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Executive Summary September 27, 2013

The Economy

While some big macro factors -- the Federal Reserve's no-taper decision and the looming federal budget impasse -- have been pushing and pulling on investors' psyches, the U.S. economy has continued to perform fairly well in recent weeks.

Industrial production rose, for example, 0.4% in August, according to a new Federal Reserve report. The report showed that manufacturing output jumped 0.7%, the biggest increase since last December. Mining activity rose 0.3%, while utility output, which is very dependent on weather, fell 1.5%. Overall, the increase in industrial production was the biggest since February.

The housing market, meanwhile, continues to be a driving factor behind the economy. New home sales jumped 7.9% in August, according to the Commerce Department, putting them about 13% above where they stood last August. The median sales price was slightly higher than it was a year ago (+0.6%). Existing home prices jumped more, however, rising 1.7% during the month to reach their highest level in six-and-a-half years, according to the National Association of Realtors. Existing home sales now stand 10.5% above where they were a year ago, with median sale prices nearly 15% above their year-ago level.

Housing starts increased slightly in August, rising by about 1%, according to a new government report. That put them 17.7% above where they stood last August, showing strong year-over-year gains. Permit issuance for new construction was down 3.8%, but still remains 5.4% above its year-ago pace.

Consumer data has been decent. Retail and food service sales increased 0.2% in August, according to the Commerce Department. The increase was led by a nice jump in auto sales. Retail and food service sales are now 4.8% above where they stood a year ago. Inflation, meanwhile, lessened a bit in August, according to another government report. The Consumer Price Index rose just 0.1%, making for a year-over-year inflation rate of just 1.5%, down from the 2.0% figure we had seen in July. Core inflation, which takes out volatile food and energy prices, was also up 0.1%, and has risen 1.8% over the past year. Some speculated that the weak inflation numbers were one reason behind the Federal Reserve's decision not to start tapering its giant asset purchasing plans.

Another major macro event on investors' minds that may well have impacted the no-taper decision: the looming federal budget standoff between Republicans and Democrats. In remarks that followed the Fed's decision not to taper, Fed Chairman Ben Bernanke spoke a good deal on the dangers involved if a budget standoff shuts down the government. I would say that hopefully we'll see some sort of resolution, but given our legislators' track records, I wouldn't count on it. That could make for some short-term bumps for the stock market, though it shouldn't affect one's long-term investing strategy.

All in all, these issues have made for an up-and-down fortnight for the stock market. Since our last newsletter, the S&P 500 returned 0.9%, while the Hot List returned 4.1%. So far in 2013, the portfolio has returned 31.0% vs. 19.1% for the S&P. Since its inception in July 2003, the Hot List is far outpacing the index, having gained 255.3% vs. the S&P's 69.8% gain.

The Ever-Present "Stock-Picker's Market"

Since the 2008 financial crisis, one of the main investing themes you've probably heard is that of high correlations. Many have talked about the "risk-on, risk-off" environment that has existed, one in which stocks (and a number of other assets) tend to rise and fall en masse based on macroeconomic news. The presumption is that in such an environment, stock-picking isn't particularly useful. The trick is less about picking the right stocks than it is about picking the right time to be in the market and the right time to be out, the conventional wisdom goes.

At first glance, then, it seemed like very good news when correlations dropped sharply last month. As The Wall Street Journal noted, correlation among the 10 large-cap sectors in the S&P 500 fell to 69.9%, the lowest level in two years. The figure had been at nearly 90% a month earlier. Stock-picking, it seemed, was back in focus, and those who focused on fundamentals could well reap the rewards -- for now, at least. I say for now because, with macro factors like the Federal Reserve's tapering plans and Washington's budget impasse looming, it would also seem that a return to a high-correlation environment might not be too far away.

But while the talk of "stock-picker's markets" (or lack thereof) has been prominent over the past several years (I myself have brought up the issue in the past), it's a bit of a fallacy. That's because the truth is that it's always a stock-picker's market. "The problem," Investment News' Jason Kephart recently explained, "is that correlation, which measures how stocks move in relation to each other, doesn't actually tell you anything about the opportunities available to portfolio managers. Even though correlations between stocks historically have been high, meaning stocks generally have moved in one direction -- up -- since the market bottomed, that doesn't mean they're moving [up] at the same speed."

According to Kephart (citing Vanguard Group data), in every year since 2008, more than half the stocks in the S&P 500 have finished the year with a return either 10% greater or 10% lower than the index. This year (through Aug. 19), 262 of the S&P's 500 firms had returned 10% more or less than the index. That means that, while correlations have been high, there has been -- and continues to be -- plenty of opportunity for stock-pickers to distinguish themselves from the crowd.

Keep in mind, however, that distinguishing yourself from the crowd means you have to be willing to go through some periods when your returns vary significantly from the market -- on the downside. No one beats the market every month, or quarter, or even every year. That's because while you may be able to find undervalued stocks, you never know exactly how long they'll stay undervalued. Sometimes you can get lucky, and an attractively valued stock you buy will jump the week you buy it; other times, it can take months for investors to come around to recognizing the value in the stock. Still other times, they may never come around.

More often than not, however, they do come around -- you just have to stay disciplined. It can be painstaking sometimes, to watch as your portfolio takes short-term hits. But all of the gurus I follow have experienced that. And they've succeeded over the long haul by staying disciplined and sticking to their strategies during these short-term troubles. Mutual fund legend Peter Lynch, for example, was hit hard by the 1980-82 bear market, with his Magellan Fund losing 22.6% -- more than four times the S&P 500's loss -- in 1981. At times during the rough 1973-74 bear market, both Warren Buffett and John Neff took a pounding. Neff's fund lost 25% in '73 when the S&P was down 14.7%; Buffett lost 43.7% in '74 when the index fell 26.4%.

It wasn't just during bear markets that the gurus had down years. In 1989, in the middle of a lengthy bull market, the S&P gained 31.7%. Neff, however, gained just 15.0%. Martin Zweig's fund lagged by nine percentage points that year, while Lynch's Magellan lagged by nearly 8 points. In 1995, when the S&P surged 37.6%, Zweig's fund lagged by nearly 20 percentage points. Then there was the tech bubble, when value-oriented investors like Buffett had downright awful years even though the broader market surged. In 1999, when the S&P was up 21%, Buffett was down nearly 20%.

While it's been on the winning side more than the losing side, the Hot List has also had some flat-out bad years. In 2007 it lost 11.6% while the S&P rose 3.5%. In 2011, it lost 16.2% while the index was flat. But despite those hiccups, it has performed remarkably well over the long term. If you'd invested $10,000 in the Hot List on its July 15, 2003 inception, you'd have $34,850 today. The same investment in the S&P 500? You'd have less than half of that, $17,010 (both figures are through last week, not including dividends). The gap hasn't changed since the "lock-step" environment supposedly began in 2008. Since the start of that year, the Hot List is up 38.3%, while the S&P is up just 15.9%. Clearly, some stocks have been better than others -- a lot better -- despite the high-correlation environment.

The bottom line is that it's always a stock-picker's market. Yes, the general direction (up or down) of stocks may be highly correlated at times, but the degree to which individual stocks rise or fall will vary significantly. The things you need to do to be a good stock-picker -- use a fundamental-focused approach, stay disciplined, think long-term -- are thus always important. Lose sight of them for even just a bit, and the market will very likely make you wish you hadn't.

Editor-in-Chief: John Reese

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The Fallen

As we rebalance the Validea Hot List, 3 stocks leave our portfolio. These include: Joy Global Inc. (JOY), Jpmorgan Chase & Co (JPM) and Ross Stores, Inc. (ROST).

The Keepers

7 stocks remain in the portfolio. They are: Usana Health Sciences, Inc. (USNA), Stamps.com Inc. (STMP), Amtrust Financial Services, Inc. (AFSI), Bridgepoint Education Inc (BPI), Lear Corporation (LEA), Hollyfrontier Corp (HFC) and Hci Group Inc (HCI).

The Newbies

We are adding 3 stocks to the portfolio. These include: The Tjx Companies, Inc. (TJX), Lukoil (Adr) (LUKOY) and Hibbett Sports, Inc. (HIBB).

Portfolio Changes

Newcomers to the Validea Hot List

The TJX Companies (TJX): The parent of Marshalls, T.J. Maxx, and HomeGoods, this frequent Hot List favorite offers brand-named clothing and merchandise at discount prices -- making it attractive when times are good or bad. The $40-billion-market-cap firm has taken in about $27 billion in sales in the past year.

TJX gets approval from my Peter Lynch- and Warren Buffett-based models. To read more about the stock, scroll down to the "Detailed Stock Analysis" section below.

Lukoil OAO (LUKOY): Another past Hot List favorite, Russia-based Lukoil ($55 billion market cap) is the world's largest privately owned oil and gas company based on proved oil reserves, and is responsible for about 17% of Russian crude oil production. Its products are sold in Russia and former USSR republics, as well as Europe, Asia, and the U.S.

Lukoil gets approval from my James O'Shaughnessy- and Peter Lynch-based models. To read more about it, check out the "Detailed Stock Analysis" section below.

Hibbett Sports (HIBB): This Alabama-based sporting goods retailer is also no stranger to the Hot List, having appeared earlier this year. It focuses on small and mid-sized markets, mostly in the South, Southwest, Mid-Atlantic and Midwest. It has about 850 retail stores across 26 states, mostly under the Hibbett Sports name but with some also under the Sports Additions and Sports & Co. names.

Hibbett gets strong interest from my Warren Buffett- and Peter Lynch-based models and high marks from some other strategies as well. To read more about it, scroll down to the "Detailed Stock Analysis" section.

News about Validea Hot List Stocks

JPMorgan Chase & Co. (JPM): Chase expanded its settlement talks with the Justice Department regarding a number of federal probes into the financial firm,The Wall Street Journal reported on Sept. 24. Chase has offered to pay about $3 billion to resolve the investigations, the Journal reported, but the Justice Department maintains the dollar amount should be much higher. The Hot List is selling the stock on today's rebalancing, as its Guru Strategy scores have been surpassed by those of other stocks.

AmTrust Financial Services (AFSI): AmTrust announced on Sept. 18 that it has reached an agreement to buy The Insco Dico Group for approximately $85 million. The company said the acquisition is to be funded through existing working capital, and should close within the next six months pending regulatory approval. Insco Dico's subsidiaries include Developers Surety and Indemnity Company and Indemnity Company of California, which offer surety insurance to developers and contractors in all 50 states with California as the largest state. Another Insco Dico subsidiary, Builders Insurance Services, markets general liability insurance policies to contractors in several western states.

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   |   BPI   |   HCI   |   STMP   |   LUKOY   |   LEA   |   AFSI   |   HFC   |   TJX   |   HIBB   |  

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.

Bridgepoint Education, Inc. (Bridgepoint) is a provider of postsecondary education services. The Company's academic institutions include Ashford University and University of the Rockies. Its institutions deliver programs primarily online, as well as at their traditional campuses. As of December 31, 2011, the Company had 86,642 total students enrolled in its institutions. Bridgepoint's institutions conduct ongoing faculty and student assessment processes and provide a range of student services. The Company is also focused on developing new technologies, such as through Waypoint Outcomes, Constellation, and the development of its institutions' mobile learning platforms. The Company has developed Constellation to replace third party textbooks with digital course materials. Constellation materials are displayed in a browser-based platform. In January 2012, Bridgepoint introduced Thuze.

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.

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.

NK Lukoil OAO (Neftyanaya Kompaniya LUKOIL OAO or NK LUKOIL OJSC) is a Russia-based integrated oil and gas company. The Company is engaged in the business of oil exploration, production, refining, marketing and distribution. It is an owner of refineries, gas processing, petrochemical plants and gas stations network located in Russia, Eastern and Western Europe, as well as Africa. The Company's petroleum products are sold in the Russian Federation, the Commonwealth of Independent States (CIS) countries, Eastern and Western Europe, Asia and the United States. NK Lukoil OAO operates through numerous subsidiaries and affiliated companies. In April 2013, the Company acquired a 100% of Samara-Nafta ZAO and completed acquisition of CJSC Kama-Oil. In June 2013, it sold a 99.57% stake in Lukoil Odes'kyi NPZ PAT. The Company's major shareholder is NKO ZAO NRD with a stake of 91.60%.

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.

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.

The TJX Companies, Inc. (TJX) is the off-price apparel and home fashions retailer in the United States and worldwide. As of January 28, 2012, the Company operated in four business segments. It has two segments in the United States, Marmaxx (T.J. Maxx and Marshalls) and HomeGoods; one in Canada, TJX Canada (Winners, Marshalls and HomeSense) and one in Europe, TJX Europe (T.K. Maxx and HomeSense). As a result of the consolidation of the A.J. Wright chain, all A.J. Wright stores ceased operations by the end of February 2011. It completed the consolidation of A.J. Wright, converting 90 of the A.J. Wright stores to T.J. Maxx, Marshalls or HomeGoods banners and closed the remaining 72 stores, two distribution centers and home office. In December 2012, the Company acquired Sierra Trading Post, an off-price Internet retailer.

Hibbett Sports, Inc. is an operator of sporting goods retail stores in small to mid-sized markets predominately in the Southeast, Southwest, Mid-Atlantic and Midwest regions of the United States. The Company offers a range of athletic equipment, footwear and apparel. Its stores concepts are Hibbett Sports, Sports Additions, Sports & Co. and Hibbett Team Sales, Inc. As of January 28, 2012, it operated 832 stores in 26 states, which consisted of 812 Hibbett Sports stores, as well as 19 smaller-format Sports Additions athletic shoe stores and one larger-format Sports & Co. superstore. Of 832 stores, 203 were located in enclosed malls and 629 are located in strip-shopping centers. During the fiscal year ended January 28, 2012 (fiscal 2012), it opened 49 Hibbett Sports stores and three Sports Addition stores while closing 17 Hibbett Sports stores and one Sports & Co. stores. In fiscal 2012, it expanded or remodeled 18 stores and converted one Sports & Co. store to a Hibbett Sports store.

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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