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Executive Summary April 16, 2010

The Economy

The economic recovery is continuing, with slow and steady improvement in some areas and stronger gains in others, though some trouble spots remain.

On the positive side, consumers are spending -- something many analysts said they would not do in the supposed "new normal". Retail sales increased an impressive 1.6% in March, and were also revised upward for February. Retail figures have increased in each month of 2010, and the March figures were up 7.6% over March 2009 levels. That's very good news given that about 70% of the economy is made up of consumer spending.

The rise in consumer spending may have been in part related to long-awaited good news in another area: unemployment. Earlier this month, the Labor Department announced that the economy added 162,000 non-farm jobs in March -- the third month of job growth in the last five, and by far the greatest increase in that period. It was the most significant growth in more than three years.

We also got some strong regional manufacturing numbers this week, with the Federal Reserve Bank of Philadelphia reporting that its business conditions index improved for the eighth straight month in April. And the New York Federal Reserve Bank said its manufacturing index jumped almost 40% in April.

Much more modest gains came from the latest national industrial sector report. U.S. industrial production rose 0.1% in March, the Federal Reserve reported this week, with major storms likely holding back factory output. It was still the ninth straight month the figure has increased, following 18 straight months of losses, however, another good sign. Areas of particular strength included business equipment and construction supplies.

Speaking of construction, homebuilder sentiment jumped sharply this month, reaching its highest level since last September. The figure was apparently driven by the looming expiration of the government's homebuyer tax credits, however, and it remains to be seen how the construction industry -- and housing market -- will fare once those carrots are removed.

What is clear, however, is that the housing market is far from healthy. Pending home sales did rise 8.2% in February (vs. January), the National Association of Realtors reported last week, but foreclosures remain a big problem. Foreclosure filings rose 19% in March (vs. February), according to RealtyTrac, which also said that lenders repossessed more than a quarter of a million properties in the first quarter, setting a new record and representing a 35% increase over the year-ago quarter. A weak housing market impacts not only the broader economy, but also the financial institutions that still hold significant amounts of mortgage-backed securities.

The problems still facing the economy are putting "restraints" on growth, Federal Reserve Chairman Ben Bernanke told Congress this week. While those restraints -- including high unemployment levels -- are troubling, they also have one positive impact on the stock market: Bernanke indicated the Fed will continue with its pledge to keep interest rates extremely low to help spur growth, and those low rates have been one reason for the stock market's big rally.

The continued low rates and generally positive economic news have helped the market push higher since our last newsletter, with the S&P 500 returning 2.8%. The Hot List has also fared well, jumping 4.6%. It's now up 14.1% in 2010 vs. 8.7% for the S&P, and since its July 2003 inception the portfolio has gained 175.0%, while the index is up just 21.1%.

The Return of Winners & Losers

The Hot List is shaking up the portfolio a bit this rebalancing, saying goodbye to four stocks and welcoming four new firms that my Guru Strategies are keen on. The newcomers are a varied bunch, coming from several industries -- auto & truck parts (China Automotive Systems), communications services (Telestone Technologies and Telefonica S.A.), and retail apparel (lululemon athletica). And while two of those newcomers do come from the same industry, their differences are striking: Telestone is a very small ($151 million market cap) China-based tech company that focuses on developing wireless equipment and network solutions; Spain-based Telefonica is one of the largest companies in the world ($113 billion market cap), and is a major provider of landline and cellular phone service in Latin America and Europe.

As has been the case with other recent Hot List additions, however, one similarity these firms share is a history of strong earnings growth. Three of the four grew earnings per share in both 2008 and 2009, both of which were marred by a global recession. And the fourth, Telefonica, had a dip in 2008 but a rebound in 2009, and has over the past five years almost doubled earnings.

That's important because in the past couple years we've seen (first) an ebbing tide pull almost all stock-boats lower, and (second) a rising tide lift them back upward. To be sure, the magnitude of the gains and declines of specific stocks varied, but, generally, if you were invested in stocks in 2008 you lost money, and if you were invested in stocks in 2009 you made money. In 2008, every sector of the S&P 500 lost money, as did more than 95% of stocks in the index, according to The New York Times. In 2009, every sector gained ground, and more than 90% of S&P stocks pushed higher.

But that's changing. The Times' Paul Lim noted earlier this month that while the S&P is well in the black in 2010, about a quarter of its component stocks were in the red. And that's not unusual, Oppenheimer Chief Investment Strategist for Equities Brian Belski told Lim. He said that's what usually happens in the year after a recession -- and it seems there's a good chance the recession ended sometime in 2009.

This would seem to go hand in hand with the research of James O'Shaughnessy (one of the gurus upon whom I base my models), which I highlighted earlier this year. O'Shaughnessy found that while "junk"-type stocks tend to lead in the first year after severe bear markets, fundamentals start to matter much more in the second year. Both that trend and the trend cited by Belski, if they continue, bode very well for my guru-based models, which key in on only the strongest companies with the most fundamentally sound stocks in the market.

Blending Strategies

With fundamentals in mind, I wanted to touch on one of the reasons that I think the Hot List has fared so well over the long haul. It's a reason that came to mind recently when reading a very interesting report from Tweedy, Browne Company entitled "What Has Worked in Investing".

The report includes a compilation of various studies performed by many different researchers over the years on how stocks with certain fundamental characteristics perform. Among the studies analyzed are those that look at the historical performance of stocks with high price/book ratios vs. those with lower price/book values; stocks with strong dividend yields vs. those with lower yields; stocks with low price/cash flow ratios vs. those with high price/cash flow ratios; and stocks with high market caps vs. those with lower market caps. The studies also covered a variety of different countries and timeframes.

In general, the dozens of different studies showed that over the longer term, fundamentals get rewarded. Stocks with low price/book ratios tend to outperform those with high price/book ratios. Those with high yields tend to outperform those with low yields. Stocks with low P/E ratios tend to outperform those with high P/Es. Of course there are exceptions, but the general trend appears pretty clear.

What struck me about the report was that most of the studies looked at how one or two variables impacted returns. And, as I noted, the results show that even using just one or two variables can help improve investment returns.

But for the most part, each of my Guru Strategies use a much wider array of variables (the exception being the two-variable Joel Greenblatt-based model). Most use between five and ten fundamental criteria, ranging from market cap to various earnings assessments to several different valuation metrics to analyses of debt levels. Because of that, they really put a company through the wringer, assessing its health and prospects on a number of different levels.

The Hot List then goes a step further, looking for consensus from about a dozen different strategies to find its favorite picks. As you've probably seen, most of the Hot List picks get approval from more than one of my models, which means that they have really made it through a gauntlet of fundamental tests. To me, that's one of the biggest reasons the portfolio has fared so well. If fundamentals do matter in stock-picking -- and both my own experience and the studies I referenced earlier show that they do -- then an approach that assesses a stock on several different fundamental levels is more often than not going to find winners.

As we move forward, I expect the market will continue to show lower levels of correlation. (This would figure to be particularly true as the government pulls away the stimulus efforts and low interest rates that have thrown life preservers to struggling companies.) And as that happens, I expect that fundamentals -- and the Hot List -- will be rewarded.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 4 stocks leave our portfolio. These include: Amedisys, Inc. (AMED), Jos. A. Bank Clothiers, Inc. (JOSB), Triumph Group, Inc. (TGI) and Raytheon Company (RTN).

The Keepers

6 stocks remain in the portfolio. They are: Itt Educational Services, Inc. (ESI), Emcor Group, Inc. (EME), Aeropostale, Inc. (ARO), Sanofi-aventis Sa (Adr) (SNY), The Brink's Company (BCO) and Ares Capital Corporation (ARCC).

The Newbies

We are adding 4 stocks to the portfolio. These include: Telefonica S.a. (Adr) (TEF), China Automotive Systems, Inc. (CAAS), Telestone Technologies Corporation (TSTC) and Lululemon Athletica Inc. (LULU).

Portfolio Changes

Newcomers to the Validea Hot List

China Automotive Systems (CAAS): This small-cap, which is based in Hubei province, about 500 miles west of Shanghai, supplies an array of power steering systems and components to the Chinese automobile market. It has a market cap of about $600 million, and it's been growing earnings rapidly, even through the global recession in 2008 and 2009.

China Automotive gets strong interest from my Peter Lynch-based model. To see why, check out the "Detailed Stock Analysis" section below.

lululemon athletica inc. (LULU): This Vancouver-based firm makes clothing for a variety of athletics, focusing largely on technical athletic apparel for yoga, running, and dancing. It has more than 100 stores across Canada, the U.S., Australia, and Hong Kong.

lululemon, which has a market cap of about $3.1 billion, has been growing earnings rapidly, nearly tripling them in its 2009 fiscal fourth-quarter (ending Jan. 31). It gets strong interest from two of my growth strategies, my Momentum Investor model and the model I base on the writings of Tom and David Gardner, the creators of The Motley Fool investment web site. The "Detailed Stock Analysis" section below explains why.

Telefonica (TEF): Based in Madrid, this telecom firm operates in 25 countries and has almost 270 million customers. Its main markets are Latin America and Europe. Over the past year, the $113 billion market cap firm has taken in almost $80 billion in sales.

Telefonica gets strong interest from my James O'Shaughnessy-based value strategy. To see what the O'Shaughnessy approach likes about it, check out the "Detailed Stock Analysis" section below

Telestone Technologies Corporation (TSTC): Headquartered in Beijing, this Chinese tech firm is involved in the development of wireless equipment and network solutions. The company, which holds intellectual property rights to 400 types of products, is a small-cap ($151 million), which means it could be subject to more volatility than larger stocks. But my Peter Lynch- and Martin Zweig-based models both think it's worth it, as both give the stock their approval. To see why these strategies like Telestone, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Sanofi-Aventis (SNY): On April 8, Sanofi announced that it will enter a $335 million licensing deal with CureDM Group Holdings for the CureDM's experimental diabetes treatment Pancreate, The Wall Street Journal reported. Sanofi will be able to develop, manufacture and commercialize the treatment, which is a human peptide scheduled for phase 1 studies later this year, the Journal reported.

Aeropostale (ARO): Aeropostale posted strong March sales, with same-store sales up 19% from March 2009, the Associated Press reported. The figures include sales at stores that have been open at least one year.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will take an in-depth look at one of my individual guru-based strategies. 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

LULU   |   TSTC   |   ARO   |   TEF   |   CAAS   |   EME   |   SNY   |   ARCC   |   ESI   |   BCO   |  

lululemon athletica inc. is a designer and retailer of technical athletic apparel primarily in North America. Its yoga-inspired apparel is marketed under the lululemon athletica brand name. The Company offers a line of apparel and accessories, including fitness pants, shorts, tops and jackets designed for athletic pursuits, such as yoga, running and general fitness. As of January 31, 2010, its branded apparel was principally sold through 124 stores that are primarily located in Canada and the United States. As of January 31, 2010, its retail footprint included 45 stores in Canada, 70 stores in the United States and nine franchise stores in Australia.

Telestone Technologies Corporation (Telestone) is a wireless communications coverage solutions provider. The Company's wireless coverage solutions include research and development and application of wireless communications technology. In addition to its homegrown wireless communications equipment, which includes repeaters, antennas and radio frequency peripherals, it also offers project design, project management, installation, maintenance and other after-sales services, which are required by its customers. Telestone's wireless coverage solutions are created to enhance the coverage of mobile telecommunications networks. These solutions it provides to the telecommunications industry cover indoor and outdoor environments, including hotels, residential estates, office buildings, airports, underground stations, highways and tunnels. During the year ended December 31, 2008, The Company launched a new generation of wireless distribution system, weight factor display system (WFDS).

Aeropostale, Inc. is a mall-based specialty retailer of casual apparel and accessories. The Company designs, markets and sells its own brand of merchandise principally targeting 14 to 17 year-old young women and young men. The Company also sells Aropostale merchandise through its e-commerce Website, www.aeropostale.com. During the fiscal year ended January 30, 2010 (fiscal 2009), the Company launched P.S. from Aeropostale, which offers casual clothing and accessories focused on elementary school children between the ages of 7 and 12. During fiscal 2009, the Company completed the closure of its 14 store Jimmy'Z concept. Jimmy'Z Surf Co., Inc., a wholly owned subsidiary of Aeropostale, Inc., was a contemporary lifestyle brand targeting young women and men aged 18 to 25.

Telefonica S.A. (Telefonica) together with its subsidiaries and investees operates in the telecommunications, media and contact center industries. Telefonica basic purpose is the provision of all manner of public or private telecommunications services, including ancillary or complementary telecommunications services or related services. The Company operates in three business areas: Telefonica Spain, Telefonica Latin America and Telefonica Europe. During the year ended December 31, 2009, Telefonica Moviles Espana, S.A.U., a wholly owned subsidiary of the Company completed the sale of its 32.18% stake in Medi Telecom, S.A. In January 2010, the Telefonica Group, through its wholly owned subsidiary, Telef=nica Europe plc completed the acquisition of JAJAH.

China Automotive Systems, Inc. (China Automotive) is a holding company and has no significant business operations or assets other than its interest in Great Genesis Holdings Limited (Genesis). Through Genesis, the Company manufactures power steering systems and other component parts for automobiles. All operations are conducted through eight Sino-foreign joint ventures in China and a wholly owned subsidiary in the United States. The Company has business relations with more than 60 vehicle manufacturers, including FAW Group and Dongfeng Auto Group, automobile manufacturers in China; Shenyang Brilliance Jinbei Co., Ltd., light vehicle manufacturer in China; Chery Automobile Co., Ltd, state-owned car manufacturer in China, and Xi'an BYD Auto Co., Ltd and Zhejiang Geely Automobile Co., Ltd., car manufacturers.

EMCOR Group, Inc. is an electrical and mechanical construction and facilities services company. It has six segments: United States electrical construction and facilities services, which involves systems for electrical power transmission and distribution, premises electrical and lighting systems, low-voltage systems, such as fire alarm, security and process control, voice and data communication, and fiber optic lines); United States mechanical construction and facilities services, which involves systems for heating, ventilation, air conditioning, refrigeration and clean-room process ventilation, fire protection, plumbing, process and high-purity piping, water and wastewater treatment, and central plant heating and cooling; United States facilities services; Canada construction and facilities services; United Kingdom construction and facilities services, and other international construction and facilities services. In February 2010, the Company acquired Scalise Industries.

Sanofi-Aventis is a pharmaceutical group engaged in the research, development, manufacture and marketing of healthcare products. The Company's business includes two main activities: pharmaceuticals and human vaccines through sanofi pasteur. The Company is also present in animal health products through Merial Limited (Merial). In its pharmaceutical activity, the Company specializes in six therapeutic areas: diabetes, oncology, thrombosis and cardiovascular, central nervous system (CNS), and internal medicine. The global portfolio of sanofi-aventis also consists of a range of other pharmaceutical products in Consumer Health Care (CHC) and other prescription drugs, including generics. It offers vaccines in five areas: pediatric combination vaccines, influenza vaccines, adult and adolescent booster vaccines, meningitis vaccines and travel and endemic vaccines.

Ares Capital Corporation (Ares Capital) is a specialty finance company, which is a closed-end, non-diversified management investment company. Ares Capital's investment objective is to generate both current income and capital appreciation through debt and equity investments. It invests in United States middle-market companies. It invests primarily in first and second lien senior loans and mezzanine debt, which in some cases includes an equity component like warrants. First and second lien senior loans generally are senior debt instruments that rank ahead of subordinated debt of a given portfolio company. Its investments have ranged between $10 million and $100 million each, although the investment sizes may be more or less than the targeted range. The Company's investment adviser is Ares Capital Management LLC. In April 2010, Ares Capital Corporation completed its merger with Allied Capital Corporation.

ITT Educational Services, Inc. (ITT/ESI) is a provider of postsecondary degree programs in the United States. As of December 31, 2009, the Company offered master, bachelor and associate degree programs to approximately 80,000 students. As of December 31, 2009, it had 125 locations (including 121 campuses and four learning sites) in 38 states. All of its institutions are authorized by the applicable education authorities of the states, in which they operate, and are accredited by an accrediting commission recognized by the United States Department of Education (ED). It designs its education programs, after consultation with employers and other constituents, to help graduates prepare for careers in various fields involving their areas of study. On June 10, 2009, it acquired Daniel Webster College (DWC). DWC offers programs of study at the master, bachelor and associate degree levels both in residence and through distance education.

The Brink's Company (Brink's) is a provider of secure transportation, cash logistics and other security-related services to banks and financial institutions, retailers, government agencies, mints, jewelers and other commercial operations worldwide. The Company's international network serves customers in more than 50 countries and employs approximately 59,400 people. Its operations include approximately 875 facilities and 10,500 vehicles. 71% of its revenues are from outside North America. The Company has two segments: International and North America. International operations has three regions: Europe, Middle East and Africa (EMEA); Latin America, and Asia Pacific. North American operations include 181 branches in the United States and 52 branches in Canada. Brink's EMEA operates 258 branches in 22 countries. Its main operations are in France, the Netherlands and Germany. The Company's other security services include security and guarding.

Watch List

The Watch List contains the highest scoring stocks according to our guru consensus system that are not currently in the Hot List portfolio. We provide this list both for informational purposes and for investors who are not comfortable with a portfolio of ten stocks.


The names of individuals (i.e., the 'gurus') appearing in this report are for identification purposes of his methodology only, as derived by Validea.com from published sources, and are not intended to suggest or imply any affiliation with or endorsement or even agreement with this report personally by such gurus, or any knowledge or approval by such persons of the content of this report. All trademarks, service marks and tradenames appearing in this report are the property of their respective owners, and are likewise used for identification purposes only.

Validea is not registered as a securities broker-dealer or investment advisor either with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. Validea is not responsible for trades executed by users of this site based on the information included herein. The information presented on this website does not represent a recommendation to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment. The information on this website is generic by nature and is not personalized to the specific situation of any individual. The user therefore bears complete responsibility for their own investment research and should seek the advice of a qualified investment professional prior to making any investment decisions.

Performance results are based on model portfolios and do not reflect actual trading. Actual performance will vary based on a variety of factors, including market conditions and trading costs. Past performance is not necessarily indicative of future results. Individual stocks mentioned throughout this web site may be holdings in the managed portfolios of Validea Capital Management, a separate asset management firm founded by Validea.com founder John Reese. Validea Capital Management, which is a separate legal entity and an SEC registered investment advisory firm, uses, in part, the strategies on the web site to select stocks for its clients.