be less than the previous fiscal year. LUKOY's LTD/Assets was 0.17 in the most recent year and 0.14 in the previous year, therefore it fails this test.


CHANGE IN CURRENT RATIO: PASS

As an additional test of firm solvency, the current ratio for the most recent fiscal year must be greater than the current ratio for the previous fiscal year. LUKOY's current ratio was 1.75 in the most recent year and 1.59 in the previous year, therefore it passes this test.


CHANGE IN SHARES OUTSTANDING: PASS

The issuance of new stock is considered by this methodology to be a sign that a company is not able to generate enough internal cash to fund its business. Therefore, shares outstanding for the most recent fiscal year must be less than or equal to shares outstanding for the previous fiscal year. LUKOY's shares outstanding was 712.9 million in the most recent year and 754.9 million in the previous year, therefore it passes this test.


CHANGE IN GROSS MARGIN: PASS

As a sign that a company is expanding its profitability, this strategy requires that gross margin for the most recent fiscal year be greater than gross margin for the previous fiscal year. LUKOY's gross margin was 40.00% in the most recent year and 35.00% in the previous year, therefore it passes this test.


CHANGE IN ASSET TURNOVER: FAIL

The final criterion of this strategy requires that asset turnover for the most recent fiscal year be greater than asset turnover for the previous fiscal year. LUKOY's asset turnover was 1.15 in the most recent year and 1.16 in the previous year, therefore it fails this test.

INDEPENDENT BANK GROUP INC

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

Independent Bank Group, Inc. is a bank holding company. Through the Company's subsidiary, Independent Bank (the Bank), it provides a range of commercial banking products and services tailored to meet the needs of businesses, professionals and individuals. Its commercial lending products include owner-occupied commercial real estate loans, interim construction loans, commercial loans to a mix of small and midsized businesses, and loans to professionals, particularly medical practices. Its retail lending products include residential first and second mortgage loans and consumer installment loans, such as loans to purchase cars, boats and other recreational vehicles. The Company operates approximately 40 banking offices in the Dallas-Fort Worth metropolitan area, the Austin/Central Texas area, and the Houston metropolitan area. The Company also provides wealth management services to its customers, including investment advisory and other related services.


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. IBTX's profit margin is not available at this time. Hence this variable cannot be analyzed currently.


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. IBTX, with a relative strength of 92, 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 IBTX (65.96% for EPS, and 22.28% for Sales) are not good enough to pass.


INSIDER HOLDINGS: PASS

IBTX's insiders should own at least 10% (they own 15.93% ) of the company's outstanding shares which is the minimum required. A high percentage typically 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. IBTX's free cash flow of $1.46 per share passes this test.


PROFIT MARGIN CONSISTENCY: FAIL

The profit margin in the past must be consistently increasing. The profit margin of IBTX has been inconsistent in the past three years (Current year: 22.29%, Last year: 20.68%, Two years ago: 22.70%), which is unacceptable. This inconsistency will carryover directly to the company's bottom line, or earnings per share.


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 IBTX's case.


CASH AND CASH EQUIVALENTS: PASS

IBTX's level of cash $158.7 million passes this criteria. If a company is a cash generator, like IBTX, it has the ability to pay off debt (if it has any) or acquire other companies. Most importantly, good operations generate cash.


"THE FOOL RATIO" (P/E TO GROWTH): FAIL

The "Fool Ratio" is an extremely important aspect of this analysis. Unfortunately, IBTX's "Fool Ratio" is not available due to a lack of one or more important figures. Hence, an opinion cannot be given at this time.

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

AVERAGE SHARES OUTSTANDING: FAIL

IBTX has either issued a significant amount of new shares over the past year or has been issuing more and more shares over the past five years. IBTX currently has 69.0 million shares outstanding. Neither of these are a good sign. Generally when a small-cap company issues more stock, the existing stock becomes devalued by the market, and hence diluted.


SALES: PASS

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. IBTX's sales of $104.2 million based on trailing 12 month sales, are fine, making this company one such "prospective gem". IBTX passes the sales test.


DAILY DOLLAR VOLUME: PASS

IBTX passes the Daily Dollar Volume (DDV of $5.9 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. IBTX with a price of $64.30 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: PASS

IBTX's income tax paid expressed as a percentage of pretax income this year was (32.89%) and last year (33.99%) are greater than 20% which is an acceptable level. If the tax rate is below 20% this could mean that the earnings that were reported were unrealistically inflated due to the lower level of income tax paid. This is a concern.


Watch List

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

Ticker Company Name Current
Score
LTXB LEGACYTEXAS FINANCIAL GROUP INC 52%
TARO TARO PHARMACEUTICAL INDUSTRIES LTD. 51%
CATO CATO CORP 48%
UVE UNIVERSAL INSURANCE HOLDINGS, INC. 40%
GGAL GRUPO FINANCIERO GALICIA S.A. (ADR) 37%
GRUB GRUBHUB INC 36%
CPLA CAPELLA EDUCATION COMPANY 36%
BOFI BOFI HOLDING, INC. 35%
TROW T. ROWE PRICE GROUP INC 35%
TSM TAIWAN SEMICONDUCTOR MFG. CO. LTD. (ADR) 34%



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