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Executive Summary April 11, 2014

The Economy

The U.S. economy is continuing to rebound from its winter slowdown, with good news coming in from the manufacturing, service, and employment arenas.

The private sector added 192,000 jobs in March, according to a new Labor Department report, and February's jobs-added number was revised upward by 26,000. The headline unemployment rate remained steady at 6.7%, while the broader "U-6" rate, which also includes part-time workers who want full-time work and discouraged workers who have given up looking for a job, rose just slightly by 0.1 percentage point, to 12.7%. The number of people not in the workforce declined by 331,000.

More encouraging signs on the jobs front: The Labor Department said job openings rose in February to their highest level since January 2008, and new claims for unemployment fell last week to their lowest level since May 2007. Continuing claims hit their lowest level since January 2008.

Good news also came from the manufacturing sector. The Institute for Supply Management's manufacturing index rose slightly in March, signaling that the sector expanded for the 10th straight month. The new orders sub-index also increased, the second straight month it has done so following a big drop in January. The production sub-index, which had fallen sharply in February, rebounded sharply in March to very healthy levels, another sign that weather may have been behind some of the weaker economic data we saw in early 2014.

The service sector, meanwhile, expanded for the 50th straight month in March, and it did so at an accelerating rate, according to ISM. The new orders sub-index also rose, and the employment sub-index, which had fallen sharply in February, rebounded strongly. ISM's survey did indicate a pretty significant uptick in prices. Manufacturing prices have been at an elevated level for the past few months, and with service sector prices rising, inflation may be something to keep an eye on.

New data also showed that personal income increased 0.3% in February, as did real disposable personal income. Real personal consumption expenditures rose 0.2%, which meant that the personal savings rate ticked upward by a percentage point, to 4.3%. That makes the second straight month that personal income and disposable personal income have made strong gains.

The housing market has continued to level off. The National Association of Realtors' Pending Home Sales Index fell slightly in February, according to a new report. That put pending home sales down a little more than 10% versus a year ago levels. Some have cited weather as a reason for the housing market's stalling momentum. Prices continue to rise, though, with the latest S&P/Case-Shiller Home Price Indices data showing that prices rose on average by 0.8% across 20 U.S. cities in January. Compared to a year earlier, prices were up more than 13%.

All in all, it has been an up-and-down fortnight for the market, particularly among smaller stocks and growth stocks. Since our last newsletter, the S&P 500 returned -0.9%, while the Hot List returned 0.2%. So far in 2014, the portfolio has returned -12.3% vs. -0.8% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 219.1% vs. the S&P's 83.2% gain.

Stalled Momentum

So far in 2014, the Hot List has been experiencing some major volatility, and over the past month or so most of that volatility has been on the downside. Investors have been ditching higher-growth, higher-momentum stocks at a pretty rapid clip -- in the past month, large growth, medium growth, and small growth are the bottom three on Morningstar's style box category returns, returning -5.1%, -6.0%, and -7.9%, respectively (as of April 9). Of the eight different types of stocks Morningstar tracks, aggressive growth and speculative growth are far and away the worst two performers over the last month, returning -5.1% and -9.8%, respectively.

Prior to that, these types of high-growth, high-momentum stocks had been surging. It appears that things got a bit frothy, at least in the minds of many investors, and thus we've seen a fairly steep pullback.

While my Guru Strategies collectively have a distinct value bias, some of the best performers over the long haul incorporate momentum metrics as well. My Motley Fool-based strategy and my James O'Shaughnessy-based growth model, for example, both look at 12-month relative strength -- that is, how a stock has performed compared to all other stocks in the market over the past year. As you may know, while all of my individual guru models contribute to the Hot List, the models with the best historical performance are weighted more heavily in assembling the portfolio. Both the Fool- and O'Shaughnessy-based models have been very good long-term performers, and thus make a strong contribution to the Hot List's holdings, which means that a number of the stocks in the portfolio usually have strong momentum. As of April 9, the portfolio had an average 12-month relative strength of 74, meaning that on average its holdings had beaten 74% of other stocks in the market over the past year.

Of course, I've often talked about the dangers of chasing hot stocks. That's why models like the Fool strategy and the O'Shaughnessy growth strategy employ a lot more than just momentum metrics. In fact both use very strong value criteria as well. The Fool model looks for stocks that have P/E-to-growth ratios less than 0.5 -- a very strict target. (My Peter Lynch-based model uses a target of 1.0, by comparison.) The O'Shaughnessy model, meanwhile, looks for stocks with price/sales ratios below 1.5. These models are thus looking for high-momentum stocks that are still cheap -- the best of both worlds. (In fact, O'Shaughnessy's research shows that throughout history, the combination of growth and momentum has been extremely successful.)

The mix of momentum and value in the Hot List is thus one reason that the portfolio has fared so well over the long haul. But at times when momentum stocks are getting hit hard, as they have been lately, investors can sometimes punish inexpensive, fundamentally sound high-momentum plays along with the speculative momentum stocks that likely to deserve to be taken down a notch. That seems to be what has happened lately. While the high-momentum stocks in the Hot List like Caesarstone, Lannett, and BofI certainly haven't been dirt cheap, the premiums they've been trading at have appeared to be well worth it given their growth. As of our last rebalancing, for example, BofI traded at a P/E-to-growth ratio just below 1.0 and Caesarstone's was around 0.5. Lannett's was quite high, around 5.6, but that's a bit skewed in light of the fact that its earnings are expected to quadruple in the current fiscal year, which ends June 30.

Several of the Hot List's new additions on today's rebalancing also have had strong momentum behind them; five of the seven newcomers have relative strengths above 70, with two at 80 or above. Should high-momentum stocks continue to get hit hard, that could of course mean more short-term underperformance for the portfolio. Of course, absolutely anything can happen in the short term, so we are certainly not going to alter our approach based on the recent momentum stock troubles. If anything, the fact that momentum stocks have gotten hit hard has made them -- particularly the fundamentally sound high-momentum stocks that the Hot List targets -- more attractive from a long-term perspective.

Take Dorman Products, which has a 12-month relative strength of 80 and is up about 15% since mid-January. Yes, it has good momentum, but it also has stellar fundamentals and financials -- no long-term debt, a 4.7 current ratio, 22% return on equity, 17.8% return on retained earnings over the past decade, and 0.89 PEG. In other words, this isn't a speculative, ride-the-wave stock; it's a strong company with good long-term prospects and reasonable valuation given its stellar growth history.

High-momentum stocks with those types of characteristics may get lumped in with more speculative, momentum-driven shares for short periods of time. But history shows that over the long term, these fundamentally sound stocks should deliver very good results. That's what we've seen with the Hot List and our individual momentum/value models over the years, and I expect that will continue to be the case over the long term.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 7 stocks leave our portfolio. These include: Lannett Company, Inc. (LCI), Coach, Inc. (COH), Drew Industries, Inc. (DW), Parexel International Corporation (PRXL), Caesarstone Sdot-yam Ltd (CSTE), Netease, Inc (Adr) (NTES) and Usana Health Sciences, Inc. (USNA).

The Keepers

3 stocks remain in the portfolio. They are: Agco Corporation (AGCO), Bofi Holding, Inc. (BOFI) and Hyster-yale Materials Handling Inc (HY).

The Newbies

We are adding 7 stocks to the portfolio. These include: Valero Energy Corporation (VLO), Cnooc Ltd (Adr) (CEO), Foot Locker, Inc. (FL), Smith & Wesson Holding Corp (SWHC), Dorman Products Inc. (DORM), Trueblue Inc (TBI) and Hollyfrontier Corp (HFC).

Portfolio Changes

Newcomers to the Validea Hot List

HollyFrontier Corp. (HFC): Formed when Holly Corp. merged with Frontier Oil in 2011, Dallas-based HollyFrontier ($10 billion market cap) is one of the U.S.'s largest independent petroleum refiners. It has operations in the Midwest, Southwestern, and Rocky Mountain regions, operating five complex refineries.

HollyFrontier gets strong interest from my Benjamin Graham-based strategy and high marks from my Peter Lynch- and Kenneth Fisher-based models. To read more about its fundamentals, scroll down to the "Detailed Stock Analysis" section below.

Valero Energy Corporation (VLO): This San Antonio-based oil refiner has taken in $138 billion in sales in the past year. It has 16 petroleum refineries, 10 ethanol plants, and a 50-megawatt wind farm among its assets.

Valero ($28 billion market cap) gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. For more on the stock, see the "Detailed Stock Analysis" section below.

TrueBlue Inc. (TBI): Tacoma, Wash.-based TrueBlue provides temporary blue-collar staffing services to a variety of industries, including construction, manufacturing, transportation, aviation, waste, hospitality, retail, and renewable energy. It operates about 700 branches in all 50 states, Puerto Rico and Canada, and has taken in about $1.7 billion in sales over the past 12 months.

TrueBlue ($1.2 billion market cap) gets strong interest from my Peter Lynch- and James O'Shaughnessy-based models. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

CNOOC Limited (CEO): This $73-billion-market-cap oil and natural gas operations giant (the Chinese National Offshore Oil Corporation) has taken in more than $40 billion in sales over the past 12 months. It gets strong interest from a trio of my models, those I base on the writings of David Dreman, Peter Lynch, and James O'Shaughnessy. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

Dorman Products (DORM): This Pennsylvania-based firm ($2.1 billion market cap) sells auto replacement parts and fasteners and products for the automotive aftermarket.

Dorman gets strong interest from my Peter Lynch- and Martin Zweig-based models, as well as my Momentum Investor approach. To read more about the stock, scroll down to the "Detailed Stock Analysis" section below.

Foot Locker (FL): This specialty athletic retailer operates nearly 3,500 stores in 23 countries in North America, Europe, Australia, and New Zealand, offering athletic footwear and apparel.

Foot Locker ($6.7 billion market cap) gets strong interest from my James O'Shaughnessy-based model. To read more about its fundamentals, check out the "Detailed Stock Analysis" section below.

Smith & Wesson Holding (SWHC): This Massachusetts-based company ($800 million market cap) makes firearms and firearm related products, including handguns, modern sporting rifles, hunting rifles, black powder firearms, and handcuffs. Its customers include collectors, hunters, competitive shooters, individuals desiring home and personal protection, law enforcement and security agencies and officers, and military agencies.

Smith & Wesson gets strong interest from my Peter Lynch- and Joel Greenblatt-based models. For more on its fundamentals, see the "Detailed Stock Analysis" section below.

News about Validea Hot List Stocks

USANA Health Sciences (USNA): USANA shares were up about 7% since our last newsletter as of mid-afternoon trading on April 10. The bounce may have been related to Barclays maintaining its outperform rating on Herbalife, whose similar business model has led the two stocks to often trade on each other's news. Some deterioration in USANA's fundamentals is leading the Hot List to sell the stock as part of today's rebalancing. The stock had a great run for the portfolio, gaining 135% since joining the Hot List last Dec. 21 (through April 9).

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

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

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

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

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

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

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

CNOOC Limited is an investment holding company. The Company, along with its subsidiaries, is a producer of offshore crude oil and natural gas and an independent oil and gas exploration and production company. Its subsidiaries are engaged in exploration, development, production and sales of oil and natural gas. It has three segments: independent operations, operations under joint arrangement and trading business. The Company has four producing areas in offshore China, which include the Bohai Bay, Western South China Sea, Eastern South China Sea and East China Sea. It also has oil and gas assets in Indonesia, Iraq, Australia, Africa, North America and South America. As of December 31, 2012, its subsidiaries included CNOOC China Limited, CNOOC International Limited, China Offshore Oil (Singapore) International Pte Ltd and others.

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

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

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

AGCO Corporation (AGCO) is a manufacturer and distributor of agricultural equipment and related replacement parts globally. The Company sells a range of agricultural equipment, including tractors, combines, self-propelled sprayers, hay tools, forage equipment and implements. It also manufactures and distributes grain storage and handling equipment systems, as well as protein production systems. Its products are recognized in the agricultural equipment industry and are marketed under a range of brands, including Challenger, Fendt, Massey Ferguson and Valtra. The Company distributes its products through a combination of approximately 3,100 independent dealers and distributors in more than 140 countries. In September 2013, Grain Systems, Inc. (GSI), a global brand of the Company announced that it has purchased Johnson System Inc. (JSI), manufacturer of catwalks, towers and support structures based in Marshall, Michigan.

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.

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