Executive Summary  |   Portfolio  |   Guru Analysis  |   Watch List

Executive Summary July 5, 2013

The Economy

After a month or two stretch in which economic data softened and the stock market stumbled, the economy and market appear to be strengthening.

The big driver continues to be the housing market, with strong reports coming in from multiple sources since our last newsletter. In April, a new report showed, the S&P/Case-Shiller Home Price Indices notched the biggest year-over-year gains in their history, with the 10-city composite up 11.6% and the 20-city composite up 12.1%. The gains were broad-based, with 19 of the 20 metro areas posting gains for the month (vs. March); the lone city not to was Detroit, where prices were flat.

More good housing news came from the National Association of Realtors, which said that its Pending Home Sales Index jumped 6.7% in May, reaching its highest level in more than six years. The index is 12.5% above where it was a year ago.

The housing market's effects can be broad-based, and we're seeing that right now. Auto sales jumped in June, in part because of a nice gain in the sale of pickup trucks -- part of which is likely attributable to increased construction activity. The month was the best in at least six years for Ford and Chrysler and the best for General Motors since September 2008, the New York Times said.

On the jobs front, payroll processing firm ADP said the private sector added 188,000 jobs in June, the second-strongest gain of 2013. Today, the Labor Department is scheduled to release its data for June, and investors will no doubt be watching closely.

The manufacturing sector also seems to be improving. The sector expanded in June after having contracted in May, according to the Institute for Supply Management. It wasn't a particularly strong showing, with ISM's manufacturing index coming in at 50.8, just above the 50 mark that separates expansion from contraction, and the group's employment sub-index showing that manufacturing employment conditions worsened for the month. Still, the report was on the whole better than the previous month's.

The service sector, meanwhile, expanded for the 42nd straight month in June, according to ISM, though the pace of expansion slowed slightly. The service sector report showed that employment conditions improved significantly for the month.

Data for U.S. consumers was also encouraging. Real disposable personal income rose 0.4% in May, according to a government report, while real personal consumption expenditures were up 0.2%. That meant that the personal savings rate increased to 3.2%, the highest it has been this year.

As far as inflation, it continues to be quite meager. The personal consumption expenditure price index increased just 0.1% in May, making for a 1.0% year-over-year gain. That's better than April's 0.7% year-over-year gain, but nowhere near the 2% to 3% figure policymakers target.

Since our last newsletter, the S&P 500 returned -0.8%, while the Hot List returned -2.4%. So far in 2013, the portfolio has returned 19.8% vs. 13.3% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 224.8% vs. the S&P's 61.5% gain.

The Cash Conundrum

Whether it's a slowdown and housing bubble in China, lingering problems in Europe, or the unknown landscape of a post-QE environment, the investment world seems to be teeming with frightening risk factors these days. All this, combined with a hangover from 2007-2009 bear market, is enough to make you want to pull your money out of stocks and shove it under your mattress, where it is seemingly safe from the unwinding of the Federal Reserve's quantitative easing policies, China's troubles, and Europe's woes.

The problem is that, while those risks grab the headlines, the biggest risk of all may lie underneath that proverbial mattress.

I realize this sounds like the kind of thing investment advisors say when trying to sell you something. But the data backs it up. A quick look at historical returns shows just how dangerous holding too much cash can be for an investor -- and the reasons involve inflation and taxes. According to data from BlackRock, Morningstar, and the Tax Foundation, stocks averaged annual compound returns of 9.8% from 1926 through 2012. After inflation, however, the return fell to 6.7%. And after taxes are also factored in, the average returns were 4.5%. (Thanks to Josh Brown of The Reformed Broker blog for highlighting the data).

But if you think that's disappointing, look at bonds. They averaged a compound annual return of 5.4% over that period -- not bad at all. After inflation, however, the figure dips to just 2.3%. After taxes? A paltry 0.6%.

Still, at least that paltry 0.6% means bond investors took home something after inflation and taxes. While conventional wisdom is that you can't lose money you put in the bank, that is exactly what has happened to cash holders over the long haul. In that 1926-2012 period, cash earned a nominal average compound return of 3.5%. After inflation, they earned just 0.5%. Throw in taxes, and the return on cash turns negative, at -0.8%.

If, as contrarian guru David Dreman has said, risk is not short-term volatility, but instead "the probability your investment will preserve your capital over your investment time horizon [and] the probability your investments will outperform alternative investments during the period," it's clear that cash has been a risky choice over the long term. It's a hard concept to wrap your mind around. "Indeed," Dreman wrote in Contrarian Investment Strategies, "it goes against the principle we were taught from childhood -- that the safest way to save was putting our money in the bank."

All this isn't to say that having a lot of cash in the bank is inherently bad. It can be a very good thing, and a very wise move -- the key is why you're holding it, and what your time horizon is. If you need to use that money in the shorter term -- you're retiring next year, or your child is heading off to college, or you're buying a house, etc. -- then the bank is probably a good place for it, because the risk of cash losing value in the short term is far smaller than stocks or bonds or gold losing value. And, of course, you should always have some cash available in case emergencies (job loss, health issues, etc.) pop up.

But if you are trying to build wealth for the long haul, holding excess cash becomes risky. And if the "why" behind your decision to hold a lot of cash has anything to do with a belief that the market is going down in the short term, you're really asking for trouble. Sure, it's easy now to look back and think how much money you'd have saved if you'd moved out of stocks and into cash anytime between late 2007 and early 2009. But think back to that period. Could you really have predicted that there would be such a huge decline -- and could you have gotten the timing right? Long-term data shows investors who try to make such calls far more often than not fail. Dalbar Inc., for example, found that in the 20 years ending at the end of 2012, the S&P 500 averaged 8.21% annual returns, and the Barclays Aggregate Bond Index averaged 6.34%. Average equity fund investors, meanwhile, earned just 4.25% annualized, while average fixed-income fund investors earned just 0.98%. The reason: Investors tend to exercise terrible timing in their decisions about jumping in and out of both equity and bond funds. (I'd also note that Dalbar said inflation averaged 2.43% over that period, which would have brought actual returns to less than 2% for stock fund investors and well into the red for fixed-income investors -- and that's before taxes).

But what about Warren Buffett, you might be thinking. Perhaps the greatest investor ever, Buffett and his Berkshire Hathaway tend to carry a good amount of cash -- it had nearly $50 billion on hand at the end of the first quarter. But Buffett doesn't use cash as a way to side-step market downturns. He keeps cash on hand in case excellent new opportunities pop up. If the opportunity is there -- that is, if he can buy the stock of a good company, or the company itself, at a good price, he'll do it regardless of what the broader market is doing. But I think it's important to remember that Buffett's opportunities are limited by the size of Berkshire Hathaway. You won't see Berkshire buy shares in, say, a $250-million-market-cap company, because even if it bought all of the firm's shares it would be just a drop in the bucket for a $275-billion-market-cap company like Berkshire. Part of the reason why Buffett sometimes holds a good amount of cash likely has to do with the fact that he's thus forced to wait for legitimate opportunities to arise. (I'd also note that while Berkshire had close to $50 billion in cash on hand at the end of Q1, it also had almost $90 billion of stock in its portfolio, and hundreds of billions more invested in companies that it has purchased and taken private, like Burlington Northern Santa Fe. In that context, $50 billion doesn't seem so huge.)

Individual investors, meanwhile, have far more opportunities available to them. (Buffett himself has said that he would invest a lot differently if he were managing a $1 million portfolio rather than Berkshire's enormous portfolio.) There are almost always opportunities out there to buy strong, undervalued stocks, no matter what the economic or market environment. That's one advantage that individuals have over Buffett and other gurus who manage large funds.

To me, the most important thing is to determine an asset allocation plan that takes into account all of the things I've discussed above when it comes to cash -- short-term expenses, emergency funds, and whatever other sort of cushion you need to feel comfortable. Then, stick to that allocation mix and your investing strategy. If something changes in your life where you will need more cash (or less cash) in the short term, you can adjust your mix. But don't adjust it because the market is up this month or down this month, or because Europe's having problems, or because you are worried about all of the post-quantitative-easing uncertainty.

As you earn new cash, one way to keep yourself disciplined is dollar-cost averaging. By putting a fixed amount of money into stocks and other assets (as per your pre-set allocation mix) at a regular interval (such as every month), you force yourself to stay disciplined, regardless of what is happening in the short term. You also buy more shares when prices are low and fewer shares when prices are high, decreasing the risk that you'll deploy a big sum of cash at a time when stocks are overvalued.

The bottom line, to me, is that stocks have proven to be the best long-term investment vehicle -- if you stick with them. Because of that, investors who have long time horizons and don't have special circumstances are wise to focus on them, and not get scared into cash when short-term trouble arises. That's hard to do at times like these, when a number of different fears are prominent in investors' minds. But if you forget what history has shown and get too cash-happy, you may leave yourself exposed to far more risk of not reaching your long-term goals than you realize.

Editor-in-Chief: John Reese

Validea Capital Management - Private Portfolio Management Based on Strategies of Legends

Are you looking for an alternative to your underperforming mutual funds or financial advisor? Click here to download Validea Capital's investment kit and learn more about the firm's guru-based portfolios.

Get More Information on Validea Capital!

** Validea Capital Management is a separate investment advisory firm managed by Validea.com founder John Reese. Thre information above in not intended as personal investment advice and should not be interpreted as such.

The Fallen

As we rebalance the Validea Hot List, 2 stocks leave our portfolio. These include: Patterson Companies, Inc. (PDCO) and Valero Energy Corporation (VLO).

The Keepers

8 stocks remain in the portfolio. They are: Williams-sonoma, Inc. (WSM), Usana Health Sciences, Inc. (USNA), Chevron Corporation (CVX), Stamps.com Inc. (STMP), Royal Dutch Shell Plc (Adr) (RDS.A), Lear Corporation (LEA), Hollyfrontier Corp (HFC) and Hci Group Inc (HCI).

The Newbies

We are adding 2 stocks to the portfolio. These include: Western Digital Corp (WDC) and Amtrust Financial Services, Inc. (AFSI).

Portfolio Changes

Newcomers to the Validea Hot List

Western Digital Corp. (WDC): This California-based firm is a leader in the hard drive and digital storage business. The 40-year-old company has a market cap of about $15 billion, and has raked in $16.4 billion in sales in the past year. It gets approval from my Peter Lynch-based model. For more on the stock, see the "Detailed Stock Analysis" section below.

AmTrust Financial Services (AFSI): Founded as a workers' compensation insurance firm, this New York City-based company has expanded into a multi-national property and casualty insurer. It specializes in coverage for small businesses.

AmTrust ($2.5 billion market cap) gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. To read more about its fundamentals, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

Lear Corporation (LEA): Lear hit a 52-week high on July 2, with the catalyst seeming to be data showing continuing strength in the auto industry. Shares were up 4.5% since our last newsletter through July 4.

Chevron Corporation (CVX): Chevron announced that it will be expanding its Houston facilities, creating 1,752 new jobs and a new 50-story office tower, the Associated Press reported. The investment in part involves $12 million Chevron will receive from the Texas Enterprise Fund, which is used to attract outside firms and businesses to Texas, AP said.

The Next Issue

In two weeks, we will publish another issue of the Hot List, at which time we will take a closer look at my strategies and investment approach. 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

USNA   |   HCI   |   LEA   |   WDC   |   RDS.A   |   AFSI   |   HFC   |   CVX   |   WSM   |   STMP   |  

USANA Health Sciences, Inc. develops and manufactures science-based nutritional and personal care products. The Company has operations in 15 markets worldwide, where it distributes and sells its products by way of direct selling. The Company reports operations in two geographic regions: North America and Asia Pacific, which is further divided into three sub-regions; Southeast Asia/Pacific, Greater China, and North Asia. North America includes the United States, Canada, Mexico, and direct sales from the United States to the United Kingdom and the Netherlands. Southeast Asia/Pacific includes Australia, New Zealand, Singapore, Malaysia, and the Philippines; Greater China includes Hong Kong, Taiwan and China; and North Asia includes Japan and South Korea. The Company's customer base consists of two types of customers: Associates and Preferred Customers. As of December 31, 2011, the Company had 222,000 active Associates and 64,000 active Preferred Customers worldwide.

HCI Group Inc, formerly Homeowners Choice, Inc., is a holding company. The Company, through its subsidiaries, is engaged in the property and casualty insurance business. Through Homeowners Choice Property & Casualty Insurance Company, Inc. (HCPC) and subsidiaries, primarily Homeowners Choice Managers, Inc. (HCM), Southern Administration, Inc., Claddaugh Casualty Insurance Company, Ltd., and its subsidiary, HCPCI Holdings LLC, it provides property and casualty homeowners' insurance, condominium-owners' insurance and tenants' insurance to individuals owning property in Florida. Its subsidiaries also include TV Investment Holdings LLC, which owns and operates a marina facility located in Florida; Unthink Technologies Private Limited. During the year ended December 31, 2011, it organized TV Investment Holdings LLC, HCI Holdings LLC and HCI Technical Resources, Inc.

Lear Corporation is a tier 1 supplier to the global automotive industry. The Company supplies its products to automotive manufacturers with automotive seat systems and related components, as well as electrical distribution systems and related components. The Company has two segments: seating and electrical power management systems (EPMS). The seating segment includes seat systems and related components, such as seat frames, recliner mechanisms, seat tracks, seat trim covers, headrests and seat foam. The EPMS segment includes electrical distribution systems for traditional powertrain vehicles, as well as for hybrid and electric vehicles. As of December 31, 2011, it had 20 joint ventures located throughout Asia, as well as five in North America, two in Europe and Africa and one with operations in all three regions.

Western Digital Corporation (WD) is a provider of solutions for the collection, storage, management, protection and use of digital content, including audio and video. Its principal products are hard drives, which are devices that use one or more rotating magnetic disks (magnetic media) to store and allow access to data. Its hard drives are used in desktop and notebook computers, corporate and cloud computing data centers, home entertainment equipment and stand-alone consumer storage devices. In addition to hard drives, its other products include solid-state drives and home entertainment and networking products. Effective March 8, 2012, it acquired Viviti Technologies Ltd. In May 2012, the Company completed the divestiture of certain 3.5-inch hard drive assets to Toshiba Corporation. As part of its deal with Toshiba, WD also completed its purchase of Toshiba Storage Device (Thailand) Company Limited (TSDT), which manufactured hard drives.

Royal Dutch Shell plc (Shell) is an independent oil and gas company. The Company owns, directly or indirectly, investments in the numerous companies constituting Shell. Shell is engaged worldwide in the principal aspects of the oil and gas industry and also has interests in chemicals and other energy-related businesses. The Company operates in three segments: Upstream, Downstream and Corporate. Upstream combines the operating segments Upstream International and Upstream Americas, which are engaged in searching for and recovering crude oil and natural gas; the liquefaction and transportation of gas; the extraction of bitumen from oil sands that is converted into synthetic crude oil, and wind energy. Downstream is engaged in manufacturing; distribution and marketing activities for oil products and chemicals. Corporate represents the key support functions, comprising holdings and treasury, headquarters, central functions and Shells self-insurance activities.

Amtrust Financial Services, Inc. is a holding company. The Company is a multinational specialty property and casualty insurer focused on generating consistent underwriting profits. The Company operates in four segments: small commercial business, specialty program and personal lines reinsurance. In January 2013, the Company acquired First Nonprofit Companies, Inc. In February 2013, its subsidiary acquired Car Care Plan (Holdings) Limited from Ally Insurance Holdings, Inc. In April 2013, it acquired Sequoia Insurance Company and its subsidiaries, Sequoia Indemnity Company and Personal Express Insurance Company. In May 2013, the Company acquired Mutual Insurers Holding Company (MIHC) and MIHC's subsidiary, First Nonprofit Insurance Company.

HollyFrontier Corporation (HollyFrontier), formerly Holly Corporation, is a petroleum refiner, which produces light products, such as gasoline, diesel fuel, jet fuel, specialty lubricant products, and specialty and modified asphalt. HollyFrontier operates in two segments: Refining and Holly Energy Partners, L.P. (HEP). The Refining segment includes the operations of its El Dorado, Tulsa, Navajo, Cheyenne and Woods Cross Refineries and NK Asphalt. The HEP segment involves all of the operations of HEP. As of December 31, 2011, it operated five refineries having a combined crude oil processing capacity of 443,000 barrels per day that serve markets throughout the Mid-Continent, Southwest and Rocky Mountain regions of the United States. The Company merged with Frontier Oil Corporation (Frontier), on July 1, 2011. On November 9, 2011, HEP acquired from the Company certain tankage, loading rack and crude receiving assets located at its El Dorado and Cheyenne Refineries.

Chevron Corporation (Chevron) manages its investments in subsidiaries and affiliates and provides administrative, financial, management and technology support to the United States and international subsidiaries that engage in fully integrated petroleum operations, chemicals operations, mining activities, power generation and energy services. Upstream operations consist primarily of exploring for, developing and producing crude oil and natural gas; processing, transportation and regasification associated with liquefied natural gas; transporting crude oil by international oil export pipelines; transporting, storage and marketing of natural gas, and a gas-to-liquids project. Downstream operations consist primarily of refining crude oil into petroleum products; transporting crude oil and refined products by pipeline, marine vessel, motor equipment and rail car, and manufacturing and marketing of commodity petrochemicals, plastics for industrial uses and fuel and lubricant additives.

Williams-Sonoma, Inc. is a multi-channel specialty retailer of products for the home. The direct-to-customer segment of the Company's business sells its products through its six e-commerce Websites (williams-sonoma.com, potterybarn.com, potterybarnkids.com, pbteen.com, westelm.com and rejuvenation.com) and seven direct-mail catalogs (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Bed and Bath, PBteen, West Elm and Rejuvenation). Its e-commerce platform is available to customers in more than 75 countries, while its catalogs reach customers throughout the United States. The retail segment of its business sells products through its five retail store concepts (Williams-Sonoma, Pottery Barn, Pottery Barn Kids, West Elm and Rejuvenation). As of January 29, 2012, it operated 576 stores in 44 states, Washington, D.C., Canada and Puerto Rico. On November 1, 2011, the Company acquired Rejuvenation Inc.

Stamps.com Inc. is a provider of Internet-based postage solutions. The Company's customers use its service to mail and ship a variety of mail pieces, including postcards, envelopes, flats and packages, using a range of United States Postal Service (the USPS) mail classes, including First Class Mail, Priority Mail, Express Mail, Media Mail, Parcel Post, and others. Its customers include individuals, small businesses, home offices, medium-size businesses and enterprises.

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.